In a Practising Law Institute program, a panel of SEC, CFTC, and DOJ enforcement officials discussed the impact of the Second Circuit’s decision in U.S. v. Newman on current insider trading cases. Joon H. Kim, Deputy U.S. Attorney for the Southern District of New York, said in the Southern District’s view, Newman was wrongly decided and inconsistent with Supreme Court precedent. However, he noted that the high court will consider the issue of personal benefit in Salman v. U.S. this fall.
CFTC Chief Trial Attorney Candice Aloisi and Stephanie Avakian, SEC Deputy Director of Division of Enforcement, also discussed the impact of Newman on insider trading actions. Aloisi also gave an overview on commodities insider trading law following an expansion of the CFTC’s authority under the Dodd-Frank Act.
Insider trading after Newman. Kim said the Southern District’s view on Newman, set forth in court filings, is that Newman is inconsistent with precedent, in particular Dirks. It carves out, or leaves beyond scope of prosecution, culpable conduct that has always been thought to be illegal. If the tipper needs to have received some type of pecuniary benefit, it is now hard to prosecute a case where the tipper doesn’t expect payment, said Kim. For example, a CEO of a major company, a billionaire who doesn’t need particularly need more money, could tip his son or fraternity brother or golf buddy and not receive any pecuniary benefit.
Kim observed that although the Supreme Court denied the government’s petition for certiorari in Newman, the question presented in Salman v. U.S. is exactly the question of whether the definition of “personal benefit” is correct, so the court will effectively review Newman. In Salman, an investment banker at Citibank tipped family members about classic material nonpublic information (MNPI). His personal view is that the facts in Salman are good for the government. For the markets to work and to be fair, the type of information investment banks are privy needs to be kept secret, without friends and family members being able to trade on it. Otherwise, the market will have two categories of investors: regular people and people who are friends and families of insiders, said Kim.
Avakian agreed. In Salman, the testimony was unambiguous—there was intent to benefit, there was knowledge that there was going to be trading, and there was intent that there should be trading. She believes Salman is a “very strong case” for the government and tees up the personal benefit issue well.
“I can’t imagine that someone would look at that set of facts and say that’s okay,” said Avakian.
Effect on current enforcement actions. Avakian said that Newman has “certainly had an effect” on SEC insider trading actions. It hasn’t slowed down the SEC in terms of the number of insider trading cases brought, but it has resulted in a more intense focus on the issue of personal benefit. However, she believes that district courts in the Second Circuit have largely been limiting Newman to its particular facts.
For example, Avakian noted that in the Payton v. Durant jury trial in February 2016, personal benefit was squarely the issue, and the SEC won that case. In a pre-trial ruling, the court found the SEC had sufficiently alleged a personal relationship sufficient to satisfy the personal benefit requirement. The tipper and tippee were roommates who shared housing expenses, the tippee had previously assisted the tipper with a criminal matter, and the tipper said he was happy the tippee had profited, because the tippee had helped him. Avakian said other cases in the Second Circuit have also limited the Newman ruling, as for example in the Gupta case, where Judge Rakoff said that a personal benefit did not necessarily need to be pecuniary.
Regarding the effect of Newman on CFTC insider trading cases, Aloisi said the securities cases are significant and relevant to the CFTC because they’re interpreting provisions on which the commodities insider trading provisions are based. The Commission’s guidance is that the Commission will be guided—but not controlled—by judicial precedent applying comparable language under the SEC rules.
Commodities insider trading. Aloisi gave an overview of commodities insider trading provisions. Historically, there has long been a reluctance to extend insider trading prohibitions to the commodities space, she said. This is because commodities end users legitimately use the commodities markets for hedging, and this should not be discouraged. For example, a farmer who has inside information about the state of his crops trades agricultural futures, and the farmer should have the freedom to do that.
Before Dodd-Frank, said Aloisi, the Commodity Exchange Act did regulate some forms of insider trading-type conduct, but the provisions were limited to certain actors, products, and fact patterns. In particular, Section 9(e) prohibits employees and governing members of self-regulatory organizations from trading on or disclosing MNPI. She said the CFTC is currently litigating a case against NYMEX and some of its former employees for this type of violation. A similar rule applies to Commissioners and CFTC staff. In addition, Section 4b provides a prohibition against fraud committed in connection with another person, which can cover a broker’s misappropriation of a client’s information, for example.
Dodd-Frank expanded the CFTC’s authority over insider trading, Aloisi explained. Section 9(e) was expanded to cover swap data repositories and swaps trading. Further, a new rule covers federal employees with access to MNPI and anyone who obtains information from a federal source. For example, a trading on a nonpublished Department of Agriculture report would not have been illegal before Dodd-Frank, but now would be. This is informally known as the “Eddie Murphy rule” from the movie “Trading Places,” said Aloisi.
Finally, Section 6(c) and Rule 180.1 are catchall fraud rules modeled “very closely” after Exchange Act Section 10(b) and SEC Rule 10b-5, said Aloisi. These new provisions apply to any person, not just the limited actors of the pre-Dodd Frank rules. The Commission’s guidance is that these provisions prohibit trading:
- on the basis of MNPI in breach of a pre-existing duty established by another rule, law, agreement, understanding, or some other source; or
- on the basis of MNPI obtained through fraud or deception.
Aloisi observed that a fact pattern of front-running is not new, but the charges are unique and new for the CFTC. Motazedi was charged with violating Sections 4b, 4c, and 6(c)(1) and Rule 180.1. This was the first time Section 6(c)(1) and Rule 180.1 have been used in a misappropriation of information fraud scenario. He paid a penalty, restitution to the employer, and was banned from trading and registering with the CFTC.
Aloisi added that the CFTC has seen an increase in whistleblower tips relating to insider trading, as word gets around that the CFTC is now in the insider trading space.