by T. GormanPosted on Posted in SECActions

The future path of insider trading may well be determined by the case which will be argued before the Supreme Court today, Wednesday, October 5, 2016. The case is U.S. v. Salman, No. 15-628, a tipping case from the Ninth Circuit centered on two brothers and their brother-in-law. In many ways the case traces its roots not just to the Ninth Circuit’s decision in this case (here) but also to that of the Second Circuit’s in U.S. v. Newman, 771 F. 3d 646 (2nd Cir. 2014) (here), and ultimately to the High Court’s ruling in Dirks v. SEC, 463 U.S. 646 (1983).

Petitioner Salman and Respondent both claim to faithfully apply the teachings of Dirks. (Petitioner’s opening brief is discussed here and the reply here; Respondent’s Opposition, here). Interestingly, neither party claims to follow or rely on Newman which initially sought to draw a line in the sand as to third and fourth tier tippees in criminal cases using Dirks just as the Supreme Court did decades ago between the lawful and unlawful disclosure of inside information.

Despite their claims to hew close to Dirks, the parties have taken very different approaches. Petitioner has limited the Dirks personal benefit test to one that is pecuniary in nature. That applies even to a gift. The key to this point of view is the statement in Dirks that the trading by the tippee resembles that of the insider. If the insider trades, he or she seeks trading profits. If the recipient of the gift trades he or she seeks trading profits. If the tipping insider must benefit in the same fashion from a gift of inside information to another, then the personal benefit must be pecuniary reasons Petitioner.

Petitioner backstops this argument with the fundamental concept that there are no common law crimes. Citing the Court’s jurisprudence on implied causes of action under Section 10(b), which call for restraint when interpreting the court made damage remedy, and the underlying constitutional principles of decisions such as McNally v. U.S., 483 U.S. 350 (1987), which declined to write elements for a vague honest services criminal statute, Petitioner contends that any broader definition of insider trading is for Congress, not the courts.

Petitioner’s reading of Dirks is narrow. The test would potentially permit insiders to furnish inside information to virtually anyone as long as there is no quid pro quo in the form of money or perhaps something readily convertible to money.

In contrast, the Government’s position is broad to the point of being virtually open-ended. It is built in steps, first broadening the fundamental idea from the classic theory of insider trading that inside information can only be used for a corporate purpose to the inverse – communication of the information where there is a lack of corporate purpose are not permitted. The Government then shifts to the notion that any transmission of inside information to an outsider for trading – not a corporate purpose — is banned by Dirks. Viewed in this framework the concept of a gift is not limited to relatives and close friends as stated in Dirks, since those are only examples in the Government’s view. Rather, it applies to anyone. The Dirks bright line test which delimited the instances when there is illegal tipping transforms under this approach to any instance when an insider transmits inside information to an outsider for trading. It is difficult to reconcile this approach with the foundation of Dirks — parity of information is not required by the insider trading laws.

In essence the parties in Salman appear to have etched the outrebounds of insider trading for the High Court. The Court, however, seems unlikely to adopt either approach. While Petitioner’s theory is extremely limited, the Government’s approach to insider trading would eliminate the bright line of Dirks. Since the Court has demonstrated a repeated adherence to its precedents absent a compelling reason to rewrite them – and none is apparent here – it seems likely that the basic approach of Dirks will be affirmed. Its framework of drawing a bright line, requiring a personal benefit to the insider and the demand for objective evidence will likely remain. Consistent with the foundation on which Dirks was built, it is likely that benefit will have to be real and substantial but not necessarily cash.

Finally, it seems probable that the Court to retain the well established notion of a gift in connection with the personal benefit test. But not in the broad open, ended formulation suggested by the Government. Rather, in a formulation that is consistent with the requirement that there be objective evidence of a real personal benefit to the insider from making the gift and a family or close relationship. This formulation of the overall test may result in a determination that looks more like Newman than Salman. How this formulation will apply to Petitioner is likely to be resolved on remand by the lower courts.

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by T. GormanPosted on Posted in SECActions

The SEC filed another settled FCPA action stemming from what the Order called “pervasive” practices in the China subsidiary of a multinational firm. This time GlaxoSmithKline plc was charged with internal control violations arising from the conduct of its China subsidiary and a joint venture partner in which the firm holds a controlling interest. In the Matter of GlaxoSmithKline plc., Adm. Proc. File No. 3-17606 (Sept. 30, 2016).

GSK is a global provider of pharmaceutical and consumer health care products based in Middlesex, U.K. GlaxoSmithKline (China)International Co. Ltd. or GSK China operated from Shanghai, China. The firm is an indirect subsidiary of GSK. Sino-American Tianjin Smith Kline & French Laboratories Ltd. is a public-private joint venture with Tianjin Zhong Xin Pharmaceutical Group Corporation Ltd. and Tianjin Pharmaceutical Group Co. Ltd. or TSKF is 55% owned by GSK.

GSK China and TSKF marketed GSK pharmaceutical products in China. Over a three year period beginning in 2010 the firm’s engaged in a series of improper transactions which were designed to increase sales. Specifically, the firm made a series of corrupt payments to foreign officials in China. The payments were designed to increase sales through prescriptions by individual healthcare professionals and purchases by hospital administrative staff responsible for product selection or purchase.

The payments varied in form. They included gifts, improper travel and entertainment with no or little educational purpose, shopping excursions, family and home visits and cash. The practices were pervasive among sales and marketing representatives and were condoned by regional and district managers. A plan submitted by one sales representative described an intent to make payments and furnish gifts on each holiday in exchange for a guaranteed order.

Funding for the corrupt activities was arranged through a variety of sources including:

Travel: Third party vendors who provided these services frequently inflated their invoices. A sample of invoices taken over a three year period demonstrated that 44% were inflated.

Speaker fees: The firm did not have any system in place to ensure the identity of the speaker, although there were limits on the amount of the fees. A sample of invoices demonstrated that for a significant number the qualification of the person as a health care professional could not be verified.

Marketing: SK China created a marketing program that was supposed to provide healthcare clinics with tools to facilitate the storage and administration of vaccines that require refrigeration. Senior officials at the subsidiary created the program. Rather than conduct marketing, however, the program was used to provide healthcare officials with gifts.

Over time internal audit and compliance reviews became aware of items which might be viewed as red flags and that could have alerted them to the improprieties. For example, fake bank documents and false invoices were discovered. There was also a lack of training on various policies and initiatives. The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B).

The company cooperated with the SEC’s investigation, furnishing timely updates on its inquiry and making changes to its business practices. The Order does not specify that the company self-reported. Respondent also entered into a series of undertakings which included reporting to the staff over a two year period on the implementation of its remediation.

To resolve the proceeding the firm consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, the firm will pay a penalty of $20 million.

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