There are two events driving and linking this post. First, the Supreme Court will hear argument in United States v. Salman (PDF: 97 KB) within the next few weeks, and second, the start of football season. Although these events don’t seem to go together, they do here. In the wake of United States v. Newman (PDF: 357 KB) (a precipitating factor in Salman making it to the High Court) the government seems to be employing an end run around the Newman Case.
For those non-football junkies out there, the end run is a play where the offense tries to get the defense to move one way, while the runner is moving in the opposite direction to evade the defense. In its most basic form an end run is an attempt to circumvent.
As we all know by now, Newman requires the government to prove, in an insider trading case, that the tipper and tippee exchanged a personal benefit for secret information and that the tippee (no matter where she falls in the tipping chain) knew there was a personal benefit.
The Newman end run comes into play in relation to 10b5-2. 10b5-2 permits corporate insiders to disclose confidential corporate information to outsiders where there is: (1) an explicit agreement to keep information confidential, (2) a pre-existing history of sharing confidences, or (3) a close familial relationship (i.e., spouses, parents, children and siblings).
A typical insider trading case involving more than one person unfolds as follows: a corporate insider (rightfully in possession of material nonpublic information) discloses the information to another and the latter trades and/or tips others who trade. Typically, the loose-lipped corporate insider is the tipper, the recipient is the tippee and the second recipient is the remote tippee.
But in an end run around Newman, the fact pattern changes dramatically. This is best illustrated by way of real-world examples. In SEC v. Payton, a Lawyer who worked for a prominent law firm disclosed merger information about one of the firms’ clients to a Friend. The Friend later shared the information with his Roommate and the Roommate subsequently tipped several Co-Workers. The Friend, the Roommate and the Co-Workers all traded and profited.
Can you identify the tipper? If you guessed the Lawyer, the one who owed a duty to his law firm to keep information confidential … you would be wrong. The SEC alleged that there existed a history of trust and confidence between the Lawyer and his Friend (stemming from their 8-month long relationship in which they discussed sexual conquests, played basketball and occasionally used recreational drugs) that permitted the Lawyer to reveal secret information to a Friend who worked as a stock trader. Remarkably, the complaint deemed the Lawyer a victim and the Friend, essentially, a thief. The SEC won a jury trial against the Friend and the other tippees.
The criminal authorities followed suit in a different case. In United States v. Valvani, the government charged a Portfolio Manager at a hedge fund with insider trading. There, an FDA official shared confidential information with a former colleague/Consultant to a hedge fund. The Consultant allegedly passed the information to the Portfolio Manager. The Consultant received a consulting fee from the fund and the Portfolio Manager traded and profited for the fund. (This case was subsequently dismissed after the Portfolio Manager committed suicide).
Again, can you identify the tipper? If you guessed the FDA official who owed the duty of confidentiality to his employer … well you would be wrong again. Here, the government alleged that there existed a history of trust and confidence between the FDA official and the Consultant (stemming from their previous relationship as colleagues and friends, and ignoring that the Consultant was a known paid Consultant for a hedge fund). The charging document deemed the FDA official a victim, the Consultant a misappropriator of information and the Portfolio Manager an insider trader.
A cynical fellow might opine that these charging decisions were made deliberately to circumvent Newman’s knowledge of personal benefit requirement in relation to the remote tippees because it is easier to convict certain tippees if one fudges who the real tipper is. If that’s true, here’s my problem: either you broke the law or you didn’t. The decision as to whether someone is a tipper should be made based on whether they had a proper reason and purpose for disclosing the information, not whether it makes it more difficult for the government to prevail against certain remote tippees. Then again, 10b5-2 seems to allow the government to choose who to allege is the tipper, even if the facts suggest otherwise.
Just yesterday, in fact, the SEC charged hedge fund manager Leon Cooperman with insider trading under … you guessed it … 10b5-2. The SEC complaint alleges that an APL Executive leaked confidential corporate information to Cooperman, but elicited Cooperman’s explicit agreement not to trade on the information. Under this theory the personal benefit, which is required in misappropriation cases, is obvious: Cooperman trades on the misappropriated information and benefits himself by making money. If, however, the complaint failed to allege this explicit agreement not to trade, Newman would mandate that the SEC prove the personal benefit that flowed from Cooperman to the APL Executive. The latter strikes me as a much harder case than the former. Why prove personal benefit if one can do an end-run around it?
One final example: a criminal case where the Son worked for an investment banker, and shared corporate information with his Father. The Father tipped his Friend and both traded.
Can you identify the tipper here? If you learned from the first two examples that you should have guessed the father … well you are 0-3, because that’s wrong. In United States v. Stewart, the government charged the Son as the tipper, ignoring 10b5-2(3)’s rule that deems parent-child relationships one presumptively within the scope of the rule allowing information disclosure. Even though the Son claimed he did not know his Father traded, and the Father apparently confessed that he misappropriated the information from his Son, the government charged and convicted the Son as a tipper.
Will the government continue to end run Newman? Will it even need to after Salman is decided? How this all plays out, time and the Supreme Court will tell. One thing I think we can know for sure is the Salman opinion could cause more and more government agencies to ask: Are you ready for some football?
Gregory Morvillo is a partner in the New York office of Morvillo LLP. He specializes in insider trading and securities fraud cases.
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