Why it matters: On December 6, 2016 the Supreme Court decided Salman v. U.S., in which it upheld the petitioner’s insider trading conviction. The Court found its 1983 decision in Dirks v. SEC to be controlling, holding that, for purposes of establishing the necessary “personal benefit” to the insider, it is sufficient for the government to show that the insider relayed a “gift of confidential information to a trading relative or friend” and that no evidence of an additional tangible personal benefit to the insider is necessary.
Detailed discussion: On December 6, 2016 the Supreme Court unanimously decided Salman v. U.S., in which it upheld the conviction of a tippee for insider trading. The Court deemed its 1983 decision in Dirks v. SEC to be controlling, holding that the required “personal benefit” to the insider can properly be inferred from evidence showing that the insider gave “a gift of confidential information to a trading relative or friend” and that no evidence of an additional tangible personal benefit to the insider need be provided. In so doing, the Court affirmed the Ninth Circuit’s interpretation of Dirks, and set aside the Second Circuit’s opinion in United States v. Newman to the extent that it was “inconsistent” with Dirks. We covered the oral argument before the Court in this case in our October 2016 newsletter under “Supreme Court: What Constitutes an Insider Trading ‘Personal Benefit,’” and the Ninth Circuit’s decision in our August 2015 newsletter under “Are the Circuits A-Splitting? The Ninth Circuit Declines to Follow the Second Circuit’s Insider Trading Decision in U.S. v. Newman.”
Background, procedural history and Dirks
To briefly review the underlying facts and procedural history of the case, the government introduced facts at trial showing that petitioner Bassam Yacoub Salman had received insider information involving upcoming mergers and acquisitions of an international investment bank’s clients from his brother-in-law (via marriage to his sister) Michael Kara (Kara Brother #2). Kara Brother #2 had learned the information from his brother, Mahar Kara (Kara Brother #1), who worked in the bank’s healthcare investment banking group. Salman then shared the insider information he learned from Kara Brother #2 with the husband of his wife’s sister, with whom he split the illicit profits. Of particular relevance on appeal was evidence presented by the government at trial that showed that Salman was “well aware” both that Kara Brother #1 was the source of the insider information and that Kara Brother #1 and Kara Brother #2 shared an extremely “close fraternal relationship” that was “mutually beneficial.”
In the appeals period following Salman’s conviction, the Second Circuit decided Newman, which vacated the insider trading convictions of two downstream tippees on the grounds that the government failed to prove that the tippees knew whether the original insider tippers derived a “tangible personal benefit” from disclosing the information. After the Second Circuit sitting en banc denied the government’s petition for rehearing in Newman in April 2015 (the Supreme Court subsequently denied certiorari in Newman in October 2015), Salman appealed his conviction to the Ninth Circuit. Salman argued that, applying the Second Circuit’s Newman standard to his case (which Salman urged the Ninth Circuit to adopt), the information the government presented was insufficient because it failed to show that Kara Brother #1 disclosed the information to Kara Brother #2 in exchange for a tangible personal benefit, such as a financial benefit, and that Salman knew of such benefit.
On July 6, 2015, the Ninth Circuit upheld Salman’s conviction. The panel relied on the Supreme Court’s 1983 opinion in Dirks, the last time the issue came before the Court, which found that (1) in order to establish a “personal benefit” to the insider tipper—one of the elements of insider trading liability—“the test is whether the insider personally will benefit, directly or indirectly, from his disclosure … for in that case the insider is breaching his fiduciary duty to the company’s shareholders not to exploit company information for his personal benefit”; (2) the recipient of inside information (tippee) is equally liable if “‘the tippee knows or should know that there has been [such] a breach’ … i.e., knows of the personal benefit”; and (3) that such a personal benefit can be inferred “when an insider makes a gift of confidential information to a trading relative or friend.” The panel found that “this last-quoted holding of Dirks governs the case” because Kara Brother #1’s disclosure of confidential information to Kara Brother #2, “knowing that he intended to trade on it, was precisely the ‘gift of confidential information to a trading relative’ that Dirks envisioned.” The panel specifically declined to follow the Second Circuit’s standard in Newman because “[d]oing so would require us to depart from the clear holding of Dirks that the element of breach of fiduciary duty is met where an ‘insider makes a gift of confidential information to a trading relative or friend.’”
The Supreme Court granted certiorari in Salman to consider the question presented of “[w]hether the personal benefit to the insider that is necessary to establish insider trading under Dirks v. SEC requires proof of ‘an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature,’ as the Second Circuit held in U.S. v. Newman, or whether it is enough that the insider and the tippee shared a close family relationship, as the Ninth Circuit held in this case.” The Supreme Court heard oral argument on October 5, 2016.
The Court’s Holding
In a brief (12-page) opinion written by Justice Samuel Alito, the Court unanimously held that the Ninth Circuit properly applied Dirks—which the Court deemed to be controlling—to affirm Salman’s conviction and that, under Dirks, a jury can properly infer (as they did in Salman) that an insider receives a “personal benefit” if they make a “gift of confidential information to a trading relative or friend.” The Court further found that “[t]o the extent the Second Circuit [in Newman] held that the tipper must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends … we agree with the Ninth Circuit that this requirement is inconsistent with Dirks.”
At the outset of its opinion, the Court said that it agreed to review Salman to “resolve the tension between the Second Circuit’s Newman decision and the Ninth Circuit’s decision in this case.”
The Court began its analysis by restating the relevant insider trading law. The Court first pointed to Section 10(b) of the Securities Exchange Act of 1934 and the Securities and Exchange Commission’s Rule 10b–5, which “prohibit undisclosed trading on inside corporate information by individuals who are under a duty of trust and confidence that prohibits them from secretly using such information for their personal advantage.” The Court said that, under this prohibition, “[t]hese persons also may not tip inside information to others for trading” and that “[t]he tippee acquires the tipper’s duty to disclose or abstain from trading if the tippee knows the information was disclosed in breach of the tipper’s duty, and the tippee may commit securities fraud by trading in disregard of that knowledge.”
Next, the Court pointed to its 1983 opinion in Dirks, in which it “explained that a tippee’s liability for trading on inside information hinges on whether the tipper breached a fiduciary duty by disclosing the information. A tipper breaches such a fiduciary duty, we held, when the tipper discloses the inside information for a personal benefit. And, we went on to say, 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.’”
After enumerating the arguments presented by Salman and the government, respectively, with respect to what constitutes the required “personal benefit” under the insider trading laws, the Court said that “[w]e adhere to Dirks, which easily resolves the narrow issue presented here.”
The Court first pointed to the language in Dirks that discussed the relationship between a “personal benefit” and making a quid pro quo “gift” of confidential information to family members or close friends, which it said “resolves the case”:
“In determining whether a tipper derived a personal benefit, [in Dirks] we instructed courts to ‘focus on objective criteria, i.e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earn- ings.’… This personal benefit can ‘often’ be inferred ‘from objective facts and circumstances,’ we explained, such as ‘a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient.’… In particular, we held that ‘[t]he elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend.’… In such cases, ‘[t]he tip and trade resemble trading by the insider followed by a gift of the profits to the recipient.’… We then applied this gift-giving principle to resolve Dirks itself, finding it dispositive that the tippers ‘received no monetary or personal benefit’ from their tips to Dirks, ‘nor was their purpose to make a gift of valuable information to Dirks’ (emphasis added).”
Applying this language in Dirks to the facts of the case, the Court said that “Maher, the tipper, provided inside information to a close relative, his brother Michael. Dirks makes clear that a tipper breaches a fiduciary duty by making a gift of confidential information to ‘a trading relative,’ and that rule is sufficient to resolve the case at hand.” The Court went on to explain its reasoning, and in so doing set aside the holding in the Second Circuit’s Newman decision to the extent that it was “inconsistent” with Dirks:
“As Salman’s counsel acknowledged at oral argument, Maher would have breached his duty had he personally traded on the information here himself then given the proceeds as a gift to his brother…. It is obvious that Maher would personally benefit in that situation. But Maher effectively achieved the same result by disclosing the information to Michael, and allowing him to trade on it. Dirks appropriately prohibits that approach, as well…. Dirks specifies that when a tipper gives inside information to ‘a trading relative or friend,’ the jury can infer that the tipper meant to provide the equivalent of a cash gift. In such situations, the tipper benefits personally because giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds. To the extent the Second Circuit held [in Newman] that the tipper must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends … we agree with the Ninth Circuit that this requirement is inconsistent with Dirks.”
The Court specifically rejected Salman’s argument that the gift-giving standard articulated in Dirks was unconstitutional on vagueness or “rule of lenity” grounds, stating that “[t]o the contrary, Salman’s conduct is in the heartland of Dirks’s rule concerning gifts. It remains the case that ‘[d]etermining whether an insider personally benefits from a particular disclosure, a question of fact, will not always be easy for courts.’… But there is no need for us to address those difficult cases today, because this case involves ‘precisely the “gift of confidential information to a trading relative” that Dirks envisioned.’”