Alaric Compliance Alert: Avoiding the Gift of Inside Information
‘Tis the Season to Shun the Gift of Inside Information as U.S. Supreme Court Upholds Broad Definition of Insider Trading Malfeasance
In December, the U.S. Supreme Court issued a unanimous decision in Salman v. United States, the first insider trading case to come before the nation’s highest court in more than two decades.
The Salman case affirms the precedent set forth in Dirks vs. SEC, the 1983 case that established the illegality of family and friends profiting from the disclosure of nonpublic material information even in the absence of a pecuniary or other personal benefit to the tipper.
In 2015, the Securities and Exchange Commission (SEC) announced a final judgment and permanent injunction in the civil case against Salman’s future brother-in-law Maher Kara. Kara, a former director in Citigroup Global Markets’ investment banking division in New York, tipped off Salman in advance of numerous Citigroup healthcare deals. The brother then tipped off a network of friends and family who, in turn, traded on the leaked information.
Section 204A of the Investment Advisers Act of 1940 requires advisers to establish policies and procedures to prevent the misuse of material, nonpublic information while SEC Rule 10b5-1 was introduced in 2000 to address the selective disclosure of material nonpublic information to thwart insider trading. Federal securities law prohibits trading by an insider in possession of material nonpublic information, as well as trading by a non-insider in possession of material nonpublic information where that information was improperly disclosed to the non-insider.
The December ruling does leave in question the gray area of “information gift-giving” among acquaintances, as opposed to family and close friends. But central to both the Salman and Dirk cases is the controversy surrounding what constitutes improper disclosure, and the degree of criminal liability if the tipper is not compensated monetarily.
In 2014, United States v. Newman reversed convictions against hedge fund manager Todd Newman to find that prosecutors must prove that a trader knows a tipper has received something of value in exchange for inside information. After that ruling, which was decided in the U.S. Court of Appeals for the Second Circuit, numerous defendants escaped findings of criminal liability due to this higher threshold of evidence required.1
The new ruling effectively overturns Newman by holding that tippers need not receive anything of pecuniary value in order for their actions to be illegal. The Court explained that when a tipper discloses information to a friend or relative, he or she is able to achieve the same result of reaping illicit gains without necessarily getting their own hands dirty.
Justice Samuel Alito expressed his opinion to the court that a tipper need not receive money or tangible property to be criminally liable. On the contrary, “Making a gift of inside information to a relative… is little different from trading on the information, obtaining the profits, and doling them out to the trading relative. The tipper benefits either way.”2 Justices also made the argument that helping a family member, for many people, is like helping oneself.3
Clients are encouraged to exercise the same if not greater care to ensure compliant trading activities and to safeguard nonpublic information. Moreover, clients can expect an increase in insider trading enforcement actions given that regulators no longer need to prove that a tipper shared information in order to receive a direct, indirect or potential personal gain.
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