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Ninth Circuit Tempers Second Circuit Ruling on Insider Trading Cases
Practical Law Legal Update w-000-4713 (Approx. 5 pages)
Ninth Circuit Tempers Second Circuit Ruling on Insider Trading Cases
by Practical Law Litigation
| Published on 21 Jul 2015 • USA (National/Federal) |
In United States v. Salman, the US Court of Appeals for the Ninth Circuit declined to extend a controversial appellate ruling from the Second Circuit that raised the bar for prosecutors to secure insider trading convictions. In an interesting twist, Southern District of New York Judge Jed Rakoff, sitting in the Ninth Circuit by designation, wrote the opinion. In it, the Ninth Circuit held that proof that an insider disclosed material, nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish the fiduciary element of insider trading, even without any tangible pecuniary benefit to the insider.
On July 6, 2015, the US Court of Appeals for the Ninth Circuit declined to extend a controversial appellate ruling from the Second Circuit that raised the bar for prosecutors to secure insider trading convictions where inside information is passed among family members. The twist? The Ninth Circuit's opinion is written by Southern District of New York Judge Jed Rakoff, sitting in the Ninth Circuit by designation. (United States v. Salman, No. 14-10204, (9th Cir. July 6, 2015).)
Maher Kara (Maher) began working for Citigroup's healthcare investment banking group in 2002. Maher regularly disclosed information about upcoming Citigroup client mergers and acquisitions to his older brother, Mounir "Michael" Kara (Michael), who traded on that information. Over time, Michael shared the inside information with Appellant Bassam Yacoub Salman (Salman), who was Maher's brother-in-law and close friends with Michael. Michael also encouraged Salman to replicate his trading activity.
Michael and Salman profited significantly from numerous trades in securities issued by Citigroup clients shortly before the announcement of major transactions. Although Maher did not receive any money or other tangible benefit from Michael in exchange for the inside information that he provided, he testified at trial that he intended to benefit Michael and fulfill whatever needs he had by passing along the information.
A jury convicted Salman on five counts of conspiracy and securities fraud arising from an insider trading scheme. Salmon appealed, but did not challenge the sufficiency of the government's evidence in his opening brief. After he filed his reply brief, the Second Circuit vacated insider trading convictions of two defendants based on the government's failure to present sufficient evidence that the defendants, who traded on insider information (tippees), knew the information they received from the insider (tipper) had been disclosed in breach of the tipper's fiduciary duty (see United States v. Newman, 773 F.3d 438 (2d Cir. 2014)). In Newman, the Second Circuit specifically interpreted Dirks v. SEC and others to hold that:
- Under Dirks, a tippee cannot be liable for insider trading unless the tippee knows or should know that the tipper breached a fiduciary duty to his employer by disclosure of inside information for the tipper's personal benefit (463 U.S. 646 (1983)).
- To the extent Dirks suggests that a benefit may be inferred from a personal relationship, such an inference is impermissible in the absence of proof of a meaningfully close personal relationship including an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.
Based on the Second Circuit's holding, Salman promptly moved for leave to file a supplemental brief. In his brief, he argued that the Ninth Circuit should adopt Newman and find that the evidence in his case was insufficient to prove that Maher disclosed the information to Michael in exchange for personal benefit, or that Salman knew of any benefit to Maher. Although Salman did not raise these issues in his opening brief, the Ninth Circuit agreed to consider his arguments because both parties had a full opportunity to brief and address the issues at oral argument, avoiding any prejudice to the government.
After reaching the merits of Salman's arguments, the Ninth Circuit panel unanimously affirmed his conviction. Judge Rakoff stated that the panel "would not lightly ignore the recent ruling of our sister circuit" by whose rulings Judge Rakoff is usually bound. Even so, the Ninth Circuit:
- Rejected Newman's conclusion that the government cannot prove the receipt of a personal benefit by the mere fact of a friendship, particularly of a casual or social nature.
- Relied on Dirks's holding that the "elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend" (Dirks, 463 US. at 664).
- Held that the government's evidence that Maher's disclosure was intended to benefit Michael, and that Salman knew as much, sufficed to uphold the conviction.
The Ninth Circuit's opinion in Salman follows Judge Rakoff's recently expressed concerns in his home court about the Second Circuit's ruling in Newman, where he noted that Newman's definition of "benefit" was not obvious under Dirks, and that "it may not be so easy for a lower court, which is bound to follow both decisions, to reconcile the two" (see SEC v. Payton, No. 14 Civ. 4644, , at *4 (S.D.N.Y. Apr. 6, 2015) (denying a motion to dismiss insider trading charges against two defendants based on a close, mutually dependent financial relationship between the tipper and tippee)).
The evolving standards in the Second and Ninth Circuit on insider trading result from the trend toward increased white collar prosecutions by regulators, particularly in the area of securities fraud. For more information about the government's tactics and strategies in enforcing federal criminal laws against corporate personnel, and practical advice to mitigate the risk of liability, see Practice Notes, Trends in Federal White Collar Prosecutions and Criminal and Civil Liability for Corporations, Officers and Directors. Practical Law also has a variety of resources to help companies and counsel manage risk by staying informed about the nuances and changing landscape of securities litigation, including: