Goodbye 'Newman'? High Court Puts Some Bite Back in Insider Trading Prosecutions

Supreme Court“To the extent that the Second Circuit in Newman held that the tipper must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to a trading relative, that rule is inconsistent with Dirks.”

In an opinion authored by Associate Justice Samuel Alito, issued barely two months after oral argument, a unanimous Supreme Court affirmed a Ninth Circuit decision upholding a criminal conviction for insider trading. A federal district court convicted Bassam Salman, a Chicago-area wholesale grocer, of securities fraud and sentenced him to three years in prison for trading on nonpublic information received from his brother-in-law. The case is a significant victory for prosecutors and law enforcement, but it still leaves several obstacles in the path of those policing insider trading.

In this case, Maher Kara, a former investment banker at Citigroup, provided inside information on upcoming transactions that he learned through his employment, to his brother, Michael Kara. Maher testified at Salman’s trial that he shared the information to benefit his brother. According to Justice Alito’s opinion, Maher expected his brother to trade on the information. Michael Kara also testified that he shared the information with Salman, and that Salman knew that Maher was the source of the information.

On appeal, the Ninth Circuit rejected the reasoning of the Second Circuit’s Newman holding that evidence of a friendship or familial relationship between tipper and tippee, standing alone, is always insufficient to demonstrate that the tipper received a benefit. The Supreme Court concluded that the Ninth Circuit correctly applied the high court’s 1983 Dirks ruling that a tipper breaches a fiduciary duty by making a gift of confidential information to “a trading relative.”

The Court specifically rejected the argument by Salman’s counsel, Alexandra A. E. Shapiro, that insider trading liability should be narrowly construed because the terms of the offense are not defined by statute. At oral argument, Shapiro urged the court to “limit this crime to its core,” which she described as “the insider's abuse of confidential corporate information for personal profit.” Justice Ginsburg immediately questioned Shapiro’s assertion, asking, “so what's the difference, if the insider trades and gives it, makes the proceeds a gift, or if he just says, you do the trade; here's the gift?”

Justice Alito wrote for the unanimous court that the Dirks decisioneasily resolves” the issue presented in Salman. The Court’s opinion echoed Justice Ginsburg’s oral argument question, as Justice Alito wrote that “Dirks specifies that when a tipper gives inside information to ‘a trading relative or friend,’ the jury can infer that the tipper meant to provide the equivalent of a cash gift … [i]n such situations, the tipper benefits personally because giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds.”

While significant, it is important to recognize that Salman is a rather narrow holding. Prior to taking the Salman case, the Supreme Court declined to review Newman. The Salman case presented a narrower question for the Court than did the Second Circuit holding, because unlike in Newman, there was no question of whether Salman knew of the breach and the source of the information. The Court did not address these issues in Salman, so prosecutors in future cases will likely be required to prove, amid often-murky fact patterns, that remote tippees knew of the circumstances surrounding the information breach. Future cases will also rarely present such a clear case of the existence of a benefit to the tipper as in Salmon’s “friends and family” scenario.