Clarifying insider trading laws

January 2017  |  FEATURE  |  FRAUD & CORRUPTION

Financier Worldwide Magazine

Insider trading can be a controversial practice, and as such requires stringent and aggressive monitoring by regulatory bodies. The Securities and Exchange Commission (SEC) in the US, for example, monitors the practice, and goes to great lengths to protect investments from the effects of illegal insider trading.

For those parties caught insider trading in the US, punishments can be severe. Despite the crime not actually existing in federal statutes, according to the SEC’s 2016 insider trading policy, there are both criminal and civil punishments. The maximum prison sentence for an insider trading violation is 20 years, the maximum criminal fine for individuals is $5m and the maximum fine for non-natural persons (such as an entity whose securities are publicly traded) is $25m. In terms of civil sanctions, persons who have been found to have violated insider trading laws may become subject to an injunction and may be forced to disgorge any profits gained or losses avoided. The civil penalty for a violation may be an amount up to three times the profit gained or loss avoided as a result of the insider trading violation.

Despite the lack of a federal statute on insider trading, there are efforts underway to clarify the issue. Indeed, there is hope that lawyers in the US may soon have some degree of relief from the uncertainty and inconsistency surrounding insider trading, as the US Supreme Court has begun the process of deciding upon its first major insider trading case on the subject in nearly 20 years. The Supreme Court is currently hearing arguments in a case from the Ninth Circuit, which held that the difference between insider trading and lawful trading might depend simply on the relationship between the people involved. As such, the outcome of Salman v. United States could be a landmark moment. It could help resolve a split between the Second and Ninth Circuits while also clarifying generally what constitutes a personal benefit to an insider. The court must determine whether a gift of information to family or a friend is enough to provide a ‘benefit’ for a tipper suspected of insider trading. This is the ‘personal benefit’ test, established in the 1983 case of Dirks v. SEC.

In the Salman case, Bassam Salman was convicted of trading on confidential information that came to him from an extended family member who had a brother who worked at Citigroup. Undoubtedly, Mr Salman received inside information from his future brother-in-law and profited as a result of that information. Mr Salman’s tipster did not receive any tangible benefit beyond helping his future in-law. Prosecutors in the case argued that giving the information was a ‘gift’ and, as a result, the defendant is guilty of insider trading. Justice Stephen Breyer said, “to help a family member is to help yourself”.

According to Mr Salman, the family member was never paid for the tips. As such, the question at hand is whether his actions met the definition of insider trading. According to the US government, given the fact that Mr Salman knew where the information came from and the three people involved benefited from a close family relationship, the activity can certainly be classified as insider trading. However, there are a number of contradictory Federal rulings covering this type of offence, which means the case has entered uncertain waters; the nature of a personal benefit and close relationships have been called into question.

The verdict in this case is notable, primarily as a number of potential outcomes could come to fruition. The court may decide that the tipper has to receive some kind of financial benefit, or it could adopt a broader standard in which prosecutors would not have to prove an expectation of money but just a personal benefit. Another option may be that the court adopts components of each potential outcome. Regardless of the final verdict, the implications will be substantial, given its likely impact on other high profile insider trading cases, such as Raj Rajaratnam, co-founder of the Galleon Group, who is currently serving an 11 year sentence for insider trading, and former Goldman Sachs director Rajat Gupta. Both men are appealing their convictions on related grounds.

Mr Gupta’s appeal was made possible by a December 2014 ruling by the Second Circuit of Appeal that overturned the conviction of two hedge fund managers and weakened the SEC’s ability to pursue such cases. As a result, prosecutors were forced to drop charges against 12 other suspected inside traders. Mr Gupta’s appeal is not expected to be successful, however. The Second Circuit Court has indicated that a decision to overturn Mr Gupta’s sentence is unlikely.

The United States v. Newman case also hinges on the Salman outcome. The Newman case deals with the Second Circuit’s decision limiting the reach of insider trading law. It seems likely that the court will uphold Mr Salman’s conviction and it doesn’t seem to be overly interested in making any major changes to the insider trading laws that have been in effect for over three decades. Regardless, the time may have come for some sort of Federal legislation governing this area of the law.

© Financier Worldwide

BY

Richard Summerfield