The Securities and Exchange Commission’s ill-defined and unsettled legal definition of insider trading is making it harder for advisors to understand how to comply with the rule—and advisors’ misunderstanding is likely resulting in more SEC enforcement actions.

On Oct. 13, the SEC charged a hedge fund advisor with failing to prevent insider trading in its funds based on information from one of its research analysts who received a tip from a friend employed at a public company.

The analyst made trade recommendations without the benefit of models, written reports, or research files—instead, he based his recommendations on information from his industry sources. 

On two particular occasions involving a company where his friend was employed, the analyst provided information to the fund that resulted in profitable trades.

The SEC brought an enforcement action against the advisor, alleging that the advisor did not have or enforce policies and procedures reasonably designed to prevent insider trading. 

While the adviseor had a policy requiring employees to report any material nonpublic information to the advisor’s CCO, the SEC faulted the analyst’s supervisor for not questioning the analyst about the source of his information and not asking the CCO to look into the matter despite purported “red flags.”

Further, the SEC faulted the advisor for not having policies that would have tracked and monitored the analyst’s interactions with employees of public companies.

The advisor paid $8.8 million in disgorgement and penalties to settle the case.

Hedge fund advisors in particular remember the high-profile government loss on appeal in the Newman case in 2014, overturning a criminal insider trading conviction against a couple of hedge fund portfolio managers because the prosecutors failed to prove that the insider tipper received a tangible pecuniary benefit for providing the tip. 

In Newman, according to the appellate court, the government failed to properly understand insider trading.

In a related development earlier this month, the Supreme Court heard oral argument in another insider trading case—the first such case to be heard by the Supreme Court since 1997. A majority of the justices in that case, Salman v. United States, appeared poised to rule in the government’s favor.

At issue is whether a person who provides an insider trading tip must receive a “tangible” or “pecuniary” gain in exchange for the tip, or whether a close family relationship between the tipper and tippee is sufficient to establish insider trading liability.

Bassam Salman was convicted of insider trading in 2013 after profiting from trades based on information from his future brother-in-law, who in turn received the information from his own brother, a Citigroup employee. No one paid anyone money for the tip, so the Supreme Court must decide whether the family relationship alone creates the necessary “benefit.”

Justice Breyer noted that, “to help a close family member is like helping yourself” and that the law is “filled with instances” in which providing a benefit to a close family member or friend is treated the same as providing a benefit to yourself.  Justice Kennedy agreed, pointing out that “you certainly benefit from giving to your family…it helps you financially because you make them more secure.”

However, several justices appeared skeptical of the government’s position that there is a personal benefit any time someone provides inside information to another when he or she knows that the other person will trade on it, reasoning that the “advantage that you receive is that you are able to make a gift with somebody else’s property.”

Whichever way the Supreme Court rules, one thing is clear: the standard for what constitutes insider trading remains unclear. The SEC should only punish hedge fund advisors for failing to prevent the most obvious instances.

So how obvious was the insider trading in the case the SEC brought against the hedge fund adviser last week? Not very.

In the underlying highly publicized SEC and criminal insider trading cases against the analyst, which date back to 2013, the government struggled to prove a tangible pecuniary benefit to the tipper.

The SEC alleged only that the analyst and tipper were friends and that “[o]n at least one prior occasion, [the analyst] had given [his friend] investment advice and [the friend] had traded based on such advice.” Appeals over the same issue in the criminal trial weren’t concluded until earlier this year.

Given the uncertain and shifting contours of insider trading law, and the SEC’s aggressive enforcement positions in the area, fund advisors should re-examine policies to prevent insider trading and redouble efforts to enforce those policies.