SHAREHOLDER ADVOCATE November 2016
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SHAREHOLDER ADVOCATE November 2016 TRENDS IN SECURITIES LAW AND CORPORATE GOVERNANCE Inside This Issue… Supreme Court Hears First Insider Trading Case in Nearly Twenty Years After nearly two decades, the Supreme Court returned to the issue of insider trading, hearing oral arguments last month about the level of “personal benefit” someone sharing a tip must derive for the government to convict of insider trading the person who profits on that information. The case, Salman v. United States, focuses on the potential liability of the person receiving the insider information, known in legal parlance as the “tippee.” Based on their questions during oral arguments on October 5, 2016, the justices appear likely to take a middle line, which could make it easier to civilly sue on behalf of those damaged by insider trading. Apollo Settlement Highlights Vulnerabilities Faced by Private Equity Investors For public pension fund administrators, investing in private equity poses a difficult choice. While some research has shown that private equity has significantly outperformed other asset classes over the past decade, the uptick in enforcement actions against private equity firms by federal regulators suggests that these returns come at a cost: a loss of transparency and accountability with respect to fees, conflicts of interest, and misconduct by firms and their employees. This article discusses the recent trend in government enforcement actions against private equity firms and the vulnerabilities faced by private equity investors. Finally, it offers a few observations about what public pension fund administrators should consider when managing investments with private equity firms. Q&A with New Cohen Milstein Attorney Jay Chaudhuri, Former General Counsel to the North Carolina State Treasurer Jay Chaudhuri is a true shareholder advocate. As the former general counsel and senior policy advisor to North Carolina State Treasurer Janet Cowell and former chair of the Council of Institutional Investors, Jay worked to hold public corporations accountable to their shareowners. Now a recently appointed North Carolina State Senator, Jay has joined Cohen Milstein as Of Counsel in the firm’s newly opened Raleigh office. We asked Jay to take a few minutes to share his thoughts as he embarks on the next phase of his career. More information about Cohen Milstein’s Securities Fraud/Investor Protection Practice can be found by clicking here, or by calling (202) 408-4600. Supreme Court Hears First Insider Trading Case in Nearly Twenty Years I. Overview After nearly two decades, the Supreme Court returned to the issue of insider trading, hearing oral arguments last month about the level of “personal benefit” someone sharing a tip must derive for the government to convict of insider trading the person who profits on that information. The case, Salman v. United States, focuses on the potential liability of the person receiving the insider information, known in legal parlance as the “tippee.” In this instance, the tippee, Bassam Salman, traded profitably on information he obtained from his future brother-in-law, Michael Kara, who in turn had received the information from his own brother Maher, a Citigroup employee privy to valuable advance information on healthcare stocks. Salman, who eventually reaped $1.7 million on trades based on the information, was convicted of insider trading and the verdict was upheld by the Ninth Circuit U.S. Court of Appeals. Salman’s lawyers argue that the Supreme Court should overturn the Ninth Circuit decision because Maher Kara, the Citigroup investment banker who provided the tips, did not stand to make money on Salman’s resulting stock trades. Citing the Court’s 1983 ruling in Dirks v. SEC, government prosecutors counter that such a narrow definition of a “personal benefit” would permit anyone to provide valuable inside trading tips to friends and relatives, so long as they themselves did not profit. In turn, they want the definition expanded so that sharing insider information for almost any reason incurs liability. Based on their questions during oral argumentson October 5, 2016, the justices appear likely to take a middle line, affirming the Ninth Circuit but declining to expand the “personal benefit” definition in Dirks, the leading case on tippee liability. Although Salman is a criminal case, affirming the Ninth Circuit could make it easier to civilly sue on behalf of those damaged by insider trading. II. Legal Background In Dirks, the Supreme Court said that a tippee is liable for insider trading if he knows that the tipper “personally will benefit, directly or indirectly, from his disclosure.” 463 U.S. 646 (1983). Under Dirks, a “benefit” was defined to include “mak[ing] a gift of confidential information to a trading friend or relative.” Id. at 663-664. The issue of what is meant by a “personal benefit,” particularly when inside information is exchanged between friends or relatives, seemed settled until a 2014 Second Circuit decision in United States v. Newman, which held that in the case of tipping between friends, evidence must demonstrate that the relationship was “a meaningfully close personal relationship” such that the tipper benefits by “an exchange that is objective, consequential, and represents at least a potential gain of pecuniary or similarly valuable nature.” 773 F.3d 438 (2d Cir. 2014). Many perceived Newman’s holding as going beyond the standard articulated in Dirks because it required a tangible and pecuniary benefit to the tipper. The Supreme Court refused to review Newman, but a split among circuits opened following the Ninth Circuit’s decision in United States v. Salman, which rejected the premise that a tangible benefit was necessary under Dirks for tippee liability. The Supreme Court agreed to review Salman in order to resolve the split among circuits. III. Facts As discussed above, the case involves three key players. Maher Kara worked in the healthcare investment banking division of Citigroup and often spoke about his work with his brother Michael. Maher considered Michael a mentor and an advisor on Maher’s work given Michael’s background in chemistry and his understanding of the healthcare industry. Between 2004 and 2007 Maher admitted that he regularly shared inside information with his brother and Maher suspected that Michael was trading on the information, although Michael initially denied as much. In 2003, Maher became engaged to Salman’s sister and the Kara and Salman families became close. Salman and Michael in particular developed a close relationship and Michael began sharing the inside information he received from Maher with Salman and encouraged Salman to execute trades based on the information. Salaman did, profiting by $1.7 million. The evidence presented in court demonstrated that Salman knew Maher was the source of information provided to him by Michael and that Michael and Maher shared a close and “mutually beneficial relationship.” Michael helped pay for Maher’s college, provided Maher with guidance on the healthcare industry in connection with Maher’s work at Citigroup, and stood in for Maher’s deceased father at Maher’s wedding to Salman’s sister. Maher testified that he provided Michael with inside information because he “love[d] [his] brother very much” and gave him the information to “benefit him” and “fulfill[] whatever needs [Michael] had.” In one instance, Michael told Maher he needed a “favor” and requested “information” because he “owed somebody.” Michael refused Maher’s offer of money, so Maher tipped Michael with inside information. Salman knew Michael and Maher were close. At trial, based on the evidence above, Salman was convicted of insider trading. On appeal, he argued that his conviction should be overturned on the premise that there was not enough information to convict him under Newman because Maher received “no tangible benefit in exchange for information.” The Ninth Circuit rejected Salman’s argument, explaining that “if Salman’s theory were accepted and this evidence found to be insufficient, then a corporate insider or other person in possession of confidential and proprietary information would be free to disclose that information to her relatives, and they would be free to trade on it, provided only that she asked for no tangible compensation in return.” 792 F.3d 1087 (9th Cir. 2015). The Ninth Circuit concluded that Salman knew enough about the close relationship between Maher and Michael that he “must have known that, when Maher gave confidential information to Michael, he did so with the ‘intention to benefit’ a close relative” and such a benefit is sufficient for insider trading liability. Id. Interestingly enough, the Ninth Circuit opinion was written by Judge Rakoff, a federal district court judge in the Southern District of New York, who was sitting on the Ninth Circuit by designation. Judge Rakoff, who has authored numerous opinions on insider trading, would usually be bound by the Newman decision given that his district is within the Second Circuit. However, when sitting by designation on the Ninth Circuit, he was not required to follow Newman and his decision to cabin, rather than expand Newman, adds an interesting layer to the case. IV. Analysis and Prediction The question presented to the Supreme Court by Salman is: Does the personal benefit to the insider that is necessary to establish insider trading under Dirks v. SEC require proof of ‘an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature’ as the Second Circuit held in United States v. Newman or is it enough that the insider and the tippee shared a close family relationship, as the Ninth Circuit held in this case? (citations omitted) During oral argument, the respective sides argued at the extremes of Dirks – with Salman’s attorneys urging the Court to require a tangible financial benefit for liability to attach and the government arguing that sharing inside information for any reason whatsoever is sufficient for liability.