Inside Trading Case Law Assessment

Supreme Court Landmarks on Insider Trading

Insider trading has been an issue that the Securities and Exchange Commission (SEC) has worked towards resolving over the years. Primarily, insider trading provides an unfair advantage to the trade of shares and stocks by individuals with more information than others. In essence, the public trading of stocks and shares requires that participants be aware of the processes and changes that may affect the trading process. In this directive, insider trading is deemed an unfair advantage by parties who take action that favors their chances of profitability against other participants who are unaware of any progress or changes. Therefore, the role and mandate of the SEC is to implement the relevant laws against insider trading to prevent illegal and unfair methods of capitalizing on trading information.

The United States Supreme Court has set relevant precedents concerning the approaches and understanding of what constitutes insider trading. In the triumvirate of Supreme Court landmark decisions associated with insider trading law, the primary question that sought to be addressed was whether the plaintiffs violated Section 10 of the Securities Exchange Act of 1934. In essence, there was a need to understand to what extent federal laws would be deemed to be violated when insiders of companies decide to trade. In the triarchy of decisions by the Supreme Court, it was evident that the actions of the company insiders were not in violation of the federal laws as per the provision of section 10 of the Securities Exchange Act of 1934. Therefore, the Supreme Court's decision addressed the fiduciary duty issue.

Naturally, insiders are often equipped with information and data about how their companies are bound to trade and the potential consequences of the trading activity. In both the matters concerning Chiaraella and O'Hagan, the plaintiff came into information that concerned the overall trading of the company shares where they worked. The knowledge acquired enabled them to make decisions in their favor and profit them accordingly. As insiders, they were both accused of violating the provisions of Section 10(b) of the 1934 Act on the grounds of violating their fiduciary duty. It was purported in the lower courts that in both cases, the parties had the fiduciary duty to disclose the information they had acquired concerning the future trends in trading the company shares. Significantly, the position in the trial courts that the plaintiffs were conducting insider trading granted them a higher advantage than others.

However, in both cases, the Supreme Court's decision found that the plaintiffs had no fiduciary duties to make reports of their found knowledge. On the contrary, the Supreme Court acknowledged that neither Chiaraella nor O'Hagan were directly involved in trading the companies. Therefore, the plaintiffs were not under the mandate to disclose any information they acquired about the company. In the absence of the fiduciary duty to the company, both Chiaraella and O'Hagan had no duty to disclose the privileged information. Hence, their actions were not in violation of any given federal laws.

Similarly, Dirks^[1] also came across information associated with the trading of shares in a company and informed the investors about the impending fraud by the respondent. In this capacity, Dirks was purported to have violated § 17(a) of the Securities Act of 1933 and § 10(b) of the Securities Exchange Act of 1934. However, subject to his position as an officer of a broker-dealer firm, it was within his mandate to provide intel on all information.

The decisions of the Supreme Court essentially laid due precedent on how to approach and interpret the provisions as contained under § 10(b) of the Securities Exchange Act of 1934. The individuals in the matter did not hold positions as agents of the companies, nor did they hold any fiduciary relationship with the companies. Therefore, the individuals were not mandated by law to report the information found in the public domain to highlight the potential fraud. Significantly, the plaintiffs' role in the cases was not associated with the companies; therefore, they had no mandate to make the information acquired known. On the contrary, in their capacity, Chiaraella, O'Hagan, and Dirks were more bystanders who could get across information that they could use to their benefit. Overall, the precedent set by the Supreme Court thus set forth an understanding of how the insider trading laws were interpreted and how they applied concerning the provisions detailed under § 10(b) of the Securities Exchange Act of 1934 concerning fiduciary duties on insider trading information.

Progression of Newman

The precedent set by the Supreme Court in the preceding cases associated with Chiaraella, Dirks, and O'Hagan provided that third parties to the information associated with insider information were not entirely liable or responsible for the outcomes. In essence, the fiduciary duty is not bestowed on the third parties but on the individuals directly trading the securities. In this directive, the third parties akin to insider trading information have been overlooked for the longest time, even though they pose a significant disadvantage in the investigations carried out to eliminate the negative impacts of insider trading. Practically, the SEC has worked towards establishing stable grounds and rules to ensure that the performance of the securities and trading that goes on does not violate the rules involved in protecting the trade of securities. However, the hardship associated with the precedents set by the Supreme Court proved to be a limiting factor in reducing the effects and impact of insider trading and involving third parties.

The tipper-tippee insider trading liability thus forms the primary focus in the Newman case. Primarily, the conviction of Newman led to the resetting of the insider trading theory that was advanced by the prosecutors, leading to the reversal of the decision that was arrived at in Dirks v SEC.^[2] The tipper's liability in the matter of Dirks was essentially vested on the grounds of breaching the fiduciary duty in which the third party would receive a personal gift in exchange for disclosing information that is not readily available in the public domain.^[3] Therefore, in the absence of personal benefit, it is deemed that there is no breach of duty and no tipper liability. Furthermore, in the Dirks matter, it was determined that the tippee's liability was based on two things. First, when the tipper breaches their fiduciary duty^[4] , and second, when the tippee is aware of the breach. The Second Circuit, however, brought into perspective the stance associated with the tipper-tippee liability.

The Second Circuit's decision in Newman's matter reversed the potential prosecutional overreach by the courts based on the decisions that had been arrived at concerning insider trading. Significantly, the Second Circuit Court rebuked the "doctrinal novelty of [the Government's] recent insider trading prosecutions, which increasingly target[]…remote tippees many levels removed from corporate insiders."^[5] The Second Circuit Court, in hearing the matter, took into account the arguments brought forth by the defendants on the grounds that "a tippee's knowledge of the insider's breach necessarily requires knowledge that the insider disclosed confidential information in exchange for personal benefit."^[6] Significantly, the position of the Second Circuit Court rejected the theory presented by the prosecution that the information that the defendants had obtained was, in fact, suspicious enough to support grounds that they had knowledge of the insider's disclosures and associated benefits. It was the court's position that the insider-tippers did not receive any benefits for exchanging the tips that they had.

According to the Second Circuit Court, the consideration of the personal benefits received by insiders would be too generalized because even in the case of career advice, friendships between insiders and other people would be considered based on personal benefits. In this regard, the present loophole would be too wide for the prosecution to deal with matters associated with insider trading. The Second Circuit Court established that the prosecution must establish a relationship between a tipper and the tippee that would essentially project a quid pro quo status. The consequences of the proposition of the Second Circuit Court in the requirement for evidence of an existing relationship between a tipper and tippee and the consequential personal benefit heightened the evidentiary burden to indicate the breach of fiduciary liability.

Aside from the evidentiary burden on the Government on the fiduciary duty requirements, the court also provided for the need to show that the tippee must have due knowledge of the tipper's benefit in pursuit of the insider trading convictions. Significantly, this provision works in favor of the inside traders because the tipper and the tippee may not have to know each other. Therefore, the prosecution would be barred from establishing the required evidence that the tipper and the tippees have an existing relationship and they are aware of the consequential personal benefit. Primarily, the progression of the Newman matter has, in turn, presented more challenges than solutions to prosecuting the inside traders and the associated parties they work with in the fraudulent activities.

Consequently, the stance and holding of the Second Circuit Court in reversing the position of the Supreme Court in the Dirks matter paved the way for more complications in the determination of inside trading cases as opposed to the provision of more solutions to the SEC and DOJ in the resolution of insider trading issues. Ultimately, the progression of Newman served to benefit the insider traders more than it benefited the prosecution. Ultimately, the prosecution is subject to more scrutiny in trying the insider trading cases than the defendants in the matters.

New Grounds for Insider Trading

The rules set forth by the Second Circuit Court in relation to the grounds that are to be pursued in the determination for trial for matters associated with insider trading were thus put to the test and also set aside in the matter involving Blaszczak.^[7] Primarily, the issues arising in the matter manifested the issues of trying insider trading cases. The defendant was involved in an embezzlement scheme that sought to defraud CMS. Ideally, the issue emerging from the case involved federal wire fraud, securities fraud, and conversion, codified at 18 USCS §§ 1343, 1348, and 641, respectively, engaging in securities fraud in violation of Section 10(b) of the Securities and Exchange Act, 15 USC § 78j(b), and SEC Rule 10b-5 in relation to the misappropriation of confidential information obtained from the Centers for Medicare and Medicaid Services.^[8]

The indictment essentially involved the fact that confidential information was disclosed by CMS employees to Blaszczak, who was, in fact, a political intelligence" consultant for hedge funds. Blaszczak shared the information with the employees at healthcare-focused hedge fund Deerfield Management Company, LP (Deerfield). The hedge fund thus used the information to trade and was therefore found to have engaged in wire fraud, conversion, and securities and fraud as provided for under Title 18. The central issue in the matter was vested in determining whether the wire fraud, conversion, and securities fraud statutes as provided for under 18 USC §§ 1343, 1348, and 641 were sufficient in determining the misappropriation of government agency's confidential information.

The conviction of the defendants was essentially based on the evidence produced on the defrauding activity involving confidential information from CMS. Practically, the position of the matter resulted in the concentration on the matters associated with government property. In this directive, the precedent and rules concerning the relationships between the tippers and the tippees that were initially focused on by the Second Circuit Court were not considered the primary factors for concentration. The Second Circuit Court, however, upheld the convictions of the defendants, and as a consequence, the court impacted the decision and determination of other insider trading cases from two primary perspectives.

The first perspective was based on the fact that the traditional approach towards the resolution of both civil and criminal insider trading matters required evidence touching on the breach of fiduciary duties by the tippers in exchange for a direct or indirect benefit. Secondly, the tippee was required to be aware of the actions of the tipper and their consequences. The Second Circuit Court, in this matter,^[9] found that the confidential nature of the property involved in the case was necessary to highlight the insider trading involving the embezzlement and misappropriation theory. Therefore, the decision of the Second Circuit Court essentially resulted in the expansion of criminal insider trading liability whereby the prosecution had limited to almost no evidence associated with the personal benefit to the tipper or the knowledge of the tippee. The expansion of criminal insider trading activities also involved cases that were associated with the fraudulent exposure and disclosure of confidential and nonpublic government information obtained from government agencies.

Ultimately, the decision of the Second Circuit Court remains relevant mainly on grounds of the consequences that would be attributed to the determination of other cases, including Kelly v. United States,^[10] that was involved in the Bridgegate matter and involved the scope of government property. Overall, it is the position of the Second Circuit Court to provide a distinction between the exercise of regulatory power in the Kelly matter and the predecisional government information as in the matter of Blaszczak. The decision of the Second Circuit Court stands out as relevant and critical in relation to the understanding of confidential property. Overall, the Second Circuit Court has to ensure that its decisions are well-impacted and grounded in the provision of a solution to the determination of insider trading matters.

Insider trading liability continues to be a challenge in the United States, and it is critical that the decision of the Second Circuit Court is aligned with the provisions of the law to provide the opportunity to capture successful trials and determine insider trading cases. The determination of liability is also critical as it is used in the assessment and determination of the stance of the Second Circuit Court. The decisions of the court will be analyzed with the prior rules that it had established in terms of providing evidence showing the breach of fiduciary duty for the opportunity of personal benefit and the inclusion of evidence revealing the knowledge of the tippee about the activities of the tipper. In the long term, the Blaszczak matter has placed a spotlight on the Second Circuit Court and its final decision.

Analysis and Opinion on Insider Trading

White-collar crimes in the United States have been difficult to resolve and have consequently impacted the operations of different businesses differently. Insider trading is among the white-collar crimes that have crippled several businesses in the United States involved in the trade of securities. Critically, the sensitivity of trading securities, more often than not, attracts the attention of the SEC and the need to adhere to the provisions contained in the federal statutes governing the trading of securities. However, insider trading has paved the way for traders to gain information fraudulently, which consequently impacts In essence, through insider trading, individuals and companies have had the opportunity to make fraudulent profits at the expense of other traders within the same capacity. The introduction of the tipper-tippee liability thus aimed at providing the SEC with the opportunity to manage and prosecute illegal insider trading activities.

Considering the tipper's liability, the SEC and the DOJ had sufficient grounds to prosecute several insiders who, in essence, breached their fiduciary duties to their companies by sharing nonpublic information. However, with the limitation brought in place by the precedents of the Supreme Court, as in the matters of Dirks, O'Hagan, and Chiaraella, the prosecution of inside traders became hard. Ideally, third parties involved in insider trading were considered exempt from prosecution, especially if it is established that they have no interaction or direct connection with the trading of securities involving the companies in the matter. In essence, with this consideration of third parties as exempt parties, a loophole was thus developed. Practically, it is justifiable that the involvement of parties with no relationship with the trading activities of the companies does not constitute insider trading. However, there is the consideration of loopholes that inside traders may propose, such as the fact that they are not involved in the trade and still benefit from the activity.

The decision of the Second Circuit Court in the Newman matter proved that the court only sufficed to make matters difficult for the SEC and the DOJ in terms of prosecuting inside traders. Primarily, the established rules and requirements by the Second Circuit Court only provided the fraudsters involved in inside trading with the opportunity to make it difficult for law enforcement authorities to link them to fraudulent activities. The Second Circuit Court put measures in place to ensure that the prosecution provided more than sufficient evidence connecting the suspected inside traders with the activities taking place. One of the requirements by the Second Circuit Court involves proving the relationship between the tipper and the tippee. Practically, the tippers can use strangers and still achieve their goal of inside trading and receiving personal benefits from the tips they share. The use of people who are not within their social circles thus limits the prosecution in proving that the tippees were aware of the actions of the tipper, including the personal benefit they are to accrue from the tips shared. The tipper and the tippee may arrive at an agreement that further complicates the investigations in determining the relationship that exists.

Additionally, it is also required by the Second Circuit Court that the prosecution also proves the breach of fiduciary duty based on the interaction between the tipper and the tippee. Practically, the Second Circuit Court failed to take into consideration that the requirements also provide the fraudsters with the opportunity to proceed with formulating more complex relationships that counter the required quid pro quo. Therefore, in the long term, the actions of inside traders can easily be covered in several layers of cover-ups and unrelated relationships between the tippers and tippees. Conversely, the prosecution faces more complications in pursuing its responsibilities towards resolving the insider trading cases. The lack of evidence would quickly render a matter dismissed for failing to meet the requirements as set forth by the Second Circuit Court. Therefore, the prosecution and Government would have to do more to prove their cases against the inside traders before the issues become severe in the economy's performance and affected companies in the long term.

The assessment of the case laws and the decisions of the Second Circuit Court primarily provide for the need for further assessment and understanding of the activities surrounding the inside trading of securities. The role and responsibility of the SEC is to ensure that corporations abide by the securities trading laws. However, the provisions of the law also have to align with the interpretation of the law by the courts to avert cases of confused and misguided decisions that affect the overall performance of the SEC and DOJ in curbing inside trading crimes from both a civil and criminal perspective.

1. Dirks v. SEC, 463 U.S. 646 (1983) ↑

2. Ibid ↑

3. United States v. Martoma - 894 F.3d 64 (2d Cir. 2017) ↑

4. Salman v. United States - 137 S. Ct. 420 (2016) ↑

5. United States v. Newman, 773 F.3d 438 (2d Cir. 2014), ↑

6. Ibid ↑

7. United States v. Blaszczak - 947 F.3d 19 (2d Cir. 2019) ↑

8. Ibid ↑

9. Ibid ↑

10. Kelly v. United States, 140 S. Ct. 1565 (2020). ↑