Sean Stewart, left, trusting son.

Photographer: Louis Lanzano/Bloomberg

Insider Trading Is Sometimes a Family Affair

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Let's say you are the chief executive officer of a company that is about to announce a big merger that will push up its stock price. And let's say you tell your best friend about it. And let's say he buys stock in the company and makes a lot of money. Is that insider trading? The answer -- to everything -- is "it depends," but I think there are three possible answers.

One is that it is insider trading in a straightforward traditional way: You are the tipper, he is the tippee, and you breached your fiduciary duty to your company and its shareholders by giving him information to trade on. (Normally prosecutors also need to show that you got a "personal benefit" from his trading, though it's a little unclear whether really close friendship can qualify as that benefit. But of course if he gave you sacks of cash, that counts.) You are guilty of insider trading. Your buddy probably is too.

A second possibility is that it is still insider trading, but on an entirely different theory. On this theory, you have a long "history, pattern, or practice of sharing confidences" with your best friend. You told him about the merger in confidence, not because you wanted him to trade on it, but because you wanted to, like, get his advice, or just talk about your day with your best friend who understands you and whom you trust. You were shocked to learn that he traded on it. The breach of duty in this case wasn't yours -- you didn't do anything wrong -- but rather your friend's. He violated his duties to you. (The duties of a friend.) In this theory, he is guilty of insider trading -- because he misappropriated information from you and traded on it -- but you aren't. 

The difference between these cases depends on the precise facts, and the same relationship can give rise sometimes to the first theory, sometimes to the second. So sometimes an executive will tell his golf buddy about a deal, the buddy will trade, and the executive will be charged with insider trading. Sometimes the executive will get away clean, and his buddy will be charged with trading in violation of the sacred duty of golf-buddy confidence.

The third possibility is that it isn't insider trading at all, because you neither tipped him in the expectation that he'd trade and give you a personal benefit, nor talked to him in the expectation that he'd keep it secret and not trade on it. Like if you and he aren't that close, and if you just sort of casually mention the deal, not in a heart-to-heart conversation but also not in a nudge-nudge-wink-wink-where's-my-bribe sort of way, maybe he could trade on it?

This is an odd one; it is hard to see why it's any better than the first two, and also a bit hard to imagine how it would actually happen. I am not quite sure how often it occurs out in the wild. But the theory predicts that it should exist, and it's basically the defense argument in the Salman case, which is up before the Supreme Court. Bassam Salman was convicted of trading on information that a banker gave to his (the banker's) brother. The banker doesn't seem to have gotten any personal benefit for the information, or to have told the brother about the deals in confidence. He just, like, told his brother about the deals, and went on with his day. Perhaps that isn't insider trading at all, though Salman has lost in court so far. 

Anyway here's a schematic diagram:

I have conflicted feelings about this chart. On the one hand, I must stress that it oversimplifies drastically and is in any case not legal advice. On the other hand, if potential insider traders want to cut it out and keep it in their wallets to remind them of how this all works ... I mean, don't actually do that, but if you do, I cannot deny that I'll be flattered. 

Obviously, I know the chart makes no sense. Don't blame me for that! Blame, like, the Supreme Court.  It's a weird area of law.

We talked a while back about an insider trading case in which Sean Stewart, a banker at Perella Weinberg Partners, allegedly passed confidential information about upcoming mergers to his father, Bob Stewart, who then passed it on to a friend named Dick Cunniffe. (Disclosure: Next month, my wife will go back to work for the federal defender's office that currently represents Sean Stewart. ) Back then, I was impressed by, among other things, Cunniffe and Bob Stewart's use of a golf-based code to talk about their insider trading. If there's insider trading, there is usually also golf, and I respect them for upholding that tradition.

Cunniffe and Bob Stewart have pleaded guilty to insider trading. That's fairly straightforward: They had inside information, they traded, and Cunniffe ended up working as an informant and recording some pretty guilty-sounding conversations with Bob Stewart.  

Sean Stewart's trial starts next week, and Bloomberg News reports that he has a defense: "When Bob pleaded guilty, he admitted he got confidential information from Sean but didn’t say Sean knew he was using it." Aha! The prosecution thinks that this is a case of the left-hand side of the chart, where Sean Stewart tipped his father in the expectation that he'd trade. (There are also some alleged quid pro quos -- "Bob paid $10,000 for a photographer at Sean’s wedding and gave his son an additional $15,000" -- though I am not sure how important that is in a father-son case? Like, many parents pay for their children's weddings without expecting illegal stock tips in exchange.) But the defense can argue that it's actually the middle of the chart: Sean told Bob about his work in confidence, as father-son bonding, and Bob then betrayed his fatherly duty by trading on it.

From Cunniffe's recorded conversations with Bob Stewart, there seems to be evidence both ways. On the one hand ("CW-1" is Cunniffe):

A few minutes later, when CW-1 once again asked, "out of curiosity," to "understand[] the relationship," whether SEAN STEWART had offered tips on deals "out of the goodness and kindness of his heart," or if ROBERT STEWART had instead "throw[n] [SEAN STEWART] money," ROBERT STEWART denied the provision of cash to SEAN STEWART. He also claimed that he never told SEAN STEWART "I've done anything."

That sounds good! On the other hand:

In one conversation, at Andrew’s Coffee Shop in midtown Manhattan, Bob allegedly told Cunniffe that his son had scolded him for failing to trade on a tip.

“I can’t believe it,” Bob quoted Sean as saying, according to prosecutors. “I handed you this on a silver platter and you didn’t invest.”

That sounds bad! 

There is precedent for this, by the way, in a case called U.S. v. Gansman, in which James Gansman, a lawyer at Ernst & Young, "repeatedly disclosed material non-public information to Donna Murdoch, a woman with whom he was having an affair." (They met on Ashleymadison.com.) Murdoch traded, and both she and Gansman were charged with insider trading. Gansman's defense was: No, no, this isn't a case of my violating my duty of confidentiality to Ernst & Young; this is a case of Murdoch violating her duty of confidentiality to me. I guess it makes sense that she'd have such a duty. Surely if you are having an affair with someone, you have a history of sharing secrets with her. That, I gather, is how affairs work.

So if Gansman told Murdoch about upcoming mergers, he could have assumed that she would keep those mergers confidential and not trade on them. Ashleymadison.com, like the confessional and the golf course, creates a sacred relationship of confidence that insider trading law should respect. An appeals court endorsed the basic soundness of this argument, and Gansman's right to submit it to a jury, though it ultimately didn't work and the jury convicted him.  Presumably the father-son relationship, like the golf-buddy and extramarital-affair relationships, can create an obligation of confidentiality that would make any insider trading Bob Stewart's problem, not Sean's.

The reason I love insider trading law is that this is all so weird and murky and human. You'd think that what is allowed would be clearer, and would be based on the needs of the capital markets rather than the nuances of family relationships. I like to say that insider trading is illegal, not because it is unfair, but because it is theft. But neither theory quite explains this stuff. If insider trading law is about creating a level playing field for all investors, then it shouldn't matter whether Sean Stewart told his father about upcoming mergers in confidence; Bob Stewart's trading was "unfair" in either case. If insider trading law is about companies' ability to control their own information, then it shouldn't matter whether Sean Stewart expected his father to trade on the information; either way, he shouldn't have shared his company's information. But those things do matter, because the law is a haphazard accretion of rules of thumb that don't quite respond to any higher purpose. And so prosecutors and juries have to pry into the detailed workings of family (and extramarital!) relationships, to decide whether a son trusted his father and why a father supported his son. As securities law -- as a way of regulating the capital markets -- it is pretty odd.

  1. Also, as with everything, nothing here is legal advice.

  2. Unless he didn't know you were breaching your duty to your company, which seems unlikely. But it becomes more relevant if your buddy tells his buddy, who tells his buddy, who trades. Those are roughly the facts of the Newman case

  3. It is mostly called the "misappropriation theory," though I don't love that terminology. The first ("classical") theory is about misappropriation too; it's just, you misappropriated the information from your shareholders.

  4. That's from a Securities and Exchange Commission rule, Rule 10b5-2, which says that it's insider trading to trade on the basis of "material nonpublic information misappropriated in breach of a duty of trust or confidence," and says that such a duty exists:

    (1) Whenever a person agrees to maintain information in confidence;

    (2) Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or

    (3) Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling; provided, however, that the person receiving or obtaining the information may demonstrate that no duty of trust or confidence existed with respect to the information, by establishing that he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties' history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information.

  5. This, by the way, is not generally true. Like, if you work at a hedge fund, and you talk about your fund's secret market-moving plans with your roommate in confidence, and he runs off and trades on those plans, you may not be guilty of insider trading if regulators and prosecutors conclude that you didn't intend for him to trade. But that doesn't mean you did nothing wrong! Your hedge fund (or investment bank, or law firm, or corporation, or whatever) probably does have policies that boil down to "don't talk about confidential work stuff with your roommate, even if he promises to keep it secret, come on." And you probably did violate those policies by talking.

    But there is a difference between being indiscreet about your work and being a criminal, and insider-trading law draws the line (sensibly enough!) at "did you intend for him to trade."

  6. Particular caveats:

    1. I don't literally mean "you want him to trade." I mean something like "you want him to trade, or you expect that he'll trade, or you are reckless in not knowing that he'll trade, etc."
    2. On the other hand, in some cases even wanting him to trade isn't enough for liability: There needs to be a quid pro quo, a personal benefit to you, for it to be insider trading. Maybe! If you just want him to trade out of disinterested generosity, it may not be insider trading. Maybe! This area is particularly murky; perhaps the Supreme Court's Salman decision will resolve it.
    3. Similarly, if there's no quid pro quo, your buddy (and certainly any downstream tippees) may get off, on the theory that they didn't know about your fiduciary breach.
    4. "You don't want him to trade" is, again, inexact; I mean more like "you shared it in confidence in the expectation that he wouldn't trade, and you had a pattern of sharing and keeping confidences."
    5. The right-hand category may not really exist and I'd be extra wary about trying it. 
    6. All of this is very different when it comes to tender offers and also probably a million other situations. 
  7. Or Congress, which has never passed a clear insider-trading law.

  8. Coincidentally, she has also written recently about some of the same issues I talk about here.

  9. I was less impressed by Sean Stewart's apparent failure to recognize his father's name on a list of people who traded the stock of a deal he worked on. But hey -- that happens.

  10. When we previously talked about this case, I was also impressed by Cunniffe's probing about Sean Stewart's motivations:

    Also at the April 16, 2015 meeting, CW-1 asked ROBERT STEWART whether SEAN STEWART had supplied the information for ROBERT STEWART's and CW-1's trades "out of the goodness and kindness of his heart for you." ROBERT STEWART responded, "No, you know what? I think he gets angry at times. Angry at the industry."

    That seems to me like an effort to establish whether Sean Stewart was getting a quid pro quo for tipping Bob Stewart. If he was, it would clearly be the left-hand category of my chart, and everyone would be guilty. If he wasn't, then ... maybe it would be the middle column? Maybe even the mythical right-hand column? (Tips without a confidential relationship, and without a quid pro quo?) Maybe Cunniffe himself would have a defense, if there was no quid pro quo?

    In any case, it's not clear where "I think he gets angry at times" puts you. Maybe it means that Sean Stewart wanted his father to trade, to, like, get back at the industry. (Itself a personal benefit, and so the first category? Maybe? Or just a disinterested tip, and so the third category? Who knows.) Or maybe it means that Sean was just venting about his feelings to his father, and never expected his father to trade.

  11. From the Second Circuit opinion (citations omitted):

    Pursuant to this misappropriation concept of insider trading liability, the SEC has recognized a number of situations, set forth in Rule 10b5–2, in which a tippee, but not the tipper, may be liable for insider trading on the theory that the tippee owed a duty of trust or confidence to the tipper and the tipper conveyed confidential information without intending to have it used for securities trading purposes.

    Here, it was perfectly appropriate for Gansman to seek to present to a jury a defense that his relationship and interactions with Murdoch exemplified just such circumstances. That is, Gansman was entitled to support his general defense that he lacked the intent to commit securities fraud by showing, in particular, that he shared “a history, pattern, [and] practice of sharing confidences” with Murdoch sufficient to create a duty of trust running to Gansman, see SEC Rule 10b5–2, and that Gansman had confided in Murdoch with the understanding that his communications would not be used for securities trading purposes. By presenting the defense theory in this way, Gansman presumably wished to show that his relationship with Murdoch was factually similar to cases in which a tipper (like Gansman) was not liable for insider trading despite the presence of a tippee (like Murdoch) who was liable for insider trading. Gansman could have been properly acquitted of the crime with which he was charged if the trier of fact had agreed with his theory.

    But the jury didn't buy it and he was convicted.

  12. In fact, the parental relationship is specifically mentioned in Rule 10b5-2(b) ("Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling"), whereas the golf-buddy and extramarital-affair relationships of trust and confidence are just implied.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net