Quarterly Securities Enforcement Briefing
- Supreme Court Poised to Revisit Scope of Insider Trading Liability
- SEC Settles Case with Company and Its General Counsel Over Disclosure Failures
- D.C. Circuit Hands SEC First Win on In-House Court Constitutionality
It has been more than three decades since the Supreme Court last weighed in on insider trading liability in Dirks v. SEC, 463 U.S. 646 (1983). Meanwhile, the high profile trials of Martha Stewart, Jeff Skilling, Raj Rajaratnam, to name a few, have kept insider trading in the spotlight. On Oct. 5, 2016, the Supreme Court heard oral argument in Salmon v. U.S., an insider trading case that stands to make waves in the trading community and courtrooms across the country.
In Salmon, an investment banker shared material non-public information with his brother, who in turn shared that information with his future brother-in-law. The future brother-in-law was convicted for making a series of profitable trades based on that non-public information. The 9th Circuit affirmed. In his briefing to the Supreme Court, the defendant argued that the government should have had to prove the investment banker – the original source of the tip – personally benefited from the tip to his brother. The defendant based his argument on a recent 2nd Circuit decision that held a personal benefit sufficient to trigger insider trading liability must be “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” United States v. Newman, 773 F.3d 438 (2d Cir. 2014), cert. denied, No. 15-137 (U.S. Oct. 5, 2015).
The government advocates that a tip to a relative or friend is itself a personal benefit to the tipper. The government’s position is rooted in the language of Dirks: “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. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.” 463 U.S. at 664.
At oral argument, the justices were hostile to a narrow or concrete interpretation of what constitutes a “personal benefit.” For instance, Justice Kagan stated to the defendant’s counsel “[y]ou’re asking us to cut back significantly from something that we said several decades ago, something that Congress has shown no indication that it’s unhappy with, and in a context in which, I mean, obviously the integrity of the markets are a very important thing for this country.” Justice Kennedy echoed this loyalty to Dirks: “Dirks says there's a benefit in making a gift… [Y]ou certainly benefit from giving to your family.”
The Justices’ questioning at oral argument suggests that the defendant’s conviction is likely to be affirmed. However, the government made a fairly significant concession, stating that the Supreme Court “doesn’t have to reconceptualize Dirks…. If the Court feels more comfortable given the facts of this case of reaffirming Dirks and saying that was the law in 1983, it remains the law today, that is completely fine with the government.” That position walks back the more government’s more aggressive stance in briefing, which sought to expand liability by treating a tip to an acquaintance as a personal benefit.
On Sept. 9, 2016, the SEC brought a lawsuit in federal court in Washington, D.C., against RPM International, Inc., and its general counsel for alleged failure to timely disclose a loss contingency, or record an accrual for an anticipated settlement, to resolve an investigation of the company by the U.S. Department of Justice. The company came under DOJ investigation in 2011 regarding whether it overcharged the government on some government contracts. The SEC alleges that the general counsel knew but failed to disclose to the CEO, CFO, Audit Committee, and independent auditors that RPM had sent the DOJ several analyses showing the overcharges were at least $11.9 million, that RPM agreed to submit a settlement offer to DOJ by a certain date, and that RPM then revised its overcharge estimate up to $27-28 million. The SEC alleges that the general counsel’s failure to disclose these matters resulted in a failure by the company to disclose any loss contingency or accrual on RPM’s financial statements. This made periodic filings the company submitted to the SEC in 2012 and 2013 materially false and misleading. RPM settled the DOJ matter for almost $61 million in Aug. 2013.
The SEC’s complaint alleged violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933, and Section 13(a) of the Securities Exchange Act of 1934 and its corresponding SEC rules. These charges are negligence-based against the general counsel (and a combination of negligence and strict liability against the company). The lack of fraud claims will allow the general counsel to escape being barred from serving as an officer and director of a public company if he is found liable. The SEC is seeking injunctive relief, as well as penalties and disgorgement. The company has stated it intends to vigorously defend. According to RPM’s website, the general counsel continues to serve in that role.
D.C. Circuit Hands SEC First Win on In-House Court Constitutionality
By Conner G. Peretti
Our coverage of the challenges to the constitutionality of the SEC’s in-house courts continues with news of the SEC’s first federal appellate ruling to find that the SEC’s in-house courts are constitutionally sound. In Raymond J. Lucia Companies, Inc., et al v. SEC, the District of Columbia Circuit denied an investment advisor’s petition for review of a decision of the Securities and Exchange Commission. The investment advisor claimed that the SEC’s in-house courts are unconstitutional under the Appointments Clause on the grounds that the President must appoint the SEC’s in-house judges. Most of our coverage has been of cases where parties named as defendants in an SEC in-house court proceeding tried to challenge the constitutionality of those administrative courts in federal district court, in order to avoid having to go through the in-house proceeding altogether and force the SEC to proceed instead in federal court. We reported on those cases here. Federal appellate courts in those cases addressed whether the parties could bring the constitutional challenges before exhausting the administrative process. The 2nd and 11th Circuits held they could not, and that the petitioners had to return to the SEC administrative process, obtain a final ruling, and if the ruling was adverse they could then petition for review to the court of appeals.
In Lucia, Mr. Lucia completed the administrative proceeding and then filed an appeal from the SEC’s administrative judgment to the D.C. Circuit. The in-house SEC court and the SEC had found that the in-house court and its judges did not violate the appointments clause. On appeal, the D.C. Circuit panel reasoned that the commission itself still retained “full decision-making powers” by issuing a final order after the in-house judge made a decision. The commission therefore acted on its own rather than using in-house judges to make final decisions in potential violation of the delegation statute and appointments clause. Mr. Lucia has filed a petition for rehearing en banc, which has not yet been ruled on.