Insider Trading: Supreme Court Decision Enables Securities Law Theater

By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends most of her time in Asia researching a book about textile artisans. She also writes regularly about legal, political economy, and regulatory topics for various consulting clients and publications, as well as scribbles occasional travel pieces for The National.

In a unanimous decision Tuesday in Salman v. United States, the United States Supreme Court upheld the insider trading conviction of Bassam Salman.  This was the Court’s first insider trading decision in more than two decades.

Salman was convicted of federal securities-fraud crimes for trading on inside information received from a friend,  who in turn, received the information from his brother, a former Citigroup investment banker (and Salman’s brother-in-law). The case turned on whether prosecutors needed to prove that the banker disclosed the information in exchange for a personal benefit.  The Court rejected Salman’s argument that he could not be held liable because his brother-in-law did not personally receive money or property in exchange for the tips he provided and thus this insider did not personally benefit from them.

As Jon Eisenberg has written:

Insider trading law has always been confusing when it comes to the liability of non-insiders, such as “friends” who trade based on information received from an insider. Until 1980, the Government took the position that anyone who trades while in possession of material nonpublic information violates the antifraud provisions of the federal securities laws. The Supreme Court, however, emphatically rejected the Government’s parity of information position first in Chiarella v. United States, 445 U.S. 222 (1980) and then again in Dirks v. SEC, 463 U.S. 646 (1983). Instead of focusing on anyone who trades or tips, the Court held that the appropriate test focuses on whether an insider benefitted—either by trading or by tipping in exchange for a benefit from the person to whom she tipped material nonpublic information. Under the antifraud provisions of the federal securities laws, the test after Dirks is whether the insider has breached a duty by conveying the information for the insider’s personal benefit, and whether the tippee knows or at least should know of the breach.

The case resolved a conflict in the correct interpretation of the Dirks between the United States Court of Appeals for the Second Circuit (including New York) and the United States Court of Appeals for the Ninth Circuit (including California), which heard Salman’s appeal.

In 2014, in United States v. Newman, the Second Circuit overturned an insider trading conviction, on the basis that Dirks requires prosecutors to prove both a meaningfully close personal relationship between tippee and tipper (e.g., the insider), and that the tipper received  a pecuniary benefit in order to establish insider trading liability for the tippee.  The Department of Justice (DoJ) petitioned for the Court to grant certiorari and review the Newman decision. The Court declined, but soon thereafter agreed to consider the Salman case.

The  United States Court of Appeals for the Ninth Circuit, where Salman’s appeal was lodged, had not followed the Newman interpretation, and instead decided that the correct interpretation of Dirks allowed Salman’s jury to infer that the insider breached a duty when he provided confidential information to a trading relative.  It was thus not necessary for prosecutors to show that the insider himself received any pecuniary benefit from providing  the tip. Thus, Salman’s conviction would stand.  Writing for a unanimous court, Justice Alito upheld the Ninth Circuit’s decision, while taking pains to emphasize that the decision was a narrow one, turning on the gift of the confidential information to “a trading relative”.

Implications for Pending Cases

This decision was significant in that if the Court had elected to follow the reasoning of the Second Circuit in the Newman decision, the potential existed  to overturn some of the unbroken series of successful insider trading convictions secured by United States Attorney for the Southern District of New York Preet Bharara as well as other pending investigations.

According to The New York Times:

The Supreme Court’s endorsement of the gift analysis for tipping by family and friends will also affect pending cases. Mathew Martoma, the former portfolio manager for SAC Capital Advisors, relied on the Newman benefit requirement in asking the Second Circuit to overturn his conviction for trading on information received about a failed drug trial that generated gains and losses avoided of nearly $275 million. He is currently serving a nine-year prison term.

Rajat Gupta, who was convicted of tipping the hedge fund manager Raj Rajaratnam about developments at Goldman Sachs during the financial crisis when he was a director of the bank, had another appeal in his case heard by the Second Circuit on Nov. 16 claiming that the Newman decision required that he receive a new trial. With the Supreme Court’s clear rejection of the heightened benefit requirement, those arguments appear to be moot.

Another case that could be affected involves Leon Cooperman, a prominent hedge fund manager who was sued by the S.E.C. for trading profitably ahead of an impending asset sale at Atlas Pipeline Partners in 2010 based on nonpublic information he got from a company executive in his position as one of its largest shareholders. Mr. Cooperman sent a letter to his investors after the case was filed that the Justice Department delayed its inquiry until the Salman case was decided. Now that the Supreme Court adopted a more expansive view of the benefit requirement for tipping, it will be interesting to see if the criminal investigation moves forward.” (Links omitted) [Jerri-Lynn here: I have previously written about the Cooperman case here]

Insider Trading Focus As Securities Law Theater

As I’ve written before, both the Securities and Exchange Commission (SEC) and the DoJ now generally perform an elaborate form of securities law theater, electing  to “focus on alleged insider trading at the exclusion of far more important systemic abuses is part of the theatrical spectacle that substitutes for effective regulation and coincides with the rot that has overtaken so many aspects of our wider regulatory systems.”

As I elaborated here:

The insider trading focus provides the illusion that the DoJ is doing something about high-level cheating.  Yet it has little broader deterrent effect on stymieing the wider corporate scams that misallocate resources and erode confidence in the integrity of the system. Insider trading enforcement is usually directed at individuals, and doesn’t implicate wider considerations of corporate strategy or policy. Prosecuting insider traders maintains the myth that the greatest threats to US capitalism are individual bad corporate actors, rather than anything more sweeping or systemic. Catch the bad actors, fine them or throw them in jail, and never think about any deeper problems.

So, for those of us who advocate that the federal government undertake a more aggressive approach toward prosecuting financial sector abuses — particularly those with systemic significance– or for that matter, white collar crime, the government’s win in the Salman case is a bit of a mixed blessing. It’s likely that this will only encourage further ultra-cautious enforcement practices, at both the DoJ and the SEC– and that’s not a trend that warrants extending.

Bharara to Stay on as US Attorney for the Southern District of New York

US attorneys serve at the pleasure of the president, and typically tender their resignations after a new president is inaugurated. Unusually, president-elect Trump met with Bharara at Trump Tower last month, and Bharara agreed to stay on in his position.

What does this imply, going forward?  Well, although Bharara did undertake some successful high-profile successful corruption prosecutions– most notably that of Sheldon Silver, former speaker of the New York State Assembly and Dean G. Skelos, the former majority leader of the New York State Senate, he’s not exactly blazed any paths of glory on white collar crime, with the exception of the insider trading prosecutions.

It is to Bharara’s credit that he’s opted to remain  in his position rather than cash out and take a lucrative partnership at a white shoe law firm. Bharara is the third-longest serving US Attorney for the Southern District, after Robert Morgenthau and Mary Jo White.  White left that position to take up a partnership and head the litigation department at the firm of Debeviose & Plimpton. By the time she returned to public service as SEC chair, White apparently lost her prosecutorial zeal– despite her valedictory claim that the SEC during her tenure pursued “bold and unrelenting results”.

The US Attorney for the Southern District enjoys an unusual degree of autonomy within the DoJ.  Yet his or her actions are ultimately subject to overall DoJ policy parameters. It is difficult to speculate whether Bharara will take a more aggressive approach to prosecution of systemic financial sector abuses under Attorney General-designate Jeff Sessions than he did under former Attorney General Eric Holder and current incumbent Loretta Lynch.  At least arguably, Bharara might have been constrained by DoJ prosecutorial guidelines outlined by Holder in what was known as the Holder doctrine and then in the subsequent memo authored by Deputy Attorney General Sally Quillian Yates in September 2015.  Allow me to quote from an earlier post:

[Under the Holder doctrine the DoJ eschewed corporate charges against companies and executives, instead opting for negotiated settlements (often imposing de minimis, slap-on-the wrist penalties that were significantly undersized compared to the magnitude of damage done, especially by TBTF banks and other financial predators, to name just a few).

The DoJ under Obama’s second AG, Loretta Lynch, originally followed the Holder doctrine, until that was superseded when Deputy Attorney General Sally Quillian Yates authored a memo outlining a new approach in September 2015. Under this approach, the DoJ intended to increase accountability for corporate wrongdoing, and this included an increased focus on pursuing criminal charges against responsible individuals. The DoJ sought to drive a legal wedge between individuals and the corporations for whom they worked by only allowing corporations to receive “cooperation credit” that would reduce their potential exposure (including penalties) if the corporation cooperates in surrendering as early as possible comprehensive detailed information concerning the individual misconduct.

I have written about these guidelines in greater detail here about how little impact the Yates memorandum so far has had.

Schumer Imprimatur

In assessing whether Bharara might be more aggressive in prosecuting white collar crime and systemic financial sector abuses, I do note that before assuming his current role, Bharara was chief counsel to incoming Senate Minority leader Chuck Schumer—  a man not known for taking Wall Street to task.

As the New York Daily News has reported:

“President-elect Trump called me last week” about Bharara, Schumer said. “I told him I thought Preet was great, and I would be all for keeping him on the job.”

A source said Trump had also hit up Schumer for Bharara’s cell phone number.

“I am glad they met and am glad Preet is staying on. He’s been one of the best U.S Attorneys New York has ever seen,” Schumer said.

To say the least, this does not augur well for a stepped up approach to aggressive prosecution of financial sector and white collar misconduct.

Where does that leave us?

Well, I’m willing to bet we’ll probably soon see further rollout of the same securities law theater.

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  1. Romancing The Loan

    I remember having a discussion once with a distinguished (read wealthy) older Dem fellow about an incoming AG (I think Lynch? doesn’t matter) and he was very positive about the person’s “strong prosecutorial chops” and thought that this indicated the person would be “very tough” on banks and white collar criminals.

    I asked if he didn’t think that there was rather a large difference between prosecuting banks and CEOs and prosecuting poor people for drugs/theft/gang violence, and that perhaps one was more politically beneficial than the other, and so it might not carry over?

    He said he didn’t see how.

  2. 873450

    We were supposed to be impressed by absurdist political/judicial theater extracting seemingly high penalties/fines from systemic TBTF criminal behavior, then subsequently an occasional tossed out sacrificial lamb earning reduced fines/penalties.

    Obama’s “My administration is the only thing between you and the pitchforks.” legacy is the cost of criminal immunity for TBTF bankers came cheap. Not free, but negotiable and cheap.

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