14779792521_b054cf2506_zIn the few days since the Supreme Court handed down its decision in Salman v. United States, many commentators have said, in effect, that criminal prosecutions for insider trading are alive and well.  Alive, yes; well, maybe not.

At the risk of quoting myself, almost exactly two years ago I posted an item on this blog entitled “There ought to be a law”.  My belief at the time was that insider trading law is so byzantine that it’s impossible to know where legally permissible behavior becomes legally impermissible behavior.  For better or worse (worse, IMHO), nothing has changed all that much.  In the Salman decision, SCOTUS says that a prosecutor need not prove that a tipper received something of a “pecuniary or similarly valuable nature” to convict the tipper of illegal insider trading.  So far, so good.  However, as many commentators have pointed out, Salman leaves any number of other issues wide open.


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A great deal has been written about the recent reversal of two insider trading convictions.  Specifically, the U.S. Court of Appeals for the Second Circuit threw out the convictions of Todd Newman and Anthony Chiasson, hedge fund traders found guilty at the District Court level.

The press reports have treated the reversal as a major

Imagine the following scenario. Your company is publicly traded. As such, senior management is keenly aware of the potential for executives and employees trading in the company’s securities on the basis of material nonpublic information in violation of Section 10(b) of the Exchange Act and the infamous Rule 10b-5 promulgated thereunder. To prevent improper trading, the company has instituted an insider trading policy which, among other things, requires certain high-level executives to pre-clear trades internally, prohibits directors and officers from trading during “blackout periods” (i.e., the period immediately prior to fiscal quarter and year ends), and requires periodic training for all employees on the scope of insider trading laws. As model corporate citizens, all of the company’s directors, officers, and employees follow the company’s policies precisely. No one would dare to take the risk of attempting to gain illicit profits by trading the company’s stock while in possession of material nonpublic information.

One day, just before the end of a quarter (and therefore during a blackout period), analysts covering your company reduce their estimates for the company’s quarterly results which in turn, causes the company’s share price to decline. The company’s officers know that the analysts’ revised estimates are accurate and that the company will report sub-par earnings results the following week but none of those officers initiated any trades to improperly take advantage of this material nonpublic information. However, as a result of the decline in share price alone, one of the company’s executive officers unknowingly violated Section 10(b) and Rule 10b-5 and both he and the company are now potentially on the hook for insider trading liability. 

How can this be if none of the officers executed any trades you ask? The problem arises from the fact that company policy does not prohibit margining company securities. When the share price declined, the value of the securities in the executive’s margin account dropped sufficiently to trigger a margin call requiring the executive to deposit additional collateral to make up the shortfall or risk having the broker sell a portion of the pledged securities (this is similar to what happened to the founder and chairman of Green Mountain Coffee Roasters, Inc. earlier this year). Regardless of which route is taken, the executive is in a problematic situation. 

If the executive does nothing and allows the broker to sell company stock, he’d be violating company policy by trading during the blackout
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