Let’s say you’ve got a friend, a friend who works as an investment banker, and he gifts you with some inside information. Not for any compensation, just because he wants you to make some bacon, and you make $1.5 million on the trade. Is that cool?
Believe it or not, it used to be. But it’s not any more. The United States Supreme Court just decided that the free gift of inside information is illegal for you to trade on.
The questions before the court was, if the person passing along the inside information isn’t paid or compensated for gifting you with it, how can that be a crime? And, if the person acting on the tip doesn’t know the tipster is breaking some fiduciary duty they have, how can the person who makes a trade on that information be committing a crime?
Those questions were answered previously by a New York Appellate Court in the negative- no, it wasn’t a crime.
So what happened?
Determining the Value of Inside Information
Prosecutors in California had charged one-time Chicago grocery wholesaler Bassam Yacoub Salman with one count of conspiracy to commit securities fraud and four counts of securities fraud, alleging Salman earned $1.5 million trading on inside information.
On September 1, 2011, Salman was convicted on all counts in the United States District Court for the Northern District of California.
The government said the tips Salman got originated with Maher Kara, then a Citigroup investment banker who gave the information to his brother, who in turn passed it on to his brother-in-law, Salman.
Salman appealed, to no avail. Then, another case came up on appeal that gave Salman’s attorneys hope.
In 2014, The United States Court of Appeals for the Second Circuit vacated the insider-trading convictions of two individuals on the ground that the Government had failed to present sufficient evidence that they knew the information they received had been disclosed in breach of a fiduciary duty.
…we conclude that, in order to sustain a conviction for insider trading, the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit. Moreover, we hold that the evidence was insufficient to sustain a guilty verdict against Newman and Chiasson for two reasons. First, the Government’s evidence of any personal benefit received by the alleged insiders was insufficient to establish the tipper liability from which defendants’ purported tippee liability would derive. Second, even assuming that the scant evidence offered on the issue of personal benefit was sufficient, which we conclude it was not, the Government presented no evidence that Newman and Chiasson knew that they were trading on information obtained from insiders in violation of those insiders’ fiduciary duties. Accordingly, we reverse the convictions of Newman and Chiasson on all counts and remand with instructions to dismiss the indictment as it pertains to them with prejudice.”
While Federal securities fraud statutes don’t specifically mention insider trading, in 1983 the Supreme Court said prosecutions could be based on an insider’s breach of a duty to the company’s shareholders. The ruling, known as Dirks v. SEC, also said the insider had to receive a “personal benefit” from the disclosure.
The 2014 Todd Newman and Anthony Chiasson appeals victory in effect established new requirements for insider trading cases. First, “the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit.” Second, those acting on a tip had to know they “were trading on information obtained from insiders in violation of those insiders’ fiduciary duties.”
Salman’s attorneys used the new benchmarks to take their case to the Supreme Court.
SCOTUS’s Ruling Toughened Insider Trading Rules
The High Court’s ruling, handed down earlier this week, affirmed Salman’s conviction, and in doing so resolved questions that had divided federal appeals courts.
The ruling, more importantly, restored prosecutorial and SEC powers lost in 2014 when the New York Appellate Court established new requirements for insider-trading cases.
The Supreme Court didn’t center on Salman’s conduct, instead it zeroed in on the tipster’s motivations.
Justice Samuel Alito wrote, “By disclosing confidential information as a gift to his brother with the expectation that he would trade on it, Maher breached his duty of trust and confidence to Citigroup and its clients.”
Essentially, the Supreme Court rejected the New York court’s suggestion that a tipster must “receive something of a “pecuniary or similarly valuable nature in exchange for a gift to family or friend.”
Preet Bharara, the U.S. Attorney for the Southern District of New York and the toughest cop on the Wall Street beat said, “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, today’s decision is a victory for fair markets and those who believe that the system should not be rigged.”
So, if you’ve got a Bad Santa trying to be good to you this Christmas and gift you with some unwrapped inside information, you might want to come up with another wish.