Insider Trading Conviction Upheld by First Circuit

by Dorsey & Whitney LLP

Salman v. U.S., 136 S.C. 899 (2016) presented issues regarding the personal benefit test and gifting in the context of an insider trading tipping case. Ultimately the High Court focused on the question of gifting material non-public information concluding that when an insider furnished inside information to his brother-in-law in breach of his duty, and knowing that the information would be used to trade, the gift constituted illegal tipping in violation Exchange Act Section 10(b). In reaching this conclusion the Court rejected claims that the benefit to the insider had to be pecuniary as argued by Mr. Salman and that any transmission of inside information to a trader constituted insider trading as claimed by the government.

In U.S. v. Bray, No. 16-1579 (1st Cir. Decided Feb. 24, 2017) the Circuit Court considered two key questions in the wake of Salman: 1) The sufficiency of the evidence on the question of personal benefit when the inside information was a gift; and 2) the adequacy of an instruction that the defendant “knew or should have known” that the tipper obtained a personal benefit.

The action centered on the June 29, 2010 announcement that Eastern Bank had agreed to acquire Wainwright Bank & Trust Co. for $19 per share. Prior to the announcement defendant Robert Bray had known John O’Neill for years. Mr. Bray was a contractor and real estate developer. Mr. O’Neill was an executive at Eastern Bank. The two men met at a country club where they both played golf, although their contacts focused largely on socializing in the pub and at dinner. Over time the two men became friends. Mr. Bray, for example, got to know Mr. O’Neill’s family and in particular his son to whom he had gifted a set of golf clubs when Matthew was a child. Later Mr. Bray helped Matthew secure an internship.

In some instances the two men discussed their respective professions. Mr. O’Neill, for example, had some of his friend’s associates refurbish the basement and roof of his home. Mr. Bray often asked his friend for stock market and investment advice and, in particular, about small bank stocks. The information was always public.

On June 13, 2010 the two men had a conversation about investing. Specifically, Mr. Bray said he need to make a “big score” to help fund one of his real estate ventures. He asked Mr. O’Neill if he had any bank stock tips. The “big score” request differed from earlier discussions. After furnishing his friend with the names of several banks, Mr. O”Neill wrote the word “Wainwright” on a napkin and gave it to his friend. Mr. Bray put it in his pocket as Mr. O’Neil remarked “this could be a good one,” or words to that effect. At the time Mr. O’Neill knew that local bank Wainwright Bank & Trust Co. was up for sale from his work — he had signed a confidentiality agreement. Mr. Bray later bought 31,000 shares of the thinly traded stock, constituting about 56% of the trading volume between June 14th and the end of the month. He liquidated a large portion of his other holdings. Following the deal announcement he had profits of about $300,000.

Mr. Bray was charged with insider trading by the SEC and the U.S. Attorney’s Office. At the criminal trial Mr. O’Neill testified that he furnished the information to “enhance our relationship, he would think more highly of me . . . [we were] friends and that’s what friends do . . . I didn’t expect anything at that exact time, but down the road he did offer me an interest in the Watertown project.”

The jury returned a verdict of guilty on a charge of insider trading. Mr. Bray was sentenced to serve two years in prison.

The Circuit Court affirmed. The government tried the case based on the misappropriation theory of insider trading. In such instances liability hinges on whether the tipper breached a duty of trust and confidence by disclosing the inside information, which in turn depends on whether the tipper personally will benefit . . .” according to the Court. There is “some disagreement,” however about whether the benefit to a tipper is required in a misappropriation case, the Court noted, citing its earlier decision in SEC v. Sargent, 229 F. 3d 68 (1st Cir. 2000).

Here Mr. Bray admitted he traded on inside information but claimed that there was insufficient evidence that Mr. O’Neill expected a personal benefit in exchange for the tip. In considering this question the Court focused on objective criteria – if the insider received a direct or indirect benefit such as a pecuniary gain or reputational benefit that will translate into future earnings. That benefit can be inferred from the evidence and from situations were the tipper makes a gift to a trading relative or friend.

Mr. Bray claimed that the relationship between the two men was “causal, as opposed to close” and thus did not meet the standard of U.S. v. Newman, 773 F. 3d 438 (2nd Cir. 2014) which required a “meaningfully close relationship” – a point not discussed in Salman, although the Supreme Court did reject a portion of the Newman standard. To the contrary, the evidence here meets this standard. First, Mr. O’Neil’s testimony was sufficient on the point. Second, that point is bolstered by the fifteen year relationship of the two men who frequently socialized and took each other’s counsel. In reaching this conclusion the Court noted that it was not deciding how close the relationship had to be but only that the evidence here was sufficient.

Finally, the Court rejected the defendant’s claim regarding the jury instruction. While Mr. Bray was correct that the “knew or should have known” standard is incorrect, he failed to object at trial. In view of the sufficiency of the evidence here his claim failed to meet the test of plain error.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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