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THE U.S. SUPREME COURT CLARIFIES THE DEFINITION OF INSIDER TRADING- A BIG WIN FOR PROSECUTORS

By Erwin J. Shustak, Esq. of Shustak Reynolds & Partners, P.C. posted on Wednesday, December 7, 2016.

Erwin J. Shustak, Esq.
619.696.9500 ex. 109
[email protected] 

For the first time since 1983 when the Supreme Court issued its decision in Dirks v. SEC, the Supreme Court yesterday clarified what “personal benefit” the tipper of non-public, inside information must receive from the tippee to sustain a conviction against the tippee who trades on that inside information. The Supreme Court’s decision makes it clear that when one with non-public, inside information gives that information to a “trading friend or relative” who, in turn, trades on the information, and without any proof the tippee gave or agreed to give anything of monetary value for the information, the mere gift of inside information allows the trier of fact (i.e. the jury) to infer the tipper personally benefited from making the gift of inside information.

The decision, handed down December 6th, is Salman v. United States which arose out of the 9th Circuit Federal Court of Appeals in San Francisco. The decision essentially relaxes the requirements for prosecutors to prove, and win, insider trading cases under Section 10(b) of the Securities Exchange Act of 1934 and the SEC’s Rule 10b-5 which prohibit undisclosed trading on inside information by persons bound by a duty of trust and confidence not to exploit that information for their personal advantage. The Court’s decision in Salman resolves a dispute between the Second and Ninth Circuits and overrules the standard that had been used in the Second Circuit (which covers New York, the hub of the financial industry) since the 2013 Newman decision. The rule in the Second Circuit, decided in United States v. Newman in 2013, had been that prosecutors needed to show more than a mere gift of inside information to a tippee from a tipper. In Newman, the Second Circuit had ruled that there needed to be proof of an actual gift or money or something of monetary value from the tippee to the tipper. It had vacated a conviction against Newman where there was no proof that he, as the tippee who traded on inside, non-public information, had given or promised anything of value to the tipper. Yesterday’s Salman decision effectively overrules the Newman decision and resolves what had been a significant dispute between the Second and the Ninth Circuit Federal Courts of Appeal.

The facts of Salman are simple. Salman was indicted, and convicted, for federal securities fraud crimes for trading stocks on inside information he received from his brother in law, Michael Kara. Kara, in turn, had received an insider “tip” from his brother, Maher Kara, a former Citigroup investment banker. At Salman’s trial, Maher Kara testified he had shared inside information about a public company with his brother, Michael, which he expected Michael to use to trade stocks for his personal, financial benefit. Michael, in turn, testified that when he received this inside information from his brother Maher, he also shared it with his brother-in-law, Salman, who knew the inside information had originated from Maher. Salman was convicted at trial.

On appeal, Salman argued that, under the Second Circuit’s decision in Newman, the jury was not entitled to infer a personal benefit to the tipper (Maher) from a gift to Salman (the tippee) of confidential information, absent proof that the tipper received at least “…a potential gain of pecuniary or similarly valuable nature”. Salman argued to the Ninth Circuit, in effect, that since he never gave, or promised to give Maher anything of monetary value in exchange for the inside information, he could not be convicted of insider trading. The Ninth Circuit disagreed, holding that the mere gift of inside information to a trading friend or relative, even without the transfer or promise to transfer something of monetary value in exchange, satisfied the statute. The Ninth Circuit upheld Salman’s conviction and refused to follow the Second Circuit’s more restrictive rule established by its decision in Newman.

In a unanimous 8-0 decision (since deceased Justice Scalia’s vacant seat has not yet been filled with a replacement), the Supreme Court re-affirmed its 1983 decision in Dirks and ruled that the mere gift of inside information to a trading friend or relative is sufficient proof on which a jury could convict the recipient of that inside information of insider trading.

The decision is a great relief to prosecutors who feared that Newman would undercut their ability to prosecute, and successfully win convictions of insider trading cases where inside information is given to trading friends or relatives as a gift or favor, without anything of monetary value changing hands for that information. The decision, in my opinion, is the correct one. Anyone receiving inside information who then trades on that information knows: (i) the information is non-public, confidential and was not meant to be disseminated or shared; and (ii) by trading on that non-public, inside information, the tippee knows he or she is taking a risk of prosecution for insider trading.

Shustak Reynolds & Partners, p.c. focuses in the areas of securities, financial services and complex business disputes. For more information, contact our managing partner, Erwin Shustak. More information is available at www.shufirm.com.

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