Insider trading: crucial decision of US Supreme Court

A recent decision of the US Supreme Court on insider trading, reported in the Economist,  has not received the attention it deserves.

The Court was asked to review a decision of an Appeals court in an insider trading case. The Appeals court had overturned the conviction of two hedge fund managers accused of insider trading. The Supreme Court refused the reivew, which means the Appeals court decision stands.

The Appeals court decision is significant. It ruled that the fact that the recipient had benefited from information (which was the case with the two fund managers) and was a friend or family member of the recipient was not sufficient to obtain a conviction. It prescribed two standards:

• Prosecutors must prove that the provider had a 'direct personal benefit'
• Prosecutors must also prove that the recipient was aware that the provider should not have been providing the information and that the provider received a benefit

The two new standards seem to imply that if somebody passes on information that benefits the recipient but not the provider  (in a 'direct' way), then it cannot be said to be insider trading. As the Economist points out, a CEO who passes on information that benefits the recipient without the CEO being compensated may avoid prosecution hereafter.

The interesting question that arises is how the case of Rajat Gupta, the former McKinsey head who is serving a jail sentence currently, will come to be viewed. Mr Gupta was not seen to have been compensated directly from the trades that happened consequent to the information he was said to have passed on. Yet, it was held that he had a relationship with fund manager Rajaratnam from which he stood to benefit. Does this constitute insider trading in light of the two criteria now laid down?