Let’s say you have a brother-in-law who in turn has a brother who works in the financial world, and the brother let’s slip some insider financial information to the brother-in-law who in turns tells you, and you decide to go make a stock trade based on this information. Could you face jail time for federal insider trading charges, even if you never spoke to the brother and provided nothing in return for the tip? According to the Supreme Court’s decision at the end of 2016 in Salman v. United States, the answer is quite possibly yes.
This decision appears to be an enormous shift from the last major federal case that looked at the question of so-called “tippee liability” in 2014 which required prosecutors to meet a much higher standard of proof before a criminal case for insider trading could go forward. That case – Newman v. United States – decided by the 2nd Circuit, had even led the US Attorney for the Southern District of New York (who had been one of the key figures in pursuing and prosecuting insider trading cases) to shift focus away from insider trading cases, but, in light of Salman, it appears to be “game on” for federal prosecutors seeking insider trading prosecutions.
A Tale of Two Brothers and a Brother-in-Law
In the Salman case, a man named Maher Kara worked in Citigroup’s healthcare investment banking group and was thus privy
to a steady flow of information about pending but undisclosed mergers and acquisitions in the healthcare world, among other things. Maher discussed his work with his older brother Michael, who had a chemistry background, as a way of understanding some aspects of his work. Michael then began requesting information about pending deals and then distributed that information to a number of people including defendant Bassam Salman who would become Maher’s brother-in-law. Salman eventually made $1.5 million in profits off of trades made on the information provided. Federal authorities caught up with all three men, and Maher and Michael pled guilty and testified against Salman who was sentenced to 39 months in jail.
How Newman Shook Things Up
Salman had been convicted based on the the legal concept of “tippee liability” espoused by the Supreme Court’s 1983 decision in Dirks v. United States. There, the court said that a person who receives a insider trading tip (in other words, a “tippee”) can be liable for insider trading if the person who breached a fiduciary benefit by providing the tip to the tippee (making this second person a “tipper”) received a personal benefit for providing the tip. Where a tippee paid the tipper cash or provided some other gifts or favor, liability was clear, but it was less clear when a less tangible personal benefit was given to the tipper by the tippee such that the tippee would be liable. In Dirks, the court held that such a personal benefit could be inferred, and thus would not have to be specifically proven, where the tippee is a “trading relative or friend” of the tipper.
This was the standard that Salman had been convicted under in his trial in the 9th Circuit, but after his conviction, the 2nd Circuit released its decision in Newman which held that, before such a personal benefit could be inferred in a relationship with a trading relative or friend, prosecutors would have to show that there was “proof of a meaningfully close personal relationship between tipper and tippee that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” This hurdle of proving both a meaningful close personal relationship and an “objective, consequential” exchange thus made insider trading prosecutions more difficult to bring, at least in the 2nd Circuit. As a result, Salman appealed his conviction under the Newman Standard.
The Supreme Court Strips Newman of Much of its Meaning
In Justice Alito’s opinion, the Supreme Court upheld the 9th Circuit’s refusal to sign on to the Newman standard and held that prosecutors were not in fact required to prove anything beyond the standard espoused three decades ago in Dirks, again that a personal benefit can be inferred where it can simply be shown that confidential information was given to a trading relative or friend. The Supreme Court acknowledged that there will be circumstances where the issue of benefit based on a relationship will not always be so clear or within the primary scope of what Dirks intended but they left that issue for another day.
There are real dangers left in the wake of Salman that the government will go back to overreaching when it comes to insider trading prosecutions. For now it is clear that we can expect that the government will try to define a relationship to satisfy benefit to a tippee as broadly as possible but just how far the courts permit this slippery slope to become even more prosecution-friendly after Salman remains to be seen.