Why it matters: On October 5, 2016, the Supreme Court heard oral argument in Salman v. United States, where the central issue was what the government needs to prove to establish a “personal benefit” to the insider tipper—one of the elements of insider trading liability. The government, relying on the 1983 Supreme Court case of Dirks v. SEC, argued that a personal benefit need not be something tangible and can be inferred if the insider and the tippee share a close family relationship and the information is relayed as a “gift.” By contrast, the petitioner argued that the personal benefit received by the insider must be financial or something of similar value that is “tangible” and “concrete,” as the Second Circuit held in 2014 in United States v. Newman. The Justices will now decide. Based on the tenor of their questioning, while the Justices may add more guidance to the “personal benefit” test set forth in Dirks, they will most likely uphold Salman’s conviction and don’t appear inclined to make any major changes to the insider trading laws that have been in effect for over three decades.
Detailed discussion: On October 5, 2016, the Supreme Court heard oral argument in Salman v. United States on the issue of what the government needs to prove to establish a “personal benefit” to the insider tipper. This was the first time that the Supreme Court had agreed to hear a case on insider trading liability since its seminal 1983 decision in Dirks v. SEC.
Review: Salman, Newman and Dirks
We covered the Ninth Circuit’s July 6, 2015, opinion in this case in our August 2015 newsletter under “Are the Circuits A-Splitting? The Ninth Circuit Declines to Follow the Second Circuit’s Insider Trading Decision in U.S. v. Newman.” To briefly review the facts and procedural history of the case, Salman involved a complicated insider trading scheme involving members of petitioner Bassam Yacoub Salman’s extended family. At trial, the government introduced facts showing that Salman had received insider information involving upcoming mergers and acquisitions of an international investment bank’s clients from his brother-in-law (via marriage to his sister) Michael Kara (Kara Brother #2). Kara Brother #2 had learned the information from his brother, Mahar Kara (Kara Brother #1), who worked in the bank’s healthcare investment banking group. Salman then shared the insider information he learned from Kara Brother #2 with the husband of his wife’s sister, with whom he split the illicit profits. Of particular relevance on appeal was evidence presented by the government at trial that showed that Salman was “well aware” both that Kara Brother #1 was the source of the insider information and that Kara Brother #1 and Kara Brother #2 shared an extremely “close fraternal relationship” that was “mutually beneficial.”
In the appeals period following Salman’s conviction, the Second Circuit decided Newman, which vacated the insider trading convictions of two downstream tippees on the grounds that the government failed to prove that the tippees knew whether the original insider tippers derived a “tangible personal benefit” from disclosing the information. After the Second Circuit sitting en banc denied the government’s petition for rehearing in Newman in April 2015 (the Supreme Court subsequently denied certiorari in Newman in October 2015), Salman appealed his conviction to the Ninth Circuit. Salman argued that, applying the Second Circuit’s Newman standard to his case (which Salman urged the Ninth Circuit to adopt), the information the government presented was insufficient because it failed to show that Kara Brother #1 disclosed the information to Kara Brother #2 in exchange for a tangible personal benefit; that is, a financial benefit, and that Salman knew of such benefit.
On July 6, 2015, the Ninth Circuit upheld Salman’s conviction. The Court pointed to the holding in Dirks that, to establish a personal benefit to the insider tipper—one of the elements of insider trading liability—“the test is whether the insider personally will benefit, directly or indirectly, from his disclosure … for in that case the insider is breaching his fiduciary duty to the company’s shareholders not to exploit company information for his personal benefit.” The Court further noted that, under Dirks, “a tippee is equally liable if ‘the tippee knows or should know that there has been [such] a breach,’ … i.e., knows of the personal benefit.” Of particular importance to the Court was the language in Dirks that gave objective examples of when a “personal benefit” to the insider can be inferred, one of which was “when an insider makes a gift of confidential information to a trading relative or friend.” The Court found that “this last-quoted holding of Dirks governs the case” because Kara Brother #1’s disclosure of confidential information to Kara Brother #2, “knowing that he intended to trade on it, was precisely the ‘gift of confidential information to a trading relative’ that Dirks envisioned.” Thus, “there can be no question that, under Dirks, the evidence was sufficient for the jury to find that [Kara Brother #1] disclosed the information in breach of his fiduciary duties and that Salman knew as much.”
The Court declined to follow the Second Circuit’s standard in Newman because “[d]oing so would require us to depart from the clear holding of Dirks that the element of breach of fiduciary duty is met where an ‘insider makes a gift of confidential information to a trading relative or friend.’ ” The Ninth Circuit concluded that, if Salman’s reading of Newman were followed and the evidence against Salman was found to be insufficient, “then a corporate insider or other person in possession of confidential and proprietary information would be free to disclose that information to her relatives, and they would be free to trade on it, provided only that she asked for no tangible compensation in return. Proof that the insider disclosed material nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish breach of the fiduciary duty element of insider trading.”
The Supreme Court granted certiorari in Salman to consider the following questions presented: “Whether the personal benefit to the insider that is necessary to establish insider trading under Dirks v. SEC requires proof of ‘an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature,’ as the Second Circuit held in U.S. v. Newman, or whether it is enough that the insider and the tippee shared a close family relationship, as the Ninth Circuit held in this case.”
The oral argument focused on the issues raised by the questions presented—i.e., whether Kara Brother #1 received a “personal benefit” from giving the information to Kara Brother #2—and touched only briefly on petitioner Salman’s downstream insider trading liability (see here to read the oral argument transcript).
Ms. Shapiro, counsel for Salman, began by arguing that, as the Court has done in cases involving public corruption, such as Skilling and McDonald, criminal statutes need to be construed narrowly to “avoid serious separation of powers and vagueness problems.” Shapiro further argued that, because there is no statute that defines the elements of the crime of insider trading and Congress has not chosen to define it, the Court should limit the insider trading crime to its “core,” which in this case is “trading by the insider or its functional equivalent … where the insider tips another person in exchange for a financial benefit” (Shapiro later clarified that, while the benefit did not necessarily have to be financial, such as cash, it should be something “concrete” or “tangible”). Thus, Shapiro argued, as Kara Brother #1 did not receive any pecuniary or other concrete benefit from Kara Brother #2 in exchange for the information, Kara Brother #1’s actions would not satisfy the “personal benefit” test.
Here, Shapiro received sharp questioning by the Justices as to why, as held in Dirks, the close family relationship between Kara Brother #1 and Kara Brother #2 wasn’t sufficient to establish personal advantage, whether or not Kara Brother #1 received a financial or other tangible benefit. For example, to Shapiro’s argument that, at most, Kara Brother #1 got the “scant” benefit of getting his brother, who was pestering him, “off his back” by providing the information, Justice Stephen Breyer asked, “[w]hy do you say ‘scant’? ... the question … is when you use [the confidential information] to benefit a close family member is that, in effect, benefiting yourself.” Added Justice Ruth Bader Ginsburg at a later point, “[a]nd why isn’t it a benefit, if you said the brother was pestering him so now his brother is happy? He’s no longer being pestered. Isn’t that a benefit?”
There then ensued a lengthy back-and-forth about the nature of gift-giving and whether the particular language in Dirks regarding the inference of personal benefit from an insider’s “gift of confidential information to a trading relative or friend” was, as the Justices’ questioning seemed to support, a part of the personal benefit test for insider trading established in that case, or, as Shapiro argued, merely dicta and not controlling. To Shapiro’s suggestion that including something so non-concrete or intangible as a “personal benefit” would serve to expand insider trading liability rather than narrowly construe it, Justice Elena Kagan responded, “Ms. Shapiro, here is not a question of expanding it further. You’re asking us to cut back significantly from something that we said several decades ago [in Dirks], something that Congress has shown no indication that it’s unhappy with, and in a context in which, I mean, obviously the integrity of the markets are a very important thing for this country. And you’re asking us essentially to change the rules in a way that threatens that integrity.”
During questioning of counsel for the government, Deputy Solicitor General Michael R. Dreeben, the Justices posed numerous hypotheticals in their attempts to ascertain where to draw the line between, on one end of the spectrum, a clearly criminal “gift” of confidential inside information to family and friends with the knowledge that they will trade on it and, on the other end of the spectrum, non-intentional or accidental “social interchange” disclosures with no anticipation of trading which would not be considered “gifts” under Dirks. Here, Chief Justice John Roberts gave the hypothetical of telling your friends you couldn’t go away with them for the weekend because you were working on a “Google thing,” adding that “[i]t’s hazy -- it’s kind of a hazy line to draw, isn’t it, between something that you characterize as a gift and something that would be characterized as social interaction, isn’t it?” Dreeben responded that it wasn’t hazy but rather was based on the facts of each particular case, and in any event, under Dirks, the burden was on the government to prove that the information was given to a third party in breach of a fiduciary duty, in exchange for a personal benefit, and with knowledge that the information would be traded. Dreeben argued that this should be the test, and that the identity of the third party the information was actually given to—friend, family, etc.—would be just one factor in that analysis. Dreeben was then subjected to lengthy questioning about the elements of his proposed test, i.e., what would constitute a “personal advantage” in various hypotheticals and what was needed to prove that the insider “knew” that the tippee would trade on the information. Dreeben concluded his argument by urging the Justices to, at a minimum, affirm Dirks and retain the “gift of confidential information to trading friends and family” language as a part of the test for proving that the insider tipper received a “personal benefit.”
During the questioning of Dreeben, Justice Ginsburg brought the questioning back to petitioner Salman himself, who was asking the Court to overturn his insider trading conviction: “[T]he defendant here is not the insider, and … we’ve been talking about the two brothers. How far down the line do you go? Because Salman is not -- he’s a relative by marriage, but … he gets the tip from the first tippee … how long does it continue?” Dreeben responded that the only limitation on the government charging in “tipping chains” is a “limitation of proof,” stating that “[w]e need to be able to show that the tippee, perhaps at the end of the chain will be more difficult than the ones earlier in the chain, had knowledge that the information originated in a circumstance in which there was a breach of fiduciary duty for personal benefit.”
A decision in Salman is expected in spring 2017. Reading the tea leaves based on the tone and tenor of the questioning during oral argument, the Justices may seek to establish a compromise “personal benefit” test between the extremes of Dirks and Newman, but will most likely affirm Salman’s conviction and not make any major changes to insider trading law that has developed over the last three decades since Dirks was decided. We will keep an eye out for the Salman decision and report back.
Other recent insider trading sentences, convictions and charges: In addition to the Salman oral argument, there has been a plethora of government announcements involving insider trading cases in the news of late. Read on for a roundup of those that caught our eye.
- On September 22, 2016, the SEC announced that judgment had been entered by a Southern District of New York court against Sheren Tsai and her boyfriend, Colin Whelehan, who allegedly tipped Tsai with confidential information relating to security company ADT. The SEC alleged that Whelehan, who was then a Senior Associate at an investment advisory firm, provided Tsai (employed at a different investment advisory firm) with inside information that he obtained in the course of his employment regarding an impending acquisition of ADT by funds managed by affiliates of Apollo Global Management, LLC. The SEC alleged that, after receiving this nonpublic information from Whelehan, Tsai purchased 1,500 shares of ADT stock in January 2016 and also recommended that a close relative purchase ADT stock, which resulted in Tsai and her close relative generating illicit profits of approximately $19,500.00 and $4,414.41, respectively, when the ADT acquisition closed in February 2016. As part of the judgment, Whelehan agreed to pay $23,914.41 in civil penalties, and Tsai agreed to disgorge $23,914.41 in illicit profits plus $521.08 in prejudgment interest, and pay $23,914.41 in civil penalties.
- On September 21, 2016, the SEC announced that final judgment had been entered by a Northern District of California court against two men, Saleem Khan and Roshanlal Chaganlal, involved in a 2014 insider trading scheme in connection with Ross Stores. The SEC’s action charged Khan and Chaganlal with insider trading in Ross Stores securities based on nonpublic sales information leaked by Chaganlal while he was a Ross Stores employee. Two other defendants who were Khan’s work colleagues settled the SEC’s charges against them in September 2015. As part of the final judgment, Khan was ordered to pay over $16 million in disgorgement, penalties and prejudgment interest and Chaganlal was ordered to pay almost $400,000 in disgorgement, penalties and prejudgment interest.
- On September 21, 2016, the SEC announced that it had charged hedge fund manager Leon G. Cooperman and his firm Omega Advisors with insider trading based on material nonpublic information Cooperman learned in confidence from a corporate executive. The SEC alleged that Cooperman generated substantial illicit profits by purchasing securities in Atlas Pipeline Partners (APL) in advance of the sale of its natural gas processing facility in Elk City, Oklahoma. The SEC alleged that Cooperman used his status as one of APL’s largest shareholders to gain access to the executive and obtain confidential details about the sale. According to the SEC, Cooperman and Omega Advisors allegedly accumulated APL securities despite explicitly agreeing not to use the material nonpublic information for trading purposes, and when APL publicly announced the asset sale its stock price jumped more than 31%.
- On September 14, 2016, the U.S. Attorney’s Office for the District of New Jersey announced that Steven Metro, a former managing clerk for Simpson, Thatcher & Bartlett LLP law firm, was sentenced to 46 months in prison and a $10,000 fine for stealing sensitive, confidential information for use in a five-year insider trader scheme that yielded net profits of more than $5.6 million. Metro had previously pled guilty to the charges. Metro admitted to stealing material nonpublic information from 2009 to 2013 from the law firm related to corporate transactions, such as mergers and acquisitions or tender offers, in which the firm represented a party or financial advisor to the transaction. Metro admitted that he stole the inside information by scouring the firm’s computer system for client names and the keywords “merger agreement,” “bid letter,” “engagement letter,” and “due diligence.” Metro would then pass the information on to a friend, Frank Tamayo, who in turn passed it on to another friend, Vladimir Eydelman (who knew Metro was the source) to purchase the securities using the inside information. The three men all benefited from and shared in the illicit profits amounting to $5.6 million. Both Tamayo and Eydelman also previously pled guilty to the charges.
- On August 17, 2016, the U.S. Attorney’s Office for the Southern District of New York announced that, after a two-week jury trial, Sean Stewart, a former managing director in the healthcare division of two unnamed Manhattan investment advisory firms (news reports identified them as Perella Weinberg Partners and JP Morgan Chase, respectively), was convicted of insider trading when a jury found that he tipped his father (who he knew was having financial difficulties) with nonpublic information relating to a number of mergers and acquisitions, which resulted in $1 million in illegal profits. Stewart is scheduled to be sentenced in February 2017. This was the first insider trading conviction obtained by SDNY U.S. Attorney Preet Bahara since the Second Circuit’s 2014 decision in Newman.
- On August 11, 2016, the SEC announced charges against Paul T. Rampoldi, a former stockbroker and his friend William Scott Blythe III for participating in an insider trading scheme through which they gained $90,000 in illicit profits in advance of two major announcements out of a pharmaceutical company. The SEC alleged that Rampoldi coordinated the insider trading with two other brokers at his firm as well as a then-IT executive at Ardea Biosciences. The SEC alleged that the Ardea employee tipped one of the brokers ahead of the company’s announcement of an agreement to license a cancer drug and later tipped him in advance of its acquisition by AstraZeneca PLC. The SEC charged the other two brokers and the Ardea employee in June 2015.