SEC's Sketchy Insider Trading Definition Sparks Enforcement Actions

In a related development earlier this month, the Supreme Court heard oral argument in another insider trading case—the first such case to be heard by the Supreme Court since 1997. A majority of the justices in that case, Salman v. United States, appeared poised to rule in the government's favor.

At issue is whether a person who provides an insider trading tip must receive a "tangible" or "pecuniary" gain in exchange for the tip, or whether a close family relationship between the tipper and tippee is sufficient to establish insider trading liability.

Bassam Salman was convicted of insider trading in 2013 after profiting from trades based on information from his future brother-in-law, who in turn received the information from his own brother, a Citigroup employee. No one paid anyone money for the tip, so the Supreme Court must decide whether the family relationship alone creates the necessary "benefit."

Justice Breyer noted that, "to help a close family member is like helping yourself" and that the law is "filled with instances" in which providing a benefit to a close family member or friend is treated the same as providing a benefit to yourself.  Justice Kennedy agreed, pointing out that "you certainly benefit from giving to your family…it helps you financially because you make them more secure."

However, several justices appeared skeptical of the government's position that there is a personal benefit any time someone provides inside information to another when he or she knows that the other person will trade on it, reasoning that the "advantage that you receive is that you are able to make a gift with somebody else's property."

Whichever way the Supreme Court rules, one thing is clear: the standard for what constitutes insider trading remains unclear. The SEC should only punish hedge fund advisors for failing to prevent the most obvious instances.

So how obvious was the insider trading in the case the SEC brought against the hedge fund adviser last week? Not very.

In the underlying highly publicized SEC and criminal insider trading cases against the analyst, which date back to 2013, the government struggled to prove a tangible pecuniary benefit to the tipper.

The SEC alleged only that the analyst and tipper were friends and that "[o]n at least one prior occasion, [the analyst] had given [his friend] investment advice and [the friend] had traded based on such advice." Appeals over the same issue in the criminal trial weren't concluded until earlier this year.

Given the uncertain and shifting contours of insider trading law, and the SEC's aggressive enforcement positions in the area, fund advisors should re-examine policies to prevent insider trading and redouble efforts to enforce those policies.