The Supreme Court and Insider Trading

Earlier this year I blogged about the fact that insider trading isn't technically illegal. It sounds far fetched, but it's true. There isn't a law on the books that specifically defines insider trading. For the back story, see the NASPP blog entry "Insider Trading Isn't Illegal?" from April 2, 2015. In the the latest twist in a story recited in that earlier blog, the Department of Justice is now petitioning the Supreme Court to review a key insider trading ruling. Could this mean the high court ends up defining insider trading once and for all? I'll explore that in today's blog.

The Back Story

The story begins with a ruling in December 2014 by the Second U.S. Circuit Court of Appeals (U.S. v. Newman) that overturned two “key” insider trading convictions, dealing a blow to the Justice Department and the SEC. At the time, the Wall Street Journal summarized the situation as follows: “…a federal appeals court overturned two insider-trading convictions and ruled it isn’t always illegal to buy or sell stocks using inside information.

The ruling raised the bar for prosecutors on a crime that is already hard to prove, and it will likely limit the types of cases the government can pursue.

Specifically, the three-judge panel of the Second U.S. Circuit Court of Appeals said prosecutors must prove traders knew that the person who provided an inside tip gained some sort of tangible reward for doing so. The judges also said it may be legal to trade on inside information, even if it gives an investor an unfair advantage in the markets, as long as the tipper didn’t commit an illegal breach of his or her duty.”

Key aspects of the appellate ruling were that in order for insider trading to have occurred,

• “the tippee know both that the tipper breached a duty of confidentiality and

• the tipper received a personal benefit of “some consequence.”

How is the Supreme Court Now Involved?

Last week, the Department of Justice petitioned the Supreme Court to review the appeals court ruling in Newman.

As described in the Wall Street Journal, "The government argues that the appeals court’s definition of what constitutes 'personal benefit' goes against a prior Supreme Court Decision, as well as conflicts with decisions made by two other courts of appeals. In its petition, the DOJ says the Second Circuit ruling 'frustrates key purposes of the securities laws,' and “blurs the lines between legitimate and prohibited activity.”

Further, the DOJ argues that any delay by the Supreme Court 'will result in continuing and serious harm' to securities markets."

What's Next?

The parties in the original case, Mr. Newman and Mr. Chiasson, may file an opposition to the DOJ’s request, according to a memo written by the law firm Davis Polk. If they do, the government has the opportunity to reply and then the court will decide, after a conference, whether or not to hear the case.

According to the Davis Polk memo, while the Supreme Court reviews only very small percentage of cases, this case may have the factors to warrant a review. There is a division in the lower courts over how to define "personal benefit" in the context of insider trading, and that inconsistency may make Supreme Court review more likely. Stay tuned.