The Supreme Court's unanimous decision affirming a criminal insider trading conviction in Salman v. United States this week marks a clear victory for federal law enforcement. Prosecutors will no longer be required to show that the tipper received a pecuniary benefit in the context of passing material nonpublic information to a friend or family member tippee. But the Salman decision also leaves many difficult questions and challenges for lawyers and compliance officers advising buy-side investors.
Salman's facts arise from one more sad chapter in the annals of family insider trading cases. The evidence showed that Maher Kara, a former investment banker at Citigroup, provided confidential information about corporate transactions he was working on to his brother Michael, who executed stock trades using the information and shared it with an extended family member, Bassam Salman (who also traded stocks using the information). Salman was indicted on one count of conspiracy to commit securities fraud and four counts of securities fraud. Facing charges of their own, both Maher and Michael pleaded guilty and testified at Salman's trial. After a jury trial in the Northern District of California, Salman was convicted on all counts.
On appeal, Salman argued that he could not be held liable as a tippee because the original tipper (Maher) did not personally receive money or property in exchange for the tips (to Michael) and thus did not personally benefit from them. The Ninth Circuit disagreed, citing the Supreme Court's decision in Dirks v. SEC, 463 U.S. 646 (1983).
In Dirks, the Court made clear that a tippee's liability for trading on inside information hinges on whether the tipper breached a fiduciary duty by disclosing the information; that a tipper breaches such a fiduciary duty only when the tipper discloses the inside information for a personal benefit; and that 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." Id. at 664. The Ninth Circuit held that Dirks allowed the jury to infer that Maher derived a personal benefit from gifting confidential information to his brother Michael, his "trading relative," and therefore it affirmed Salman's conviction.
While Salman's appeal to the Ninth Circuit was pending, the Second Circuit issued its opinion in United States v. Newman, 773 F.3d 438 (2014), cert. denied, 577 U. S. ___ (2015). In Newman, although the Second Circuit acknowledged that Dirks allowed a fact-finder to infer a personal benefit to the tipper from a gift of confidential information to a trading relative or friend, it concluded that, "[t]o the extent" Dirks permits "such an inference," the inference "is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature." Id. at 452.
In the Ninth Circuit, Salman pointed to that language in Newman and argued that there was no evidence that Maher received anything of a "pecuniary or similarly valuable nature" in exchange for the information he provided to his brother. The Ninth Circuit declined to adopt Newman's "pecuniary or similarly valuable nature" test. In affirming Salman's conviction, the Ninth Circuit held that Maher's disclosures to Michael were "precisely the gift of confidential information to a trading relative that Dirks envisioned" and that to the extent the Second Circuit went further and required additional gain to the tipper in cases involving gifts of confidential information to family and friends, the Ninth Circuit "decline[d] to follow it." 792 F.3d 1092-93.
The Supreme Court granted certiorari to resolve the tension between the Second Circuit's Newman decision and the Ninth Circuit's Salman decision. A unanimous Court sided with the Ninth Circuit and held that Dirks's test and not the "pecuniary or similarly valuable nature" test invented by the Second Circuit in Newman remains the relevant inquiry and "easily resolves the narrow issue presented" in Salman. As such, it remains the case that where a tipper makes a gift of confidential information to a trading relative, juries will be permitted to infer that the "personal benefit" prong of the test for insider trading liability has been established. The Court made clear that "there [was] no need" for it to go any further or to address the scope of the gift theory outside the context of the "gift of confidential information to a trading relative" because Salman's conduct fell within "the heartland of Dirks's rule concerning gifts."
Salman is the first Supreme Court insider trading case in two decades. Insider trading law in the United States is unique in that, unlike in virtually every other jurisdiction, there is no insider trading statute; the law is developed by enforcement, federal court decisions, and a handful of Supreme Court decisions that may be spaced by decades. The Supreme Court's unanimous decision in Salman re-affirms that, as a practical matter, any gift of confidential information to a trading relative or friend is potentially susceptible to insider trading liability, no matter whether the tipper might potentially get a pecuniary or similarly valuable benefit from the tip or not.
The implications of the Supreme Court's opinion apply more broadly to a vast universe of buy-side investors. All are conducting research. All are trying to develop a thesis to detect trends that others in the marketplace do not appreciate. Lawyers and compliance officers seeking to manage these risks need to draw lessons from a family fact pattern which is not the staple of most of the investment research they see. For those advising buy-side investors, there are three practical implications that flow from Salman.
First, the government's victory will fuel regulatory scrutiny of well-timed trading. In the wake of Newman, there were press headlines that created the misimpression, in our view, that there was a "free pass" for a subset of insider trading cases. They could have fed a perception that certain insider trading risks had diminished.
The outcome in Salman shows that that is not the case. The lack of money changing hands in exchange for confidential information does not create a safe harbor for trading on that information. Instead, courts and juries will continue to be tasked with analyzing the precise relationship between the tipper and tippee, and there will continue to be legal risk on the outer edges of legitimate investment research.
Second, investment teams need to scrutinize research sources. Relatives leaking an investment bank's deal information are not the only possible source of material nonpublic information. There exists a panoply of research sources, and those sources have been multiplied by service providers and expanded use of technology.
Paid consultants provide one real-life example. They fill a niche in the market and can be a valuable and legitimate source of legitimate investment research. An analyst researching the producer of a heart valve, for example, can gain access to cardiologists who can provide valuable first-hand experience and perspectives.
But investment teams must carefully consider who they are speaking to and what information that person is authorized to share. In one case, for example, a portfolio manager was convicted of insider trading for trading on material nonpublic information regarding a failed clinical trial for a new Alzheimer's drug that he received from a doctor who was chairman of the safety committee for the trial and who was introduced by an expert-networking firm.
To avoid similar liability, analysts must remain alert as to whether a research source is authorized to disclose information of the type being shared and should not request that research sources provide information that they would not be authorized to share.
Third, investment teams should flag when they believe that they have received nonpublic information that is material to the market for a company's securities. Issuers are under a Regulation FD obligation not to disclose material information to investors. Advisors to issuers typically are subject to confidentiality obligations. The receipt of a kernel of information that is clearly material is a rare event. Every member of every investment team should know to raise their hand when this happens.
In the normal course, there will be close judgment calls that will involve nonpublic information that may be material. An investor and the individuals involved will always be better served to raise it with their compliance and legal staff.