This article was originally published by Enforcd EDB, a regulatory intelligence service for financial services firms in the UK and beyond, on 18 October 2016. As it is a subscription service, the full text of the article is extracted below.

US Supreme Court continues to refine scope of insider trading laws

Last week, the United States Supreme Court heard oral arguments in an eagerly-awaited insider trading case, Salman v United States. This case highlights the problems in the legal framework for prosecuting insider trading in the US and provides a particularly useful point of comparison with the position in the UK and Europe.

The back-and-forth between members of the Court and counsel for both the defendant and the Government revealed that the laws criminalising insider trading in the US remain unclear, particularly for those who receive inside information from insiders indirectly.

The US position on insider trading

The issue in the Salman case arises because the US does not have an express legislative prohibition on insider trading. Insider trading cases are prosecuted on the basis that the person committed a fraudulent or deceitful act in connection with buying or selling a security.[1]

US courts accept that trading by an “insider” on information intended to be used for a corporate purpose, rather than a personal benefit, constitutes a criminal non-disclosure to a prospective purchaser or seller. In 1961, the Securities and Exchange Commission (“SEC“) stated that such insiders owe a duty not to trade on that information “lest the uninformed be exploited“.[2]

The piecemeal development of the US system, by contast to the UK approach, has produced peculiar features. For example, the courts in the US have wrestled for decades with the issue of extending liability to “outsiders” (people who received “tip-offs” from “insiders“). Criminal liability has been extended to outsiders by suggesting that the outsider is also committing a fraud if the outsider is aware that the insider breached his/her duty when disclosing the information. In order for the insider to be breaching his/her duty, the information must be passed on for the insider’s personal benefit.

Personal benefit

This has led to a number of cases where outsiders have argued that the insider did not intend to personally benefit. In 1983, an outsider escaped liability by arguing that the insider had not released the information for his personal benefit, but rather had been trying to expose a fraud by an issuer of the security.[3]

However, prosecutors have successfully argued that intangible benefits can suffice to establish liability. As a result, courts have accepted that the giving of the information for free can be intended as a gift and that gifts can provide indirect benefits, such as a “reputational benefit” that will translate into future earnings.[4]

Gifts to family and close friends

The issue for the Supreme Court in the Salman case is whether the giving of a gift to a family member is enough to establish, by itself, that the insider received a personal benefit. In this case, the insider passed information to his brother, who passed it to his brother-in-law, Salman. The Court of Appeals below (the Ninth Circuit) found that even though the insider did not receive a monetary benefit, the giving of a gift to a family member provides a number of benefits to the giver.

However, in 2015, the Supreme Court declined to hear an appeal of a decision by the Second Circuit Court of Appeal in United States v Newman.[5] In Newman, the Second Circuit stated that more proof was required than simply establishing that there was a close relationship between the insider and outsider.

Next step for insider trading in the US

Academics[6] and professionals[7] appear to agree that Mr Salman’s conviction will be maintained.

The uncertainty surrounding this case is whether the Court will take up the Government’s invitation to re-cast insider trading laws more broadly, to remove the need to establish a personal benefit to the insider. The Government proposed that the requirement to establish the fraud should merely be that the insider passed on the information with knowledge that it would be traded on. This would bring the law closer to the position in the UK, which prohibits disclosure of the information otherwise than in the normal exercise of an employment, a profession or duties.[8] However, the justices were uneasy with this suggestion, including Justice Sotomayor who said “Mr Dreeben, I think you’re taking this way out of existing law“.[9]

As a result, it appears likely that the Salman case will confirm that the passing of information to a family member (for a non-corporate purpose) will be sufficient to establish that the insider and the first outsider were engaging in fraud. Any person after the first outsider who receives that information with knowledge that the initial exchange of information was to a family member could similarly be liable.

However, this will not resolve the multitude of other possibilities involving the passing of information to non-family members.

Worth remembering

1. Under US law, passing inside information to relatives (for a non-corporate purpose) is likely to remain sufficient to establish criminal liability for both the insider and the outsider, even without any tangible benefit being provided in return.
2. If you receive inside information that you know was originally passed from an insider to the insider’s relative, you may commit an offence by trading on that information.
3. If the information was originally passed to a friend or business associate, the issue is more complicated and will somewhat depend on the purpose for passing on the information.
4. In the UK, Europe[10] and a number of other countries (including Australia[11]), these issues do not arise. With some slight differences, the laws in those countries specifically provide that any person with inside information that deals with the security (who knows or ought to know that the information is not generally available) can be liable for an offence. There is no requirement to establish that the insider received or intended to receive a personal benefit. As mentioned, there are also separate laws prohibiting insiders from passing on inside information (“tipping“) to others.

Authors

Hannah Laming – Partner

1. [1] https://www.sec.gov/news/speech/speecharchive/1998/spch221.htm
2. [2] See also the Supreme Court’s decision in the United States v O’Hagan, 117 S. Ct. 2199 (1997) at 2210 for a further explanation of the rationale for prohibiting insider trading.
3. [3] Dirks v SEC, 463 U.S. 646 (1983).
4. [4] Ibid.
5. [5] 773 F.3d 438 (2014)
6. [6] https://www.stanfordlawreview.org/online/salman-v-united-states-insider-tradings-tipping-point/
7. [7] See, for example, http://www.jdsupra.com/legalnews/supreme-court-likely-to-affirm-insider-45845/
8. [8] Article 10 of Regulation No 598/2014 on Market Abuse (“the Market Abuse Regulation”).
9. [9] https://www.supremecourt.gov/oral_arguments/argument_transcripts/2016/15-628_p86a.pdf, p44-45.
10. [10] http://www.pinsentmasons.com/PDF/2016/Market-Abuse-Regulation.pdf
11. [11] http://www.findlaw.com.au/articles/5840/insider-trading-is-easier-to-get-away-with-in-the-.aspx