On Dec. 6, 2016, a unanimous Supreme Court held in Salman v. U.S. that a tippee who trades on material non-public information provided by a friend or relative is liable for insider trading even if the tipper has received nothing tangible in return for the tip. The decision resolved a circuit split between the 2nd and 9th Circuits over what constitutes a “personal benefit” to a tipper sufficient to satisfy the Dirks standard for insider trading liability under federal securities laws. The decision partially overruled United States v. Newman, which had held that evidence of a pecuniary benefit to the tipper was required for the tippee to be liable for insider trading, even when the tipper and tippee were close friends or relatives. The Salman decision will be a relief to the government, which had abandoned a number of high-profile insider trading cases in the wake of the Newman decision.
Liability in insider trading is based on the theory that an insider breaches a duty of trust and confidence to the rightful owner of material non-public information when she trades on such information or, under certain circumstances, shares such information with someone who trades on it. The recipient of the information, a tippee, can also be liable when he is deemed to participate in the insider’s breach of her duty. Not all disclosures of material non-public information to third parties constitute a breach of duty, and the courts have found many situations in which a tip does not give rise to insider trading liability for the tipper or the tippee. In its seminal decision in Dirks v. SEC, the Supreme Court defined the circumstances under which a tip constitutes a breach of duty and therefore gives rise to liability for the tipper and tippee. The Court held that the breach of such a duty occurs when the tipper discloses the information for a “direct or indirect personal benefit.” Although the Court did not specifically define what constitutes a personal benefit to the tipper, Dirks held that when the insider “makes a gift of confidential information to a trading relative or friend,” a personal benefit to the tipper may be inferred from the fact of the gift alone.
The 2nd Circuit attempted to more specifically define “personal benefit” in its 2014 decision in Newman. In that case, the 2nd Circuit held that the government was required to prove that a tipper received a personal benefit that was “at least a potential gain of a pecuniary or similarly valuable nature.” In other words, Newman held that, notwithstanding the holding in Dirks, the fact of the gift alone, even to a close friend or relative, was in fact not sufficient to support liability. Newman also made clear that, like tippees who receive information directly from an insider, tippees who receive information indirectly from a secondary tipper, so-called “remote tippees,” must have had at least some knowledge of the personal benefit provided to the original source of the information.
In Salman, the alleged tipper was Maher Kara (“Maher”), who worked as an investment banker in Citigroup’s healthcare investment banking group. While working at Citigroup, Maher received confidential information concerning upcoming mergers and acquisitions by Citigroup’s clients. Maher discussed this information with his older brother, Mounir Kara (known as “Michael”), who began trading on that information. Although Maher knew that the information he passed on to his brother would be traded on, he continued to provide the information to him. Michael later shared that information with Bassam Salman (“Salman”), Maher’s brother-in-law and Michael’s close friend. Salman also began trading on the information, ultimately making over $1.5 million in profits. At trial, Salman was convicted of conspiracy and insider trading in violation of Section 10(b) of the Securities Exchange Act of 1934.
Following his conviction, Salman appealed to the 9th Circuit. While Salman’s appeal was pending, the 2nd Circuit issued its decision in Newman. Relying on Newman, Salman urged the court to adopt the 2nd Circuit’s interpretation of the “personal benefit” standard. Salman argued that Newman precluded his conviction because there was no evidence that the original tipper (here, Maher) received a “pecuniary or similarly valuable” benefit. The 9th Circuit disagreed and found the evidence sufficient for a conviction. The court reasoned that the tipper’s personal benefit is in making the gift of confidential information to a trading relative or friend. The court stated that under Dirks, a jury could properly infer that Maher breached a duty of trust and confidence by making the gift of confidential information to Salman.
Before the Supreme Court, Salman argued that a tipper’s benefit must be “something of tangible value,” such as money or property. The government, on the other hand, argued that the gift of confidential information to anyone is enough to satisfy the “personal benefit” standard. In its opinion, the Court found that Dirks “easily resolved” what it considered the “narrow issue presented” in Salman’s case. The Court stated that Dirks “makes clear that a tipper breaches a fiduciary duty by making a gift of confidential information to ‘a trading relative.’” The Court reasoned that Dirks held that a jury could infer the tipper meant to provide the equivalent of a cash gift by providing the confidential information. The Court stated that Maher disclosed confidential information as a gift to Michael knowing that he would trade on it. As such, Maher breached a fiduciary duty to the owners of the information. That duty was shared with and also breached by Salman, who traded on it knowing that its disclosure had been in breach of Maher’s duty.
In a purely legal sense, the Court’s holding in Salman is neither radical nor surprising. While reasonable minds may differ as to whether the Newman decision went against the letter of Dirks, Newman clearly called the continued force of Dirks into question and thereby muddied the waters of insider trading liability for tippers and tippees. This ambiguity caused the government to abandon cases and to vacate previous sanctions against tippers and tippees who clearly would have been appropriate defendants under Dirks as it was understood prior to 2014. It stands to reason that the Court would take the opportunity to clarify the holding in Dirks and remind the lower courts that Dirks is the law of the land. Moreover, as the 6-0 decision suggests, Salman’s case represented a fairly straightforward application of the holding in Dirks, so the Court was not compelled to address a number of questions that Dirks left open, such as what relationships between tipper and tippee are close enough to create liability as a result of the tip alone and how much a tippee must know about the tipper’s underlying breach of duty to be liable himself.
While the decision in Salman left important questions unanswered and did not expand the scope of tippee and tipper liability in the ways that some might have hoped, it is undoubtedly a victory for the government. Salman is also one of the rare decisions in which a victory for the government is likewise an unambiguous victory for everyone who participates in the U.S. capital markets in good faith. Insider trading is plain theft from honest investors, and, beyond a few fringe academic theories, there is no basis for defending it. Moreover, insider trading undermines public confidence in our capital markets and gives cheap ammunition to those with political reasons for arguing that Main Street and Wall Street are natural enemies. Cases like Newman are particularly discouraging to ordinary investors because they reinforce the perception that the well-connected can profit from unfair advantages and escape punishment because of what can only be described as legal technicalities. The Salman decision should be welcome for this reason alone: It has undone some of the very real damage that Newman wrought.