A question posed occasionally at this time of year is whether a director or an officer may make a gift of his or her company’s securities to a charitable organization without exposing the director or officer to insider-trading liability under SEC Rule 10b-5. Although the question is relevant whenever the insider has material non-public information, it is particularly relevant for most insiders at this time of year, when charitable gifts are frequent and when the insiders have material non-public information regarding fiscal-year-end and fourth-quarter company performance and are subject to a black-out period under the company’s insider-trading policy.
The question may be answered by the applicable insider-trading policy if it prohibits gifts, or all transfers (including gifts), of company securities during a black-out period or otherwise while the insider has material non-public information. But if the insider-trading policy does not prohibit such a gift and the insider has material non-public information, may the gift be made without constituting insider trading? It appears that the answer is the same now as it has been for a number of years: Perhaps, but making the gift is probably not a good idea.
Because liability for insider trading requires a “purchase” or “sale” of a security, or an act “in connection with” a purchase or sale of a security, a key issue is whether a gift of securities is a “sale,” or is “in connection with” a sale, for purposes of insider trading. Normally, the gift itself would not be considered a “sale,” because the donor receives no consideration for the transferred securities. I am not aware of any court decision holding that a gift of securities by an insider while in possession of material non-public information is a “sale” for purposes of insider trading. Nevertheless, it is certainly possible that a transfer of securities in the form of, or called, a “gift” might actually be a disguised sale, because the donor receives some economic benefit from the transfer, whether direct or indirect or immediate or remote. An example would be a donor’s “giving” shares to his or her child who promptly sells the shares and uses the proceeds to pay an expense for which the donor is responsible (such as car repairs or school tuition). Also, even if the donor makes a gift of securities to a charitable organization without any expectation or desire for an economic benefit, there may be a reasonable argument that the gift is a “sale” if the insider expects or knows that the charity will immediately or promptly sell the securities. Further, it has been argued that, if the gift results in a tax deduction for the donor, the deduction constitutes an economic benefit and, therefore, consideration to the donor. It seems to me that the deductibility of the gift alone would not be determinative, however.
If the gift itself is not a “sale,” there may still be a problem for the donor if the gift is an action “in connection with” a sale of securities. A gift might be so characterized if the charity immediately or promptly sells the securities, even if the donor does not expect or anticipate the sale in such a time period. In this situation, the gift may be like a “tip” where the “tipper” does not sell, but the “tippee” does. In its decision in Dirks v. Securities and Exchange Commission, 463 U.S. 646, 664 (1983), the U.S. Supreme Court noted that an insider’s tipping with a prompt trade by the tippee resembles the insider’s (improper) trading followed by a gift of the proceeds. Similarly, an insider’s gift of securities with a prompt sale of them appears to resemble tipping with a prompt trade.
In addition, like the analysis in tipping insider-trading cases, it may well be argued that the donor receives a personal benefit by making the gift. Certain courts have broadly construed “personal benefit,” finding it to include the vague expectation of future economic gain, the enhancement of friendship or other personal relationship, and the enhancement of reputation. A finding of personal benefit to the donor would be more likely if the donor controls or significantly influences the charitable organization or is otherwise closely associated with the charitable organization.
So if the facts are that the donor will not receive any significant reputational or other personal benefit from the gift, that the charitable organization will hold the securities for some time (such as during the entire black-out period or until the donor no longer has material non-public information), and that the donor will not direct the charitable organization’s sale, then it should be safe to make the gift without concern about insider-trading liability. Unfortunately, those are not always, or even frequently, the facts. And when those are not the facts, even if there is no violation of insider-trading law, a gift and sale of securities when the insider has material non-public information may have the appearance of an improper or inappropriate transaction and cause some embarrassment to the donor, the charity, and the company.
OUR TAKE: Uncertainties regarding what constitutes a “sale” or a “personal benefit” under insider-trading law make it difficult to conclude that an insider’s gift of securities to a charitable organization is permissible during a black-out period or otherwise when the insider has material non-public information. Although such a gift might appear to be permissible under the company’s insider-trading policy, it may still violate insider-trading law or at least create the appearance of inappropriate activity in the company’s securities. In most situations, unfortunately, the insider may be well-advised to refrain from making such a gift.