The Supreme Court on Wednesday is scheduled to hear a case that could mark the biggest rewrite of insider trading law since the days of Michael Milken and Ivan Boesky.
Salman v United States lacks the Wall Street stars that made trading on insider information a defining feature of the 1980s. But Bassam Salman’s appeal of his 2013 conviction for trading on information he received from his brother-in-law, at the time a Citigroup investment banker, could settle a question that has bedevilled markets players.
At issue is whether insider trading prosecutions require that corporate tipsters receive something of value in return for disclosing market-sensitive information. Two lower courts in two years have disagreed on the issue, piquing the high court’s interest.
Prosecutors warn that such a requirement would hamstring their efforts to keep markets clean, but hedge fund managers, research analysts and traders worry that too broad a definition of insider trading would criminalise the flow of routine market chatter.
“It’s potentially the most important case for market professionals in over 30 years,” says attorney Jon Eisenberg of K & L Gates in Washington.
Among those watching is hedge fund magnate Leon Cooperman. In a civil suit last month, the Securities and Exchange Commission accused the Omega Advisors chief executive of insider trading. Prosecutors in the Southern District of New York are awaiting the Supreme Court’s Salman verdict before deciding on criminal charges, Mr Cooperman has told his investors.
In the Salman case, Maher Kara, Salman’s brother-in-law who worked in Citi’s healthcare investment banking group, disclosed planned merger deals to his older brother Mounir. The brother traded on the intelligence and tipped Salman, who with an associate reaped roughly $1.7m in profits.
A federal judge in San Francisco last year sentenced Salman to three years in prison and ordered him to pay more than $738,000 in restitution. Salman’s argument in the Supreme Court hearing is that the government failed to show that the insider, Mr Kara, received a benefit in return for the disclosures.
Salman’s appeal follows a multiyear insider trading offensive by US Attorney Preet Bharara in New York, which notched up several dozen convictions and rocked the hedge fund industry. The SEC, meanwhile, filed civil charges against 87 individuals in fiscal 2015 with trading on the basis of inside information, roughly double the number from two years earlier.
US Insider Trading: Hello Newman
In the US, there is no statute that explicitly addresses insider trading
Insider trading captured the popular imagination in the 1980s as figures such as junk bond king Michael Milken, and Ivan Boesky, a stock trader, rose to wealth and prominence before drawing the scrutiny of prosecutors. In the 1987 film Wall Street, the Boesky-like character Gordon Gekko counsels a young protégé: “If you’re not inside, you’re outside.”
Yet for all the notoriety, insider trading is not defined in US law. Market enforcers and a succession of judges have inferred the prohibition on such activity from a provision in the 1934 Securities Act barring deceptive or manipulative trading. Christopher LaVigne, a partner at Shearman & Sterling, calls insider trading law “an amorphous area”.
The Supreme Court set the rules with a landmark 1983 ruling that overturned the conviction of analyst Ray Dirks. He had been prosecuted after alerting shareholders to a fraud at Equity Funding Corporation of America, an insurance company. In Dirks v SEC, the court ruled that prosecutors must prove that a tipster received a “personal gain” in return for violating his duty to keep market-moving information secret.
Defining personal gain, other than financial payments, has proven difficult. The court held that a gift of valuable information to a friend or relative also qualified, reasoning it was akin to the insider trading on the information himself and making a gift of the proceeds.
The SEC’s view of who qualified as a “friend” expanded over the years to encompass insiders’ networks of business contacts. But In 2014, the Second Circuit appeals court issued a ruling that limited the government’s ability to bring such prosecutions within the states that it covers, including New York.
The court overturned the conviction of two hedge fund managers, Todd Newman and Anthony Chiasson, ruling that they were too far removed from the initial trading tip to know that an insider had improperly disclosed the information in return for a gain.
Prosecutors said the decision severely restricted their ability to bring cases against Wall Street insiders. And more than one dozen insider trading convictions subsequently have been set aside, including that of SAC Capital portfolio manager Michael Steinberg and six of his firm’s analysts.
Salman is now arguing that the Supreme Court should extend that ruling nationwide. Attorneys representing billionaire Mark Cuban, who was acquitted in 2013 on insider trading charges, also have filed an amicus brief arguing that Salman’s conviction only compounded the ambiguity over what trading is banned.
“The government will continue to bring insider trading cases,” says John Zach, who prosecuted the Newman case and is now a partner at Boies, Schiller & Flexner in New York. “But should they rule for (Salman), this will limit the types of cases they can bring.”
Casual tips to “golfing buddies” and relatives, which have been targeted in the past, would escape the government’s net, he says.
Defence attorneys are hoping the court clarifies both what sort of benefit an insider must receive and what someone who receives the tip must know about its origins. “These are the two key uncertainties,” says Tom Sporkin, a former SEC enforcement official and now a partner at Buckley Sandler in Washington. “This is an opportunity for the Supreme Court to settle these questions.”