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Inside insider trading: Tabernula and Salman – high stakes on both sides of the Atlantic

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From Southwark to Washington, Tom Watret explores the future of financial crime — in the winning entry of the BARBRI Global Financial Crime Blogging Prize

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Insider trading might be thought the quintessential financial crime. In harming the integrity of the financial markets, it increases the cost of capital. Unfettered, it is the ultimate temptation to act not as a virtuous fiduciary but in one’s own interest. And amidst the potential complexities of financial wrongdoing, its core resonates with the man on the street (indeed, it is the gist of Bernie Sanders’s electoral battle cry): corporate insiders “rig the market” in their favour using non-public information.

Effectively policing it has two prerequisites: (i) a clear, administrable prohibition of appropriate breadth, backed by (ii) credible deterrence in the form of vigorous enforcement. Yet, historically, neither the UK nor US has had both elements. Tabernula and Salman, two insider trading cases being heard this year in Southwark Crown Court and the US Supreme Court, respectively, may mark a turning point.

UK enforcement and Tabernula

With the resources, powers and sanctions at their disposal, the Securities and Exchange Commssion (SEC) and Department of Justice are fearsome. Fines levied for insider trading run into the billions (in 2013, SAC Capital was subject to civil and criminal penalties totalling $1.8bn), while the prison terms (a maximum of twenty years in the US, seven in the UK) can exceed those for murder. Prosecutions have ensnared high-profile individuals at the heart of Wall Street (and for credible deterrence, high-profile matters): for instance, in 2011 Raj Rajaratnam, then a billionaire co-founder of one of the world’s largest hedge funds, received an 11 year sentence and $92.8m penalty.

In the UK, enforcement only really got under way post-financial crisis. The Financial Services Authority (FSA) brought its first criminal prosecution for insider trading in 2008. That same year, 140 police officers were deployed across 16 locations as the Tabernula investigation got off to a dramatic start. The era of “light touch” regulation was over. Since then, as Tabernula has crept to court, the Financial Conduct Authority (FCA) has secured 27 further insider trading convictions, whilst the FCA’s Measure of Market Cleanliness suggests insider trading has halved from pre-crisis levels.

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But the FCA’s bid to “get tough” has also faced setbacks. It was criticised as slow to act on Libor, but for rushing its FX-rigging probe; for botching prosecutions against individuals at the heart of the Libor and London “Whale” scandals; for “going soft” in ditching a significant review into banking culture; and, risibly, for breaching its own rules in briefing The Telegraph on an impending life insurance review, wiping £3bn off insurers’ share prices. Meanwhile, it has recently had more changes in top management than your average football club: when Andrew Bailey takes over in July he will be the third CEO in 12 months.

Credible deterrence is part perception, and bungling enforcement agencies are not feared ones. Tabernula is therefore an opportunity to shore-up the FCA’s reputation. But it carries an asymmetric risk. It is the FCA’s most complex and resource-intensive insider trading case to date, using new investigatory methods, involving the largest sum — and the first trial in four years. In the Financial Times’s stark terms, the “FCA has staked its reputation as an investigator and prosecutor of complex crime”. The jury began deliberations on April 22nd.

The US prohibition and Salman

As regards the prohibitions themselves, the essential difference between the UK and US is this. In the UK, one must (generally speaking) not trade on inside information, however obtained. In the US, however, there is an additional requirement, described by US commentators in such terms as “astonishingly dysfunctional”, “seriously flawed” — a “theoretical mess”. The insider must have knowingly breached a duty (a fiduciary duty or, sometimes, a duty of confidentiality) to the source of the information (e.g. his employer) in trading or disclosing the information to another (Chiarella v US). The test for “breach of duty” is whether the insider will personally benefit, directly or indirectly, from the disclosure (Dirks v SEC).

The US courts have mostly taken a broad, flexible view of “personal benefit”: a reputational benefit, quid pro quo, friendship. But in December 2014 in Newman, the US Court of Appeals for the Second Circuit seemingly propounded a stricter approach, requiring “a meaningfully close personal relationship”, generating an “objective, consequential” exchange “of a pecuniary or similarly valuable nature”. Problematically, this seems to allow insiders to give information to their friends, family and business associates provided they ask for nothing in return. When the US Supreme Court declined to hear the subsequent appeal, uproar ensued.

Now they have decided to hear Salman. At the very least, the Supremes should clarify “personal benefit”. In Salman, no money was exchanged for inside information — just love and affection between family members. But it is the prospect of a more far-reaching opinion that is mouth-watering. This is the first major insider trading case the US Supreme Court has heard since 1997. The regulatory climate has changed. In their deliberations, the justices would do well to reflect on the position across the Atlantic.

The reason US law imposes the “astonishingly dysfunctional” additional requirement of a breach of duty is, in short, a fear that legitimate research by market participants uncovering non-public information would constitute “inside information”, thus impeding the flow of information to the market. Remember: in the UK, one must not trade on inside information, however obtained. But that is exactly why UK law so carefully defines “inside information” in statute (s118C Financial Services and Markets Act 2000; s56 Criminal Justice Act 1993), supplemented by the FCA’s detailed Code of Market Conduct (e.g. s1.2.12 and s1.3.7), to except legitimate behaviours. As Newman illustrates, the US’s case law-based approach has proven to be more difficult and uncertain than flexible; the UK’s approach, by contrast, is conceptually straightforward and enhances certainty for market participants.

Being the quintessential financial crime, the treatment of insider trading is a bellwether for the prevailing norms of the markets from which we all benefit. As the two most significant insider trading cases in years come to be decided, lawyers, courts and regulators should all adopt a transatlantic perspective.

Tom Watret is a distance learning GDL student at BPP Law School, due to begin a training contract with an international law firm in London in 2017. He previously graduated with a Scots law degree from the University of Edinburgh. He is the winner of the BARBRI Global Financial Crime Blogging Prize.

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