On December 6, 2016, the United States Supreme Court decided Salman v. United States, the first significant insider trading case in over 30 years. Salman was closely watched because the Court examined the extent of personal benefit necessary to establish liability in an insider trading case. Two years earlier, the Court of Appeals for the Second Circuit ruled that a personal benefit required proof of a meaningfully close personal relationship between the tipper and tippee that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature was necessary to impose liability.1 In contrast, the Court of Appeals for the Ninth Circuit ruled that a close personal relationship was sufficient.2 The Supreme Court affirmed Salman’s conviction based on the Ninth Circuit’s interpretation of personal benefit. While the Court and the parties agreed that the majority of insider trading cases involve relatives and friends, the Court left unresolved how trading by remote tippees should be analyzed. Given that information sources are fragmented and access to information provides a competitive advantage to market participants - hedge funds, expert networks, and individual traders - courts will continue to have difficulty determining whether an insider received a personal benefit for disclosure of confidential information, and perhaps even more difficulty determining whether a remote tippee knew the insider disclosed confidential information in breach of his or her duty in exchange for a personal benefit.
II. Background to Salman v. United States
In Salman, the Government charged Maher Kara (“Maher”), Michael Kara (“Michael”), and Bassam Salman (“Salman”) with securities fraud and conspiracy to commit securities fraud. Maher, an investment banker in Citigroup’s healthcare investment banking group, disclosed material non-public information (“MNPI”) to his brother, Michael, with whom he had a very close relationship. Maher disclosed MNPI to Michael: (1) so that Michael could help him understand the healthcare industry since Michael held a degree in chemistry; and (2) to evaluate pharmaceutical companies that produced palliative drugs that could help their ailing father. Maher eventually learned that Michael traded on the MNPI that he provided.
Salman became involved in the scheme when Maher became engaged to his sister. The Salman and Kara families grew very close and Michael shared MNPI with Salman, his future brother-in-law. The Government established that: (i) Salman’s trades mirrored Michael’s trades; (ii) Michael told Salman that Maher was the source of MNPI; (iii) Maher shared MNPI in breach of his duty to Citigroup and its clients; and (iv) Salman funneled money into a brokerage account controlled by another brother-in-law to avoid detection of his trading activities. Salman’s trades netted profits of approximately $1.5 million. A jury in the Northern District of California convicted Salman of one count of conspiracy to commit securities fraud and four counts of securities fraud.
Shortly before Salman’s appeal to the United States Court of Appeals for the Ninth Circuit, the Second Circuit Court of Appeals decided United States v. Newman. In Newman, a group of finance professionals exchanged MNPI about quarterly earnings for Dell and NVIDIA before the numbers were publicly released.3 Two analysts shared the MNPI with their portfolio managers, Newman and Chaisson, who executed trades in the securities, resulting in profits of $4 million and $68 million, respectively.4 Newman and Chaisson were convicted of securities fraud. On appeal, the Second Circuit held that for a defendant to be criminally liable for insider trading, the Government must show “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”5 The Second Circuit overturned the convictions, finding that the Government failed to prove that the insiders received a personal benefit and that neither Newman nor Chaisson knew that they were trading on illegal inside information.6
The Ninth Circuit rejected Newman’s holding and affirmed Salman’s conviction. Consistent with Dirks v. SEC, the Ninth Circuit concluded that a close family relationship suffices to establish a personal benefit.7 Salman appealed his conviction to the Supreme Court to clarify the circuit split.
III. The Supreme Court Unanimously Affirms Dirks
Justice Alito, writing for an 8-0 majority, stated that Dirks easily resolved the narrow issue presented in the case. The Court reiterated that an insider is exposed to liability for disclosure of MNPI for a non-corporate purpose in breach of his or her fiduciary duty to the corporation. The Court reaffirmed that “the test to determine the purpose of the disclosure “is whether the insider personally will benefit, directly or indirectly, from his disclosure.”8 Personal benefit can be determined by a quid pro quo exchange, a reputational benefit that may lead to pecuniary gain, or as is the case in Salman, a gift of MNPI to a trading relative or friend. Focusing on the gift of MNPI to a friend or relative, the Justices concluded that a disclosure of MNPI to a trading relative or friend is no different than the insider trading on the MNPI followed by a gift of the proceeds to the relative or friend.
Applying the Dirks framework to Salman, the Court repeatedly recognized that Maher and Michael were very close. The Court concluded that Maher (the insider) breached his duty of trust and confidence to Citigroup and its clients by disclosing MNPI to his brother, Michael, whom he knew intended to trade on the information. Michael had a duty to abstain from trading, but instead he disclosed the MNPI to his brother-in-law, Salman, whom he knew would trade on the information. Michael and Salman knew that Maher was the source of the MNPI and that Maher disclosed MNPI in breach of his fiduciary duty. Each of them acquired Maher’s duty to avoid trading on the MNPI.
The Court affirmed Salman’s conviction and held that “to the extent the Second Circuit 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.” 9
IV. Ramifications of Salman v. United States
Salman is hailed as a significant win for the Department of Justice and the Securities and Exchange Commission because Newman had curtailed the Government’s ability to bring certain insider trading cases when the insider did not receive a pecuniary benefit. After the ruling, Preet Bharara, the U.S. Attorney for the Southern District of New York, issued a statement that the “Supreme Court stood up for common sense and affirmed what we have been arguing from the outset – that the law absolutely prohibits insiders from advantaging their friends and relatives at the expense of the trading public. Today’s decision is a victory for fair markets and those who believe that the system should not be rigged.”10 Andrew Ceresney, Head of the SEC’s Enforcement Division, added that “I think it’s a good victory for us. From our perspective, we had been operating as if that was the law.” 11
Salman was a clear win for prosecutors, but it left several issues unresolved. Salman was decided on very narrow facts – all of the parties were close family members and the insider cooperated with the Government. However, Salman did not decide how the Court would analyze remote tippees who are several levels away from the insider. Indeed, during oral argument, several Justices were skeptical of the Government’s argument that an insider receives a personal benefit and therefore exposes the tippee to liability whenever the insider discloses MNPI to a tippee for a non-corporate purpose. Additionally, at least three Justices expressed reservations about how close a relationship must be to impose liability on a tippee, and the magnitude or value of the tip that the insider needs to provide to the tippee for the Government to impose liability on the tippee. Finally, the Court did not address Newman’s requirement that the Government prove that remote tippees knew that the insider breached his or her fiduciary duty in exchange for a personal benefit. So, while the Government savors this win, there is likely to be intense battles down the road because, as the Court acknowledged, “determining whether an insider personally benefits from a particular disclosure, a question of fact, will not always be easy for courts.” 12