A ton of ink and air time has been spent speculating on Donald Trump’s conflicts of interest as president of the United States and how either the law may not address his unique circumstances or how Trump’s refusal to honor ethical precedents is troubling. All of this may be true. But while all this chatter has been going on almost everyone has missed how a recent Supreme Court decision may have dealt a significant below to the Trump presidency with an interpretation of a securities law that goes back to the New Deal – the prohibition on insider trading.
Donald Trump is probably the richest person ever elected president of the United States. He has a vast empire of business holdings that cover the world. These holdings could potentially create conflicts of interest for him. Much in the same way that conservatives criticized Hillary Clinton for possible conflicts of interest growing out of her role as secretary of state and the Clinton Foundation, Trump will face the same as president. He will be able, for example, to appoint members of the National Labor Relations Board (the agency that oversees private sector union rules) or issue executive orders regarding workplace safety issues that could impact his businesses. Or there are issues regarding how his foreign business holdings might influence decisions he renders in international affairs.
Precedents dating to Carter and Nixon
Past precedent dating back to Jimmy Carter has been to place one’s business holdings in a blind trust so that the president has no control over his business nor knowledge regarding who is running his affairs. Dating back to Richard Nixon, presidents have released tax returns to offer the public a clearer picture of their financial affairs. Neither of these precedents is law – they are good ethical practices that presidents have followed as a matter of good government.
Trump has essentially rejected both practices. He has yet to release his tax returns and has indicated that he will not place his business holdings in a blind trust. At various times his transition team has declared either it will soon address the conflicts-of-interest issue, but most recently a press conference scheduled to be held on the topic was canceled. Trump has also said that he might turn over day-to-day decision making of his business to his children, assuming that this would be enough to cover his ethical problems. Unfortunately, that too will be insufficient.
The core of the problem is the powerful risk of insider trading. Back in the 1930s when Congress and President Franklin Roosevelt were trying to clean up the mess on Wall Street after the stock market crash in 1928, they passed the Securities Exchange Act of 1934. Among the major provisions of the law was a provision to regulate securities fraud. Section 10(b) of the Securities Exchange Act of 1934 and the Securities and Exchange Commission’s Rule 10b-5.
Securities fraud can encompass many practices, but one of them is insider trading. Specifically, it is when those in corporations or businesses in trusted positions trade on information before it becomes public. Classic examples are when officers of a corporation knows that their business is going to have a very good or bad first quarter earnings report and then before telling the public buys or sells stock in their company.
Fraud in several ways
Such insider trading is considered fraud in several ways. One is how it allows some the chance to take advantage of privileged informed before the public can use it – this is an abuse of one’s trust or special position. But it also allows for some individuals to potentially use this information or position to manipulate stocks to their personal advantage. Many of the Enron executives did that many years ago when they sold stock based on insider information that revealed their company was tanking even though the public did not know that, or when they manipulated balance sheets of the company to facilitate their own personal stock holdings. All this is illegal, a felony security violation.
Part of what is also prohibited under insider trading law is not simply a corporate officer trading on privileged or confidential information, but also passing it on to someone else. Here both the tipper and the tippee may be guilty of insider trading. Various Supreme Court decisions have sought to define what constitutes insider trading and what has to be proved to show guilt, but on Dec. 6, 2016, in Salman v United States, the Supreme Court issued a decision that significantly impacts President Donald Trump, his family, and perhaps many business insiders in his administration.
Appeal rejected by Supreme Court
At issue in this case, Salman was indicted for federal securities fraud for trading on inside information he received from a friend and relative-by-marriage, Michael Kara, who, in turn, received the information from his brother, Maher Kara, a former investment banker at Citigroup. Salman was convicted of securities fraud but argued on appeal that 10b and 10b-5 did not apply to gifts of confidential information and that the law requires the tipper to acquire some material benefit from the tip. The Supreme Court rejected this argument.
Writing for a unanimous Court, Justice Alito declared:
Section 10(b) of the Securities Exchange Act of 1934 and the Securities and Exchange Commission’s Rule 10b-5 prohibit undisclosed trading on inside corporate information by individuals who are under a duty of trust and confidence that prohibits them from secretly using such information for their personal advantage. … These persons also may not tip inside information to others for trading. The tippee acquires the tipper’s duty to disclose or abstain from trading if the tippee knows the information was disclosed in breach of the tipper’s duty, and the tippee may commit securities fraud by trading in disregard of that knowledge. In Dirks v. SEC, this court explained that a tippee’s liability for trading on inside information hinges on whether the tipper breached a fiduciary duty by disclosing the information. A tipper breaches such a fiduciary duty, we held, when the tipper discloses the inside information for a personal benefit. And, we went on to say, a jury can infer a personal benefit—and thus a breach of the tipper’s duty—where the tipper receives something of value in exchange for the tip or “makes a gift of confidential information to a trading relative or friend.”
The critical holding
The critical holding in Salman is that liability for insider trading can be established through simply giving the gift of confidential information to a friend, family, member, or others. The gift alone may be enough to establish liability for both the tipper and tippee. According to Alito:
[A] tipper breaches a fiduciary duty by making a gift of confidential information to “a trading relative,” and that rule is sufficient to resolve the case at hand. As Salman’s counsel acknowledged at oral argument, Maher would have breached his duty had he personally traded on the information here himself then given the proceeds as a gift to his brother. It is obvious that Maher would personally benefit in that situation. But Maher effectively achieved the same result by disclosing the information to Michael, and allowing him to trade on it.
Salman in many ways builds upon a 1997 decision United States v. O’Hagen, where the Supreme Court articulated the “misappropriation theory” for securities fraud. Under this theory it is still insider trading if a person trades in securities for personal profit using material, confidential information without disclosing such use to the source of information. In addition, the 2012 STOCK Act, which made it illegal insider trading for members of Congress to use confidential information to trade on stock, arguably if not definitely applies to members of the executive branch, including the president.
So how does all this apply to Trump? Lacking a blind trust for his business holdings and where his children or he are still closely involved in the running of his business empire, use of any confidential information for business purposes could be a form of insider trading prohibited under 10b and 10b-5. For example, President Trump passes on information about imposing a tariff on a company contemplating shifting jobs overseas. He or his family now have this information, which they then use to buy or sell stock in that company or otherwise use in ways to make securities trades. Once this government information is given to a corporate officer it becomes insider information and any trading on it before it is made public would be insider trading, securities fraud.
Broad leeway to prosecute
O’Hagen and Salman give the government broad leeway to prosecute for securities fraud when individuals – both tippers and tippees – use confidential information that they have for personal benefit. And just as important, under a series of other Supreme Court decisions private parties are not barred from bringing suits raising securities fraud in some cases. Thus, even it one worries that a Trump Justice Department would not prosecute or investigate the president or his family, other private parties are not barred from bringing legal challenges.
Trump, his family, and his network of business holdings implicate many traps for insider trading. The same is true for his rich friends he is appointing to many of his Cabinet and other positions. The conflicts of interest that may ensue raise not just ethical issues but significant securities fraud issues that could create numerous criminal and civil problems.
David Schultz is a Hamline University professor of political science and the author of “Election Law and Democratic Theory” (Ashgate, 2014) and “American Politics in the Age of Ignorance” (Macmillan, 2013). He blogs at Schultz’s Take, where a version of this piece first appeared.
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