Salman v. United States And Its Impact On Insider-Trading Enforcement
On December 6, 2016, the U.S. Supreme Court ended two years of uncertainty surrounding what actually constituted illegal “insider-trading” for the “tippers” who pass on confidential information to others, and for the “tippees” who receive the information and trade on it.
2 In Newman, the Second Circuit held that a gift of material non-public information for trading purposes among friends and family did not run afoul of the insider-trading laws unless there was a quid pro quo of a pecuniary nature. In its restoration, the Supreme Court likely unleashed federal enforcement authoritiesthat were already aggressively pursuing these cases during the period of uncertainty. This article first revisits the basics of insider-trading law; second, it describes the holdings in Newman and Salman; and third, it makes predictions about future enforcement efforts and legal battlegrounds. I. INSIDER-TRADING LAW BASICS A discussion of Salman requires a rehash of the insider-trading legal framework. There is no “insidertrading” statute, as such. Insider-trading law sprouted from the fraud provisions of Section 10(b) of the Exchange Act,
3 and from the SEC’s Rule 10b-5promulgated thereunder.
4 Section 10(b) prohibits using a “manipulative or deceptive device or contrivance” in connection with securities trading, and Rule 10b-5 prohibits employing a “device, scheme, or artifice to defraud,” among other imprecisely defined activities. Neither on its face has anything directly to do with insider-trading. There are two primary theories of insider-trading rooted in these anti-fraud laws: the “classical” or “traditional” theory and the “misappropriation” theory. There is also (arguably) a third theory arising from the plain language of these rules, what may be called the “deceptive device” or “affirmative misrepresentation” theory, where the wrongdoer employs traditional methods of fraud, as in the context of computer-hacking.
These are discussed below.
A. The “Classical” Theory The classical theory involves an insider of a company who trades in breach of a duty of trust and confidence. It is deceitful, the theory goes, to take advantage of the other party to the securities transaction — buyer or seller — for personal gain when you have been entrusted with this information for corporate purposes. The classical theory was given clarity by the Supreme Court in Chiarella v. United States.
5 Chiarella was a socalled “markup man,” an apparently low-level employee who handled documents for a financial printing company. He was able to deduce corporate takeover targets from the documents he marked up. He traded on the information, got caught, settled with the SEC, but then got indicted and convicted. The law of insider-trading to that point was based on the equal-access-to-information theory: if you had material inside information, you had to disclose it to the investing public or refrain from trading on the information. The issue in Chiarella was the legal effect of the defendant’s silence, that is, the effect of his failure to tell the counter-party to his transactions that he knew a takeover was imminent. The Supreme Court rejectedthe equal-access theory — what it called the “parity-ofinformation rule” — and held that there can be no fraud, and thus no insider-trading conviction rooted in fraud, without a duty to speak. Chiarella had no such duty and thus his conviction was overturned.
B. The “Misappropriation” Theory Chiarella left open the question of whether somebody, like Chiarella, had a duty, or could breach a duty, to an insider who gives him confidential information, like the companies that hired his employer to print out their tender offers. That question leads to the so-called “misappropriation” theory, where an outsider in essence steals the information by using it in breach of a duty to the insider who gave him the information. The Supreme Court solidified the misappropriation theory in United States v. O’Hagan.
6 O’Hagan was a partner at Dorsey & Whitney in Minneapolis, and one of his law partners represented a company in its potential tender offer of Pillsbury. In possession of this information, O’Hagan bought thousands of Pillsbury call options and thousands of shares of Pillsbury stock, and made millions. Like Chiarella, he got caught and was indicted, convicted, and sentenced to prison. The Eighth Circuit reversed his conviction, finding that O’Hagan had no duty to the shareholders that sold him the Pillsbury stock and options, but the Supreme Court reinstated the conviction. Under the misappropriation theory, the Court held, a defendant owes a duty to the source of the information, not to the other parties to the transaction.
Justice Ginsburg, who authored the majority opinion, wrote, In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the company’s stock, the misappropriation theory premises liability on a fiduciary-turned-trader’s deception of those who entrusted him with access to confidential information. The fraud is the pretense of loyalty to the principal, while converting the information for one’s personal gain.
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