Wednesday, January 18, 2017

U.S. Supreme Court Clarifies Insider Trading Rules

The U.S. Supreme Court recently ruled in the case of Salman v. United States, 137 S.Ct. 420 (2016), that an insider may not avoid securities liability for insider trading by tipping inside information to the insider's family member or friend who trade shares of stock rather than the insider trading in the shares directly.

This result seems obvious - why should an insider who is prohibited from trading on insider information under federal securities laws - who is also restricted from selling the information by those same laws - nonetheless be permitted to gift that same information to the insider's family member or friend and permit that relative or friend to be unjustly enriched by trading on that same inside information?

The U.S. Supreme Court was forced to weigh in on this issue because the Second Circuit Court of Appeals had previously ruled that a jury could not infer that the tipper received a personal benefit from tipping confidential information to a family member or friend without proof of a gain to the tipper of a "pecuniary or similar valuable nature." And if the tipper did not receive any personal benefit from the tip, the tipper could not be guilty of insider trading.    

Insider Trading Law Background:

Insider trading is prohibited by Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated by the Securities and Exchange Commission (SEC) thereunder. Rule 10b-5 makes it unlawful for anyone to, among other things, "engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security."

The U.S. Supreme Court had previously interpreted that language of Rule 10b-5 to prohibit any person in a position of trust and confidence with regard to a public company (such as an officer, director, attorney, accountant, or other insider)(an "insider") from trading on confidential information for the benefit of the insider. Importantly, an insider could not be liable for tipping inside information unless the tipper breached a fiduciary duty by disclosing confidential information for a personal benefit. Supreme Court case law precedent had asked courts to consider "whether the insider receives a direct or indirect personal benefit from the disclosure." Without such personal benefit,there was no breach of fiduciary duty, and thus no fraud or deceit within the meaning of Rule 10b-5, and no liability for insider trading. If the tipper has a duty not to trade on inside information, a person who knowingly receives such information in violation of the tipper's duty of confidentiality (a "tippee") has the same duty as the tipper to refrain from trading on that inside information.

So the key issue in the Salman case was whether or not is would be appropriate for a jury to just assume that an insider is receiving a personal benefit when the insider tips confidential inside information to the insider's family member or friend - or must the party alleging insider trading bring forth further evidence demonstrating such personal benefit - such as the tipper's receipt of cash, property, or other item of tangible value as a result of the tip?

As the Salman Court explained, a tip by an insider as a gift to a family member or friend is no different than an insider trade by the insider followed by a gift of the proceeds of the trade. Accordingly, once it is established that the tippee is a relative or a close friend, it is unnecessary to show any tangible reward to the tipper to find the tipper guilty of insider trading.

This result was so obvious that the Court unanimously agreed with the opinion.

1 comment:

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