Court Ruling Backs SEC : Even ‘Outsiders’ Liable for Profiting From Tips
The Supreme Court upheld the government’s broad power to prosecute those who make money by trading securities based on secret tips, ruling Wednesday that “outsiders” as well as corporate executives can be sent to prison for insider trading.
The 6-3 decision reinstates the conviction of a Minneapolis lawyer who made a quick $4.3-million profit by buying up Pillsbury’s stock after he heard about a pending takeover from a law partner.
More important, the ruling largely endorses the government’s view that it is illegal to misuse secret tips to buy or sell securities. And the ruling comes at a time when a resurgence of corporate takeovers has triggered concern that insider trading is rampant again.
“If this case had gone the other way, it would have blown a huge hole in our ability to prosecute these activities,” said Mary Jo White, U.S. attorney for the Southern District of New York, which includes Manhattan and is by far the most active jurisdiction for insider-trading cases.
Securities law experts said the decision keeps a powerful weapon in the government’s enforcement arsenal and may spur regulators to be more aggressive and creative in pursuing insider trading.
Until Wednesday, it was unclear whether federal prosecutors indeed had the power to go after those who trade on inside tips, except for corporate officials who secretly deceived their own companies. Despite the Wall Street scandals of the 1980s, Congress never passed a law that spelled out the crime of “insider trading”--in part because the Securities and Exchange Commission indicated that it wanted significant leeway to bring such cases.
On Wednesday, Justice Ruth Bader Ginsburg, writing for the court, said the Securities Exchange Act of 1934, passed after the great stock market crash of 1929, should be interpreted in line with its broad purpose to ensure “honest securities markets and thereby promote investor confidence.”
A person who learns inside information and secretly uses it to “gain no-risk profits” has both “deceived the source of the information and simultaneously harmed the investing public,” she wrote.
The case of the Minneapolis lawyer, James H. O’Hagan, had become a major test of the government’s power to police the markets. Since 1994, two federal appeals courts, including the one in O’Hagan’s case, had said the SEC had no power to go after stock traders who were not deceiving their own employers and shareholders.
Because O’Hagan’s law firm was not employed by Pillsbury but, rather, by Grand Metropolitan, the British company that planned to buy Pillsbury, the lower court said he did not breach a duty or violate the law.
Securities regulators said they were delighted with the outcome in the high court.
“This decision reaffirms the SEC’s efforts to make the stock market fair to all people, whether you’re a Wall Street veteran or Main Street newcomer,” SEC Chairman Arthur Levitt said. “This is a reminder to all investors that insider trading is cheating and will be vigorously prosecuted.”
With no strict definition of insider trading in the law books, securities regulators have increasingly based enforcement actions on the “misappropriation theory” upheld in the O’Hagan case.
It was the basis of the 1984 fraud conviction of R. Foster Winans, the former Wall Street Journal reporter who, in one of the most notorious insider-trading cases, was found to have tipped off brokers in advance to the contents of the Journal’s influential “Heard on the Street” stock-market column.
Trading in the stock of companies to be mentioned in upcoming columns, the group of brokers cleared profits of about $700,000, of which Winans received about $30,000.
Prosecutors argued that Winans misappropriated information belonging to his employer and that that breach of duty--in connection with stock transactions--constituted insider trading.
Although Wednesday’s decision confirms regulators’ existing view of insider trading, “it does not expand the playing field,” SEC enforcement chief William McLucas said in an interview. “We’re going to continue pursuing these cases as we have in the past.”
Ginsburg did not try to define the outer limits of the government’s power. She confined her opinion in the U.S. vs. O’Hagan case to persons who have some “duty of confidentiality” against using secret information.
For example, accountants, lawyers and investment bankers who learn about a pending takeover hold a position of trust and should not abuse it, she said.
But Ginsburg and the court stopped short of deciding how the law should treat a person who learns a secret tip but has no duty to the source. For example, how about a daughter who learns from her mother about a hot stock tip she overheard at the hairdresser’s?
“It is a fair assumption that trading on the basis of material, nonpublic information will often involve a breach of a duty of confidentiality to the bidder or target company or their representatives,” she wrote. “We leave for another day” how to decide whether the same rule applies to someone with no duty to the source of the secret information, she said.
In closing, Ginsburg stressed that persons can be prosecuted only for “knowingly” and “willfully” trading on inside information. That ensures that an innocent and naive person will not be wrongly sent to prison for an honest mistake.
In dissent, Justice Clarence Thomas, joined by Chief Justice William H. Rehnquist and Justice Antonin Scalia, said he would have affirmed the appeals court because the 1934 law did not make O’Hagan’s actions a crime.
Savage reported from Washington and Mulligan reported from New York.
* OTHER SUPREME COURT RULINGS: A1
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Court Backs Broad View of Insider Trading
The U.S. Supreme Court on Wednesday upheld the government’s right to broadly define illegal insider trading by saying that people can be prosecuted for such trading even if they don’t work for the company whose securities are involved or don’t owe it any legal duty. The Securities and Exchange Commission has preferred to view insider trading in very broad terms, allowing plenty of leeway for prosecution of “gray area” cases.
The SEC’s Official Definition
Here is the SEC’s definition of insider trading, from its Web site:
“Insider trading” refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security.
Insider trading violations may also include “tipping” such information, trading by the person tipped and trading by those who misappropriate such information.
Examples From the SEC
* Corporate officers, directors and employees who traded the corporation’s securities after learning of significant, confidential corporate developments
* Friends, business associates, family members and other “tippees” of such officers, directors and employees, who traded the securities after receiving such information
* Employees of law, banking, brokerage and printing firms who were given such information in order to provide services to the corporation whose securities they traded
* Government employees who learned of such information because of their employment by the government
* Other people who misappropriated, and took advantage of, confidential information from their employers
Source: Securities and Exchange Commission
