U.S. Supreme Court to Take Up Issue of “Personal Benefit” in Insider Trading Context

The U.S. Supreme Court granted certiorari this week in a case that is sure to draw significant attention given its likely implications on insider trading liability. Bassam Salman filed the petition after the Ninth Circuit affirmed his insider trading conviction in United States v. Salman, 792 F.3d 1087 (9th Cir. 2015).

Salman was convicted of conspiracy and insider trading arising out of a trading scheme involving members of his extended family. During the time period at issue, Maher Kara, Salman’s future brother-in-law, had access to insider information regarding mergers and acquisitions of and by his firm’s clients that he provided to his brother, Michael Kara. Michael subsequently traded on the information. Michael then shared the information he learned from Maher with Salman. Salman also traded on the information.

Following his conviction, Salman appealed and argued that there was no evidence that he knew that Maher disclosed information to Michael in exchange for a personal benefit. The personal benefit requirement, first derived from the Supreme Court’s decision in Dirks v. SEC, 463 U.S. 646 (1983), requires that the insider personally benefit from the disclosure—including through pecuniary gain, a reputational benefit that will translate into future earnings, or where the insider makes a gift of confidential information to a trading relative or friend. Critical to the third manner of conferring a personal benefit, the Second Circuit recently held in United States v. Newman, 773 F.3d 438, 452 (2d Cir. 2014), that to the extent “a personal benefit may be inferred from a personal relationship between the tipper and tippee . . . such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”

Salman urged the Ninth Circuit to adopt the Newman court’s interpretation of Dirks to require more than evidence of a friendship or familial relationship between the tipper and the tippee. The Ninth Circuit declined, holding that doing so would require the court to depart from the ruling in Dirks that liability can be established where the insider makes a gift of confidential information to a trading relative or friend. The Supreme Court likely will resolve whether the concept of a personal benefit addressed in Dirks requires proof of an objective, consequential, and potential pecuniary gain—as the Newman court held—or whether it is enough that the insider and tippee shared a close family relationship.

The Newman decision has already resulted in the dismissal of insider trading charges against several individuals. The Supreme Court’s ultimate decision will therefore provide much needed clarity in this area, given the sharp split between the Second and Ninth Circuits on the issue.

Third Circuit Clarifies Extraterritorial Reach of Federal Securities Laws

The Third Circuit recently clarified the extraterritorial limits of the federal securities laws, as the U.S. Supreme Court defined in Morrison v. National Australia Bank, Ltd., 561 U.S. 247 (2010). See United States v. Georgiou, Nos. 10-4774, 11-4587, 12-2077, __ F.3d __, 2015 WL 241438 (3d Cir. Jan. 20, 2015). George Georgiou and his co-conspirators made zero-sum trades between brokerage accounts in Canada, the Bahamas, and Turks and Caicos to artificially inflate the value of four “target stocks” that were available for trade in the U.S. through two interdealer quotation systems, the OTC Bulletin Board (“OTCBB”) and the Pink Sheets. Id. at *1. Georgiou used the fraudulently inflated value of his ownership interest in the target stocks as collateral to obtain loans that he would never repay, ultimately costing his creditors and the other stockholders of the target stocks millions of dollars. Id. On appeal, Georgiou argued that his convictions could not stand because they were based on the extraterritorial application of the federal securities laws. Id.

In Morrison, the Supreme Court limited Rule 10(b)’s application to two types of transactions: “(1) transactions involving ‘the purchase or sale of a security listed on an American stock exchange,’ and (2) transactions involving ‘the purchase or sale of any other security in the United States.’” Georgiou, 2015 WL 241438, at *4 (quoting Morrison, 561 U.S. at 273). The Third Circuit determined that Georgiou’s transactions were not of the first type, even though some of the purchases were executed by market makers operating within the United States, because the SEC does not consider the OTCBB and the Pink Sheets to be securities exchanges. Id. at *4–5.

The Third Circuit held, however, that Georgiou’s transactions were of the second type because they involved “the purchase or sale of any other security in the United States.” Id. at *4. Whether a transaction is domestic, the court observed, does not depend on “‘the place where the deception originated, but [the place where] purchases and sales of securities’ occurred.” Id. at *5 (quoting Morrison, 561 U.S. at 266). A purchase or sale of securities occurs “when the parties incur irrevocable liability to carry out the transaction,” such as “the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money.” Id. at *5–6 (citations omitted) (internal quotation marks omitted). The Third Circuit held that at least one transaction in each of the target stocks involved the purchase or sale of a security in the United States because “all of the manipulative trades were ‘facilitate[d]’ by U.S.-based market makers, i.e., an American market maker bought the stock from the seller and sold it to the buyer.” Id. at *6. Accordingly, the court affirmed Georgiou’s conviction under Section 10(b).

The take away: would-be fraudsters who think they can escape federal securities laws by setting up shop outside the U.S. to manipulate domestic securities should think again.