Kemp Klein

Insider Trading - Fed's Employ New Weapon

Although the Justice Dept. has accumulated over 100 criminal convictions in the last several years, including a congressman, and maybe more to come whose recent trading is suspicious, it could have had more wins if not hampered by the principal law used to prosecute. That law, Section 10(b), and its Rule 10b-5, passed in 1934, although it banned manipulative, deceptive behavior and actions, it did not address specifically insider trading. Accordingly, the federal courts were left to determine the contours of “insider trading” and what a defendant had to have done to be guilty of such a crime.

“Classic Insider Trading” is an officer, director or other executive or employee of a publicly traded company using undisclosed information concerning a material event about the company that is likely to effect the price of its trading securities, to buy or sell those securities, depending upon whether that undisclosed information is favorable or damaging.

For there to be a “crime” the government must prove under that 1934 law that the accused abused h/his “fiduciary duty” to the company. That it had violated a duty to the company and its shareholders by using, stealing, and trading on the basis of that the confidential information, for h/his own “personal benefit” or that of a close relative or friend.

However, fact scenarios often involve “tippees,” persons not directly working for the company who were tipped off by the company officer about the confidential information with the obvious intent that such tippee would engage in h/his own trading before the public became aware of the news.

To convict such a tippee s/he must know that the tipper-leaker, e.g., officer, received a “personal benefit,”

e.g., a bribe, a share of the profits or some other quid pro quo. However, sometimes tippees don’t receive their tip directly from the company tipper, but from the first (or a prior) tippee.

These, down the line, “remote tippees,” often do not know the identity of the company tipper/leaker nor whether s/he received any personal benefit for h/his leak. Without knowing there was a personal benefit, courts have ruled that such remote tippee could not have known that there was a breach of fiduciary duty and could not be convicted.

Along comes Sarbanes-Oxley Act in 2002. It also has a securities fraud provision. It took the government 17 years to figure out it could also use Section 1348 of that 2002 statue to prosecute insider trading including dealing with the remote tippee who had formerly gotten off scot-free. In December 2019, a NY federal court of appeals upheld a verdict that such that law does not require a breach of fiduciary duty or a personal benefit to the tipper. All that it requires for conviction is that the trading tippee obviously knew the information was confidential, as-of-yet undisclosed, important enough to move markets, and traded while in possession, using, that confidential information.

Remote tippees now beware. You are the next target and could face 25-year prison terms.

For questions about this please contact Kemp Klein.