USA, December 13, 2016
The Supreme Court’s ruling on insider trading last week ends two years of enforcement uncertainty. The unanimous decision left no doubt that stock tipping by insiders can be a criminal offense — although questions remain about the status of “downstream tippees” who are several steps removed from the source of leaks.
For compliance teams, the ruling means there will be a need to follow up on suspicious trading activity that take place inside their firms. Regardless of the shifts in the legal landscape, targets of insider investigations will be pressured to know whether trading relied on tainted information.
“The basic law has been reaffirmed and clarified. In order for insider trading to be proven, prosecutors have got to show that the tippees' information came from an insider,” said Thomas Gorman of Dorsey and Whitney “In those downstream cases, and in the downstream cases the U.S. attorneys will have to work real hard to show the evidence that proves it.”
The story of the court decision this week began with the Newman case, a 2013 conviction of two traders, Todd Newman and Anthony Chiasson, who profited from receiving privileged information and were charged with having made millions of dollars on the illegal tips.
The two men appealed, and a U.S. appeals court in 2014 overturned their convictions on the grounds that they were too far removed from the original sources of the information to have known whether the tippers received any personal benefit from the leaks. The decision stunned the legal community and prosecutors complained that the ruling would make it virtually impossible to bring insider charges and a number of related and similar cases fell apart.
The Supreme Court turned down a subsequent request by federal prosecutors to review the Newman case, casting doubt over the enforcement of existing insider trading law. But the the high court later took up an unrelated case in which a Chicago man, Bassam Salman, was convicted of making $1.2 million by trading on non-public information that came from his brother-in-law at Citigroup.
The Salman’s attorneys sought to use the overturning of the Newman case as the basis for their appeal. In this week’s 8-0 decision, the court sided with prosecutors in refusing to overturn the insider trading conviction.
INSIDER TRADING: ILLEGAL AS EVER
The ruling this week marked the first time in two decades that the Supreme Court weighed in on an insider trading case. The court broke no new ground, but made clear that illegal action can take place even if no money has changed hands. It cited the landmark 1983 Supreme Court case of Dirks v. SEC and said information alone can be an exchange that represents at least a potential gain of something of value.
What the Supreme Court ruling did do was redraw the same bright line that had long existed in defining illegal insider trading: When someone knowingly trades on non-public information held by a company insider or fiduciary, that person has broken the law and is liable to prosecution.
“A tippee who receives such information with the knowledge that its disclosure breached the tipper’s duty acquires that duty and may be liable for securities fraud for any undisclosed trading on the information,” the court said in its ruling.
COURT STEPS IN
Since there is no insider trading law, per se, the law’s enforcement is defined by case law. The court acknowledged that the Newman reversal threw all insider investigations into doubt. It said it wanted to “resolve tensions” raised by the Newman case, which Salman used as the basis for an appeal.
Insider trading case law became stretched, legal experts says, as more sophisticated investigative tools began yielding trading patterns involving people far removed from the source of information. A string of wins by prosecutor Preet Bharara, the head of the busy South Manhattan U.S. District, ended with the Newman case being overturned.
Bharara, was quick to applaud the ruling as "a victory for fair markets and those who believe that the system should not be rigged.”
Bharara added that "the court stood up for common sense and affirmed what we have been arguing from the outset - that the law absolutely prohibits insiders from advantaging their friends and relatives at the expense of the trading public."
The prosecutor steered clear of any mention of the Newman case, and the “downstream tippees.” For securities firms and compliance, those are the cases that could be most relevant. In its decision, the court said that prosecutors may well go ahead with such investigations, but they will need to prove that there is a direct line linking “lucky trades” to insider information. The “facts and circumstances” need to be proved “beyond a reasonable doubt” in each instance.
With the new ruling, prosecutors are certain to continue to follow up on the suspicious trading patterns, knowing that circumstantial evidence is not enough to convict, even with the overwhelming amount that can be generated by use of big data and analytics. Compliance will need to watch those same patterns and correlate them to relationships involving those who are involved with trading and brokerage.
For securities firms, a broker sharing a tip with a trader might be giving something just as good as a cash payment and this alone might suffice to make an insider trading case stick. On the other hand, the Dirks decision was written to offer "clear guidance to industry professionals" such as securities analysts "to avoid chilling their communications with company management, " said Brad S. Karp, Paul, Weiss, Rifkind, Wharton & Garrison LLP, in a Harvard Law School Forum blog published Friday.
Regulation FD (Fair Disclosure) has mandated that when a public disclosure is made to an exclusive audience "the issuer must make public disclosure of that information." Legal experts advise handling all such contacts with caution and keeping complete records to protect their firm. This kind of situation also remains murky, however, since the Court did not directly address the sharing of material nonpublic information.
Enforcement issues, however, have been largely settled for now, although without specific insider trading laws courts are likely to see jury trials, and potentially more appeals, which could result in more conflicting rulings.
“The court did a god job of clarifying the law ... There will be other cases on the edges and some of those will end up back in the courts,” said Gorman. “But the Supreme Court will not take another case for a while. They will just sit back and let this percolate and if there is a split in appeals courts they might wade back in.”
Prosecutors were holding off on pressing a case against hedge fund billionaire Leon Cooperman, whom the Securities and Exchange Commission has already charged, while criminal investigators waited for the result of the Salman case to consider options. That case relies heavily on downstream tips.
The court acknowledged the lingering uncertainty surrounding insider cases in general, but said “there is no need for us to address those difficult cases today.” A lawyer closely involved with the Newman case said prosecutors again have “the building blocks” to take on insider trading. Bharara himself will have chances to define future enforcement. After meeting recently with president-elect Donald Trump, Bharara decided to stay on as the head of the busy New York U.S. Attorney’s office.