NEW YORK (Reuters) - On Oct. 5, the U.S. Supreme Court will hear oral arguments on a question that has created considerable confusion in lower courts: When the government claims a corporate outsider has profited from trading illegally on inside information, what must it prove about the motive of the insider who supplied the tip?
The Securities and Exchange Commission, meanwhile, just brought its biggest insider trading case in years, against hedge fund manager Leon Cooperman of Omega Advisors.
The SEC’s complaint, filed in federal district court in Philadelphia, accuses the legendary investor of earning about $4 million in illicit profits from trading in Atlas Pipeline Partners after a corporate insider gave him confidential information about a big divestiture.
Cooperman has declared his innocence Wednesday in a five-page letter to investors and a widely reported conference call.
The SEC has framed its case, as I’ll explain, to avoid the question at the Supreme Court. But I think there is a way Cooperman’s lawyers at Paul Weiss Rifkind Wharton & Garrison can take advantage of the case before the justices. My theory takes a bit of explaining, so first, some background.
In the case at the Supreme Court, Salman v. U.S., Bassam Salman was convicted of trading illegally on the basis of information that originated with a Citigroup investment banker. The banker talked to his brother about companies in play. His brother, in turn, passed tips to Salman, who matched his trades to those of the banker’s brother.
Insider trading law is quirky. Congress has never defined insider trading in a statute, so the law has been shaped by judges watching over federal prosecutors and Securities and Exchange Commission regulators asserting violations of securities fraud statutes.
As the law has developed - most notably in the 1983 Supreme Court case Dirks v. SEC - to prove insider trading by a corporate outsider, the government must show that the insider who leaked confidential information benefited from supplying the tip. Otherwise, courts have held, there’s no fraud.
In the Salman case, the justices have been asked to decide how tangible the tipster’s benefit must be. The 9th U.S. Circuit Court of Appeals, which affirmed Salman’s conviction, held the close family relationship between the Citi banker and the brother he tipped is enough to establish the banker’s personal benefit.
The 2nd Circuit suggested in a landmark 2014 decision, U.S. v. Newman, that the government must prove tipsters received a benefit “that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” The justices will have to reconcile the two circuit court standards.
The SEC contends its suit against Cooperman case falls into a different category than tipster cases. Cooperman, according to the commission, was the beneficial owner of more than 9 percent of Atlas Pipeline in 2010. As such, he had much easier access to top corporate officials than ordinary shareholders, the SEC alleges.
Through the first half of 2010, that access apparently did not give him much confidence in the company. Cooperman dumped holdings worth millions of dollars and allegedly told an Omega consultant that Atlas was a “shitty business.”
In July 2010, however, an Atlas executive allegedly told Cooperman that the company planned to sell an important operating facility for more than $700 million. The SEC claims that the unnamed Atlas official believed Cooperman had an obligation not to use the information to trade Atlas securities. According to its complaint, “Cooperman explicitly agreed that he could not and would not use the confidential information … to trade.”
The SEC, of course, alleges that Cooperman did, in fact, trade on his advance word of the divestiture, reaping about $4 million in profits in various Omega funds. The SEC claims Cooperman committed securities fraud by misappropriating information given to him in confidence by an insider who trusted him not to use the information for his own trading.
The U.S. Supreme Court gave its blessing to the government’s so-called misappropriation theory of insider trading in the 1997 case U.S. v. O’Hagan, when the justices upheld the conviction of a Dorsey & Whitney lawyer who traded options in a firm client that was about to place a tender offer. In broad strokes, the misappropriation theory presumes that corporate insiders are disclosing confidential information only to those with a duty to protect the corporation’s secrets.
In those cases, insiders are victims of fraudulent misappropriation so their personal benefit for supplying confidential information doesn’t come into play. The government’s burden is to show the alleged fraudster violated the trust of the corporate insider, not the trust of the company.
The O’Hagan case, of course, involved a lawyer who breached a fiduciary duty when he traded a client’s securities based on inside information. The SEC and the Justice Department have also brought misappropriation cases against defendants with no fiduciary duty to the insider who disclosed confidential information.
The SEC’s case against billionaire Mark Cuban, for instance, alleged circumstances very similar to those described in the Cooperman complaint. Cuban received advance word of a private placement by an Internet search company in which he held a large stake. Despite supposedly telling the company he wouldn’t reveal the confidential information, Cuban sold shares before the offering was announced to avoid losses when his ownership stake was diluted.
Cuban persuaded the trial judge in his case that he never agreed not to trade on the basis of the advance tip he received. The case was dismissed, then revived by the 5th Circuit, which said that Cuban obtained additional inside information about the private placement after telling the company he wasn’t going to sell his shares. Ultimately, a federal jury in Dallas cleared Cuban of wrongdoing.
In the 3rd Circuit, where the SEC filed its case against Cooperman, the appeals court recently upheld the SEC’s expansive view of who can be liable under the misappropriation theory. A defendant named Timothy McGee found out about an impending corporate deal from a buddy he’d befriended at Alcoholics Anonymous, who confided in McGee when the stress of the deal led him to start drinking again. McGee said he owed no duty of confidentiality to his friend, but the 3rd Circuit affirmed his conviction.
Believe it or not, all of the preceding is necessary background for how the Salman case may be useful to Cooperman. We know from the McGee and Cuban cases that courts (if not juries) are open to the idea that the government need not show a fiduciary relationship between a corporate insider and an alleged fraudster who misappropriates inside information. That’s bad news for Cooperman.
But what if the insider at Atlas tipped Cooperman about the divestiture to influence the hedge fund manager’s trading in the company? Remember, Cooperman was dumping shares until he heard about the planned sale of the facility and I’m sure Atlas executives were not thrilled about a sell off by the owner of a nearly 10 percent stake in the company. It’s not unreasonable to wonder if Atlas was hoping news of the big deal would change Cooperman’s mind about his stake. (Interestingly, holding onto shares because you’ve gotten a tip they will rise in value is not securities fraud, which requires buying or selling securities.)
To be sure, the SEC complaint explicitly said Atlas gave Cooperman inside information under the proviso that he not use it to trade. I suspect Cooperman’s lawyers are going to probe exactly what was said in the conversations between the hedge fund manager and Atlas insiders.
And if they can show Atlas tipped Cooperman to influence his trading decisions, then this case could turn on whether the tipper received a personal benefit from supplying information – the issue before the Supreme Court in Salman. If the justices come up with a very restrictive definition of what constitutes a personal benefit for a tipster, that could help Cooperman.
I know this hypothetical depends on a big pile of ifs but it’s worth thinking about. It’s also worth a reminder that insider trading law would be a lot clearer if Congress enacted a statute.
Reporting by Alison Frankel. Editing by Alessandra Rafferty.