To Whom It May Concern:

I am a conscientious professional investment adviser. For years I have carefully followed legislation, judicial decisions, and news reports regarding the law of insider trading. I make every effort to stay abreast of the latest developments so that I can fulfill my fiduciary obligation to act in the best interest of my clients and optimize their returns while, at the same time, avoiding any violation of the law against trading on inside information. The latest decisions by the United States Supreme Court and the highest federal court that covers the area that includes Wall Street have left me paralyzed with uncertainty. I increasingly am afraid that diligent review, analysis, and investigation on behalf of my clients will land me before the SEC or worse yet a defendant in a criminal case. The law of insider trading has never been defined by Congress and increasingly I have become aware that federal judges cannot agree on what it is. In particular, when determining whether a violation has occurred, courts have been battling over whether when information is shared by an insider, he or she must receive a personal benefit and what constitutes such a benefit. Can someone help me out?!

Because no statute expressly defines insider trading, I was pleased when in 1983 in Dirks v. SEC, the Supreme Court defined an improper breach of fiduciary duty as occurring when the tipper “personally will benefit, directly or indirectly, for his disclosure.” The Supreme Court specifically noted that it was articulating this “personal benefit” requirement to guide market participants like myself and avoid criminalizing legitimate communications between Wall Streeters and company insiders. The Court explicitly stated, “It is commonplace for analysts to ‘ferret out and analyze information,’ and this often is done by meeting with and questioning corporate officers and others who are insiders. And information that the analysts obtain normally may be the basis for judgments as to the market worth of a corporation's securities.” As fiduciaries, we are obligated to trade on information that we have that benefits our clients! Not doing so opens us up to a claim that we improperly have failed to act in their best interest.

After recent decisions from the Supreme Court and the Second Circuit, however, those of us who work on Wall Street have absolutely no idea when it is permissible to trade on information learned from a company insider. This lack of clarity puts me in a position where I am damned if I do trade (because of potential insider trading liability) and damned if I don’t (because of potential liability for failing to fulfill my fiduciary obligation to my clients).

It follows from Dirks that disclosures made for reasons other than for a personal benefit will not breach a fiduciary duty and, therefore, do not violate the securities laws. In some instances, the personal benefit is clear. If the tipper benefits financially by disclosing the information, there’s no question of a personal benefit. In cases where the tipper provides material, nonpublic information to relatives or close friends who then trade on that information, the personal benefit is also clear because providing inside information in this context is the same as trading by the tipper followed by a gift of the proceeds. But for those of us who participate in the market every day and engage in countless conversations with company insiders who are mere acquaintances, what qualifies as a “personal benefit” to that insider such that I cannot trade on the information I learn from them or from others who have communicated with them?

I thought that the Second Circuit provided an answer to this question in its 2014 decision in United States v. Newman. In that case, the Court held that in those cases, a personal benefit to the tipper only exists where: 1) there is a “meaningfully close personal relationship” between the tipper and tippee and 2) the relationship “generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” The second part of this construction was rejected by the Supreme Court a little over a year later, however, when it adopted the reasoning of a lower court judge, United States District Court Judge Jed S. Rakoff. Judge Rakoff normally presides in a court controlled by the Second Circuit, but as luck would have it, he was temporarily sitting as an appellate judge in a sister court in California in the Ninth Circuit when he essentially took issue with the Second Circuit’s reasoning in Newman. In Salman v. United States, the Supreme Court affirmed the Ninth Circuit’s decision authored by Judge Rakoff, holding that at least in the context of a tip of confidential information to a trading relative or friend, the personal benefit to the tipper need not include potential financial gain.

To make matters worse, in August 2017, the Second Circuit essentially annihilated what, if anything, was left of the “meaningfully close relationship” requirement articulated in Newman. The defendant-tippee in United States v. Martoma was convicted of insider trading for trades he made after receiving information from a doctor involved in a clinical trial. The doctor in that case did not receive any financial benefit by passing on the information. Martoma argued that Newman’s “meaningfully close relationship” analysis survived the Court’s relatively focused decision in Salman – where the tipper and tippee were brothers – and was still necessary to determine the existence of a personal benefit to the tipper in cases where no clear close relationship exists. In a split 2-1 panel decision, a majority of the Second Circuit rejected this argument and found that a tipper receives a personal benefit from giving a gift of inside information to another person with the expectation that the recipient will trade on that information, regardless of the relationship between the tipper and tippee.

A forceful dissent was written by Judge Rosemary S. Pooler. She wrote that the personal benefits rule created by the Supreme Court as a limiting principle of liability in Dirks allowed “many people – including reports and stock analysts – not to worry that they will become felons or face civil liability for telling information to others who later happen to trade on it.” She further argued that the majority had gone too far in eliminating this restriction in holding that an insider receives a personal benefit when the insider gives information as a gift to any person. “What counts as a ‘gift’ is vague and subjective. Juries, and, more dangerously, prosecutors, can now seize on this vagueness and subjectivity.”

Pooler’s dissent accurately captures the concerns of those of us exposed to liability. Respectfully, the majority’s well-analyzed and explained decision offers no insight to professional investment advisers like myself who regularly receive information from corporate insiders. For instance, Martoma finds that a personal benefit may exists in the case of a gift of information from the insider to an outsider regardless of the nature of their relationship where there is an expectation that the recipient will trade on it because the disclosure may be the functional equivalent of trading on the information himself and giving a cash gift to the recipient. For example, if an insider gives his doorman a tip of inside information instead of an end-of-the-year cash gift, the insider has personally benefited despite the fact that the two have no “meaningfully close relationship.” While this example makes sense in that limited context, how can I use it to assess whether I have received information in a situation that is somehow the equivalent to trading by the insider followed by a cash gift of the proceeds?

In Salman the Supreme Court acknowledged that although the facts in that case made it easy to determine that the insider personally benefited from the disclosure, this determination “will not always be easy for courts.” If federal judges struggle with drawing a line between proper and improper trading activity, how are those of us on Wall Street supposed to do so? It is time for Congress to step up and straighten the insider trading mess out by passing clear legislation.

Sincerely,

A Confused Wall Streeter

From The Insider Blog:  White Collar Defense & Securities Enforcement