Supreme Court Agrees to Clarify the Law of Insider Trading

Update 12/6/16: As predicted below, today the Supreme Court unanimously upheld Salman’s conviction and rejected the Second Circuit’s standard in Newman.  I’ll have more on the case in a post next week.

Just three months after it refused to hear the government’s appeal in a landmark insider trading case from the Second Circuit, the Supreme Court announced last week that it will revisit the law of insider trading after all. The Court’s decision to grant review of the Ninth Circuit’s ruling in Salman v. United States may bode well for the government’s future prosecutions.

Both Salman and the Second Circuit case, United States v. Newman, involve the question of “tippee” liability for insider trading: when is a person who receives a tip of confidential information from a corporate insider prohibited from trading on that information? The two courts of appeal adopted apparently conflicting standards, and now the high court will weigh in.

The Supreme Court declined to take the appeal in Newman, where the government lost, and accepted the appeal in Salman, where the government won. At first glance that might suggest the Court’s decision to take Salman’s case is bad news for the government. But I think there’s a good chance the Court will use Salman’s case to clarify the law of tippee liability while affirming Salman’s conviction and rejecting the narrower legal standard adopted in Newman – an outcome that would favor the prosecution.

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The Law of “Tippee” Insider Trading 

Insider trading is buying or selling securities based on material, non-public information, in violation of a fiduciary duty or similar duty of trust and confidence. Trading on the basis of inside information alone is not a crime. In order to constitute securities fraud, there must be a breach of a legal duty in connection with the trading.

The most classic type of insider trading involves a corporate officer personally trading the company’s stock on the basis of corporate information not available to the shareholders. This violates the officer’s fiduciary duty to act in the best interests of the shareholders and to refrain from misappropriating corporate information for his or her own private benefit.

But the ban on insider trading would be pretty toothless if an insider could simply provide confidential information to a friend or family member who did not owe a duty to the shareholders and they were free to trade on that information. Thus the law has long recognized that, under certain circumstances, tippees who receive confidential information are prohibited from trading on it just as if they were corporate insiders.

The Supreme Court ruled on tippee liability in the 1983 case of Dirks v. SEC. Raymond Dirks was a broker who received inside information from Ronald Secrist, an officer with a life insurance company called Equity Funding. Secrist claimed there was massive fraud going on within Equity Funding and urged Dirks to investigate and make it public.

Dirks spent a couple of weeks investigating and trying to expose the fraud allegations. At the same time, he advised his clients and other investors about what he was finding, and some sold their shares. The stock price plummeted; ultimately the SEC began an investigation and Equity Funding collapsed.

The SEC thanked Dirks for his work in exposing the fraud by charging him with a civil insider trading violation. The SEC’s theory was that Dirks, as a tippee who received confidential inside information from Secrist, had an obligation to refrain from trading on that information or encouraging others to do so.

But the Supreme Court rejected the SEC’s position. The Court began by reaffirming the holding of its landmark insider trading case from three years earlier, Chiarella v. United States: insider trading is not established simply because someone traded on non-public information. To constitute securities fraud there must be a “manipulation or deception” involved, which means there must be a violation of a legal duty in connection with the use of the information.

The Court noted that not all disclosures of confidential information are done with a bad purpose.  For example, corporate officers frequently talk with stock analysts, whose job it is to ferret out corporate information and report it to investors. Even the SEC agreed such information flow is good for the markets. Such conversations may sometimes include matters not yet known to the public or to all shareholders, but that is not considered improper if done for the purpose of disseminating information about the company.

What matters is not the disclosure of inside information per se, but why it was disclosed: “[w]hether disclosure is a breach of duty . . . depends in large part on the purpose of the disclosure. . . . [T]he test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach [by the tippee].”

Accordingly, the Court held, a tippee is prohibited from acting on the inside information only if: 1) the tipper was violating a duty by providing the information; and 2) the tippee knew or should have know about that violation. Whether the tipper was violating a duty depends on the purpose of the tip and whether the tipper received any personal benefit in return.

The benefit to the tipper that will indicate a breach of duty is not limited to tangible monetary gains. The Court noted there also can be reputational or other intangible and indirect benefits to the tipper. In particular, the “elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend.”

Secrist had been providing information not in order to reap some personal benefit but to help expose widespread fraud within the company. Because Secrist himself therefore did not breach a duty, the Court concluded that Dirks did not inherit any obligation to refrain from using the information and could not be liable for insider trading.

Newman and Salman

 In 2014, more than thirty years after Dirks, the Second Circuit in Newman dealt a blow to the SEC and prosecutors by adopting a very narrow view concerning the benefit to the insider that must be established for tippee liability. (The Second Circuit includes New York and Wall Street, the venue for most securities fraud cases, so its decisions on these issues are particularly important.)

Corporate insiders in Newman disclosed confidential information to several securities analysts who passed the information along to others, including the defendants. After they were convicted for trading on that information, the defendants appealed and argued the government had failed to satisfy both prongs of the Dirks test: they claimed there was insufficient evidence that the insiders had violated a duty by receiving a personal benefit in exchange for the tips, and even if they did, there was no evidence the defendants knew about that violation.

The government argued it had presented sufficient evidence of a personal benefit to the tippers. One had received occasional career advice from an analyst to whom he leaked information. The other insider was a family friend of one of the analysts; they went to the same church and occasionally socialized together.

The court found this evidence of “personal benefit” was insufficient. Although the court agreed a benefit could arise from a tip to a relative or very close friend, the mere existence of a casual friendship was not enough. Proof of a personal benefit, the court held, requires evidence of a “meaningfully close relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”   The evidence in Newman did not meet that standard, and the Second Circuit reversed the convictions.

Salman, the case that the Supreme Court took last week, also raises the issue of what kind of benefit to the insider is required. Maher Kara, a Citigroup banker, passed confidential information to his brother Michael while knowing that Michael was likely to trade based on that information. Michael, in turn, shared the information with Salman. There was evidence that Michael and Maher had a very close family relationship, that Salman knew of that relationship, and that Salman knew Maher was the source of the information.

Salman argued the Ninth Circuit should apply the Newman standard and require the government to show that any benefit to Maher was “objective, consequential, and represented at least a potential gain of a pecuniary or similarly valuable nature.” He claimed there was no evidence of such a benefit to Maher and so Salman could not be liable as a tippee.

But the Ninth Circuit rejected Salman’s claim. The court held the case was a straightforward application of the holding in Dirks that an insider personally benefits from disclosing confidential information when he “makes a gift of confidential information to a trading relative or friend.”   Maher passed the information to his brother, with whom he had a close relationship – and that, according to the court, is all that Dirks requires. To the extent Newman went further and would require proof of a “consequential” or “tangible” benefit to the tipper even when the tip was to a close family member, the Salman court disagreed.

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What to Expect from the Supreme Court’s Decision

When urging the Supreme Court to take his case, Salman argued that the Second Circuit’s holding in Newman directly conflicts with the Ninth Circuit’s decision in his case. He argued that if a close family relationship between the insider and the tippee is enough to establish a personal benefit to the insider, as the Ninth Circuit held in his case, then Salman loses. But if there must be “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 Newman, then Salman should win.

The fact the Court agreed to hear the case may suggest it agrees there is a conflict between the circuits that it wants to resolve; resolving a circuit split is one of the main reasons the Court grants certiorari. But that doesn’t necessarily translate into good news for Salman.

It’s true the Court could have granted review in Newman if it disagreed with that court’s holding about personal benefit, but Newman was not a great vehicle to address that standard. Although the question of benefit to the tipper was important in Newman, there was a second big issue looming in that case: the defendants had received the inside information second or third hand and were several steps removed from the corporate insiders who made the initial tips. The Second Circuit was deeply troubled by this aspect of the case, and scolded the government for bringing prosecutions the court said have been “increasingly targeted at remote tippees many levels removed from corporate insiders.”

In other words, even if the Supreme Court had reversed the Second Circuit on the benefit issue, the defendants in Newman likely would have gone free anyway. The government had failed meet the second requirement of Dirks: proving that the remote tippee knew about the benefit received by the tipper and the corresponding breach of duty.

Salman, on the other hand, squarely presents the benefit issue, with no issue about Salman’s knowledge of the possible violation. But although the Court granted Salman’s appeal, it would be surprising if it reversed his conviction. As the Ninth Circuit recognized, leaking information to one’s brother is exactly the kind of tip that Dirks held would qualify as a benefit: providing information to a “trading relative or friend.”

Reversing Salman’s conviction would not only require effectively overruling Dirks; it would gut the prohibition on insider trading. Corporate insiders would be free to leak confidential information to friends, relatives, neighbors, or anyone, as long as they did not receive a direct tangible benefit in return. That would overturn decades of insider trading law.

Although predicting what the Court will do is always a risky exercise in reading tea leaves, I think it is far more likely that the Court will affirm Salman’s conviction while taking the opportunity to affirm and clarify the holding of Dirks – and in the process disagreeing, directly or indirectly, with the narrower Newman rationale.

Such a ruling could focus on the statement in Dirks that whether disclosure is a breach of duty “depends in large part on the purpose of the disclosure.” The focus should be more on the insider’s purpose and less on the nature of any benefit received.

The Court in Dirks was primarily concerned about sweeping within the insider trading prohibition the activities of corporate officers who were acting in the interest of the corporation by, for example, speaking with securities analysts. Even if inside information was inadvertently disclosed, the officers were acting with the purpose of fulfilling their duties and aiding the corporation, not for some improper personal purpose.

Similarly Secrist, who tipped Dirks, was acting not for some personal purpose but for the purpose of exposing fraud and wrongdoing within the company. Once again, the purpose behind the disclosure did not suggest a corporate officer breaching a duty by using corporate information for his own benefit.

An insider who tips to a family member, close friend, or golfing buddy is not acting for any proper corporate purpose. Whether or not the insider personally receives some “consequential” or “pecuniary” benefit, he or she is not acting to further the best interests of the company. Even if the benefit received is nothing more than the intangible pleasure of seeing a friend profit from the information, the disclosure violates the insider’s duty to refrain from using corporate information for some personal end.

Focusing on the purpose of the disclosure, rather than on the precise nature of the benefit, will better serve the goals of the ban on insider trading. If a corporate insider is not acting with the purpose of fulfilling his or her corporate duties, then they are likely acting with the kind of personal purpose that will result in the required personal benefit, tangible or intangible.

Focusing on the purpose of the disclosure also avoids hinging potential criminal liability on murky questions such as whether a particular friendship was sufficiently “meaningfully close” to find that the tipper benefited from the disclosure. That’s the kind of issue invited by the Newman standard.

The Newman court’s approach of requiring a more tangible kind of benefit may have been born out of that court’s frustration with the government’s “remote tippee” cases, but it seems misplaced. The tippers in Newman had no apparent legitimate corporate purpose for sharing the inside information, and so the benefit they received from sharing that information with friends or colleagues should have been considered sufficient.

It’s been more than three decades since the Court last addressed tippee liability. The Court in Salman has the opportunity to reaffirm that a tippee can be liable for trading on inside information, even if the benefit received by the tipper is not necessarily consequential or tangible. Although the government was denied review in Newman, it may still get the clarification of insider trading law that it sought when it tried to appeal that decision.

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Why the Supreme Court Should Not Take Bob McDonnell’s Case

Update 1/15/16: The Court announced late today that it will hear McDonnell’s case, only on the “official acts” question, not on the jury selection issue.  It will be very interesting to see what happens – watch this space!

For those following the Bob McDonnell case, all eyes were on the Supreme Court this past Monday. McDonnell’s petition for certiorari was considered at the Court’s conference last week, which led many to expect the Court to announce on Monday whether it would take the case. But the Court took no action, which suggests the Justices want additional time to consider accepting McDonnell’s appeal.

They shouldn’t do it.

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The former Virginia Governor and his wife Maureen were convicted in September 2014 on multiple counts of federal corruption. The convictions were based on their relationship with businessman Jonnie Williams, who gave them more than $170,000 in secret gifts including a Rolex watch, designer gowns, vacations and golf outings, and $120,000 in no-paperwork, no-interest “loans.” In exchange, the government charged, the McDonnells agreed to use the power of the Governor’s office to promote Williams’ dietary supplement, Anatabloc.

A unanimous panel of the Fourth Circuit Court of Appeals affirmed McDonnell’s convictions, and the full court declined to re-hear the case en banc. But in a somewhat surprising move, the Supreme Court allowed McDonnell to remain free on bond while it considers whether to hear his appeal.

In his petition to the Supreme Court, McDonnell claims his conviction is unprecedented; that this is the “first time in our history that a public official has been convicted of corruption despite never agreeing to put a thumb on the scales of any government decision. ” His conviction, he says, turns all commonplace political interactions into potential federal felonies.

McDonnell has an impressive array of allies at the Supreme Court. Nearly a dozen amicus briefs were filed on his behalf, all urging the Court to take the case. Those supporting McDonnell include various criminal law and public policy organizations, a group of current and former Virginia legislators, a group of former Virginia Attorneys General, a bipartisan group of former state and federal officials, and a number of Virginia law professors. All agree that upholding McDonnell’s conviction would place every elected official at the mercy of federal prosecutors.

(McDonnell also claims that the jury selection process in his trial was flawed, but that’s a secondary issue. Most of his argument focuses on the legal validity of his corruption convictions, as do almost all the amicus briefs.)

I’ve been a little surprised to see how many current and former public officials have claimed that McDonnell’s conviction threatens to undermine the very foundations of our political system. As an example of quid pro quo corruption the McDonnell case is really not that remarkable, and it poses no threat to ordinary political activities. The apocalyptic arguments to the contrary by McDonnell and his supporters largely rest on mischaracterizations of the law, the facts, or both.

There’s really no reason for the Supreme Court to take this case. Here’s why:

1. McDonnell did not need to perform “official acts” — Since before he was even indicted, McDonnell has argued he could be convicted of federal corruption only if he performed “official acts” as defined in the federal bribery statute, 18 U.S.C. § 201, in exchange for the gifts. Section 201(a)(3) defines “official act” as “any decision or action on any question, matter, cause, suit, proceeding or controversy, which may at any time be pending, or which may by law be brought before any public official . . . .” McDonnell and his supporters have spent a great deal of time arguing that, whatever McDonnell did for Williams, it did not amount to “official acts” within this definition.

As I’ve argued here and here, the problem with this claim is that McDonnell was not charged with violating 18 U.S.C. § 201. He could not have been, because Section 201 applies only to federal public officials. McDonnell was convicted under two different statutes that cover bribery by state and local officials: Hobbs Act extortion under color of official right and honest services wire fraud. The statutory definitions in Section 201 simply do not apply to these other federal crimes.

In his petition to the Supreme Court, McDonnell has backed away somewhat from his earlier claims that the precise language of Section 201 controls. He even appears to criticize the trial court for adopting the 201 language – even though it was the very standard he argued for throughout his trial. McDonnell now claims that the statutes under which he was convicted require “official action,” an apparently undefined term that “draws content” from Section 201.

But as explained below, the key to any bribery case is whether there was a corrupt deal to exercise government power or influence in exchange for the bribe payments, not the precise nature of any actions actually taken. All of the arguments about whether McDonnell’s actions fit within a precise statutory definition are largely beside the point. Despite all the noise about “official acts,” there is no legal issue here concerning the proper definition of that term that would justify Supreme Court review.

2. In fact, McDonnell did not need to perform any acts at all . . . — McDonnell and his supporters claim his conviction is flawed because Williams did not actually get the university studies of Anatabloc and other benefits that he was seeking. His lawyers argue that neither Williams nor his company “received a dime of state money” as a result of the bribes. But as the government has pointed out, this is not a defense.

It’s well settled that fulfillment of the quid pro quo is not required for a bribery conviction. The public official only needs to make the corrupt deal; he does not need to follow through. If he backs out or is thwarted somehow in his efforts to fulfill his end of the bargain, the crime has still been committed. The failure of a bribery scheme does not make it lawful.

For example, suppose a public official accepts $100,000 from a developer in exchange for agreeing to use his influence to ensure the developer gets a contract to renovate a large public building. The next day, before the official has taken any steps to fulfill the agreement, the building burns to the ground, making the contract impossible. The crime of bribery has still been committed; the crime is the corrupt agreement to sell the powers of the office, even if the official never actually does anything.

The corrupt agreement, of course, does not have to be in writing or even be expressly stated. The agreement may be inferred based on the actions of the parties; otherwise, as the Supreme Court has noted, it would be far too easy to deny corruption by simply acting through “knowing winks and nods.”

Williams testified at trial and was very clear about what he expected from the McDonnells in exchange for the gifts. McDonnell also testified and denied any such agreement or understanding, of course, but that simply set up a classic witness credibility issue. Who to believe in such a case is a fact-bound, jury determination – not a legal question for the Supreme Court to resolve.

It was more than reasonable for the jury to accept the government’s argument that McDonnell knew that Williams – a man he didn’t even know before he ran for office – was not simply showering him with gifts out of kindness or admiration. McDonnell knew what Williams wanted in return, and the jury found he accepted the gifts with that understanding. That’s all the law requires.

3.  . . .  but in any event, McDonnell DID use the power of his office in an attempt to benefit Williams – The evidence at trial showed that the McDonnells did in fact do a number of things for Williams in exchange for his largesse. The governor asked certain officials to meet with Williams to discuss his product and plans. He suggested to state officials that Virginia universities might do research studies of Anatabloc and that perhaps it should be promoted by the Virginia state employees health plan. Perhaps most significantly, the McDonnells held a “product launch” event for Anatabloc at the Governor’s mansion, which was planned by state employees and attended by the university researchers who would decide whether to undertake the studies that Williams desired.

McDonnell and his supporters have consistently argued that these were routine political courtesies, not weighty or significant enough to be “official acts,” “official action,” or otherwise to support a bribery conviction. But these arguments largely miss the point because, as noted above, the government was not required to prove that McDonnell took any action at all, only that he entered into the corrupt agreement with Williams.

Again, the key to bribery is the existence of a corrupt agreement, not the precise nature of anything subsequently done by the public official. McDonnell’s actions were not the sine qua non for determining whether bribery took place.  They did, however, provide evidence that the corrupt agreement existed and that McDonnell was taking steps to carry it out. That was more than sufficient to support the jury’s verdict.

Suppose one of the university researchers had followed through on McDonnell’s suggestion and initiated the research study that Williams wanted. The defense then would be hard pressed to argue that Williams had received no benefit or that McDonnell had not “placed his finger on the scale” of a government decision. Yet the actions actually taken by McDonnell himself would have been exactly the same.

The evidence at trial suggested the main reason McDonnell’s efforts on Williams’ behalf did not succeed was that the governor’s staff did not follow through on his requests, in part because they did not trust Williams or believe in his product. It is not a defense for the governor that his subordinates had the good sense to resist his efforts to fulfill his end of his corrupt bargain.

4. McDonnell’s conduct was not legal under Virginia law — McDonnell and his supporters have claimed his prosecution is unjustified and presents federalism issues because what he did was perfectly legal under Virginia law. They note that Virginia’s notoriously lax ethics laws allowed politicians to accept undisclosed gifts. It’s not appropriate, they argue, for the federal government to prosecute a state official for conduct that would be legal under state law.

To bolster this argument, McDonnell and his supporters seize on a line from the trial judge’s jury instructions: “there has been no suggestion in this case that Mr. McDonnell violated Virginia law.” But the unremarkable statement that Virginia law is not an issue in the federal case and that the jury should not consider it is not the same as an affirmative finding that McDonnell did not violate Virginia law. On the contrary; based on the jury’s verdict it is clear that he did.

Virginia state law defines bribery as a public official agreeing to accept a pecuniary benefit in exchange for being influenced in a “decision, opinion, recommendation, vote or other exercise of discretion as a public servant.” VA Code §18.2-447(2). This broad application to “recommendations” and “exercises of discretion” certainly covers much of McDonnell’s conduct on behalf of Williams.

It’s true that Virginia law did allow public officials to accept undisclosed gifts, but it did not allow them to do so as part of an agreement to exercise their official powers in exchange. That is quid pro quo bribery prohibited by every state. McDonnell could have legally accepted Williams’ gifts if there were no strings attached — but that’s not what the jury found happened in this case.

5. McDonnell’s conviction poses no threat to ordinary political interactions — The scariest bogeyman raised by McDonnell and his supporters (many of them politicians, of course) is that his conviction criminalizes routine political actions and relationships. They claim that if McDonnell’s conviction stands, no politician could answer a phone call from a supporter or arrange a meeting with staff for a donor without fear of prosecution.

This claim that McDonnell’s conviction criminalizes “politics as usual” again misapprehends the nature of his case. With our system of privately financed campaigns, politicians do need to raise money, and they will inevitably take actions favored by their supporters. Similarly, individuals have a right to support politicians financially and to express their views to them about policies and actions they would like those politicians to pursue.

What politicians and their supporters cannot do, however, is enter into agreements where the politician agrees to take a particular action in direct exchange for a particular gift or contribution. That is the quid pro quo that defines the line between routine political interactions and corruption.

The distinction between taking actions generally favored by one’s political supporters and acting pursuant to a direct quid pro quo agreement may seem like a fine line, and at times it is. But that is the stuff of which political corruption cases are made. Politicians in a corruption case routinely claim there was no quid pro quo; the ongoing case involving New Jersey Senator Bob Menendez involves the same defense. Whether the corrupt agreement existed is a jury question that will turn on the facts of the particular case.

When trying to determine whether a particular relationship is corrupt or simply politics as usual, the entire relationship needs to be examined. McDonnell and his supporters have consistently tried to cloud this issue by referring to Williams as a “supporter” or a “donor.” They suggest McDonnell’s conviction means any politician may be prosecuted for any favor done for someone who attended a fundraiser or contributed to their campaign.

But Williams was not just a “donor” or “supporter.” The gifts from Williams were not campaign or PAC contributions – they were secret gifts and undocumented loans. Individual campaign contributions, which take place within a legal and regulated system, have almost a presumption of legitimacy. They are subject to legal limits and are publicly disclosed, so all may see who is supporting a particular politician and where he or she may have potential conflicts of interest. And the funds are used for documented political purposes, not to line the candidate’s own pockets.

Gifts of Rolex watches, designer gowns, payment for wedding caterers, and sweetheart “loans” take place outside of this system. The gifts from Williams were secret, and both sides wanted it kept that way. There was no way for the public to know about Williams’ support of McDonnell, and no legal limits to that support. Gifts like these, unlike routine campaign contributions, are indicative of potential corruption. Referring to Williams as simply a “donor” or “supporter” obscures this critical distinction and the corrupt nature of his interactions with the McDonnells.

Although it’s true that a bribery case may be based on campaign contributions, it is very rare. Any such case would be scrutinized extremely closely to ensure that routine political support is not being criminalized and that the jury did not infer a quid pro quo simply because a politician took action that benefited a supporter. If that scrutiny revealed there was in fact an express quid pro quo in exchange for a campaign contribution, that would still be bribery – but that is not new, and was not something created by the McDonnell case.

Secret gifts enter the equation on a far different footing from legitimate campaign contributions. In other words, contrary to McDonnell’s claims, all quids are not created equal when evaluating whether a corrupt relationship existed. Extrapolating from McDonnell’s conviction to argue that all routine political interactions are now at risk is simply politicians claiming that the sky is falling.


McDonnell’s conviction breaks no new ground and raises no novel questions of federal law. It’s a case of simple quid pro quo corruption, where the jury heard both sides and reached a unanimous verdict that no federal judge has seen any reason to disturb. Despite the parade of horribles presented by McDonnell and his supporters, there is no reason for the Supreme Court to get involved.

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