The U.S. Supreme Court earlier today rejected an attempt to cut back on liability for insider trading where people give inside tips to family members and friends. In Salman v. United States, the Court unanimously held that where an insider tips a family member that creates the breach of duty needed to establish insider trading liability, even if the tipper does not receive a pecuniary benefit.
A contrary ruling, as sought by the defendant in the case, could have dramatically changed insider trading law by effectively permitting gifts of insider tips to family and friends so long as the tipper was not motivated by direct monetary gain.
In many ways, the decision was hardly a surprise in light of a 1983 Supreme Court precedent, except that two years ago a widely publicized Second Circuit decision seemed to take a different approach and call into question that precedent. The Supreme Court’s decision today reaffirmed its earlier decision and rejected the approach of the Second Circuit.
More than 30 years ago, in Dirks v. SEC, 463 U.S. 646 (1983), the Supreme Court stated that when an insider “makes a gift of confidential information to a trading relative or friend,” that supplied the necessary elements of fiduciary duty and exploitation of nonpublic information to give rise to insider trading liability. Taking those words at face value seemed to require affirmance of the conviction in Salman, where the defendant received a tip from his friend, who in turn had received the tip from his investment-banker brother.
But in 2014, the U.S. Court of Appeals for the Second Circuit issued its decision in United States v. Newman, 773 F.3d 438 (2d Cir. 2014). In that case, the court reversed convictions based on insider tips in part on the basis that the government failed to prove that the tippers acted to obtain a “personal benefit.” (It also reversed based on the grounds that the government failed to prove the defendant tippees had the required knowledge of any benefit to the tippers, assuming there was one; knowledge was not at issue in the Salman case).
The Newman court said a personal benefit cannot be inferred from a personal relationship between the tipper and the tippee “in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential and represents at least a potential gain of a pecuniary or similarly valuable nature.”
What exactly this language means, and how it can be reconciled with what the Supreme Court said in Dirks, is not clear. But it was interpreted by some as meaning that the government always would have to show some kind of tangible benefit to the tipper, beyond whatever inherent “benefit” there is to being able to make a gift of valuable information to your family member or friend.
That, in essence, was the argument made by the defendant in Salman, and rejected by the District Court for the District of California and the Ninth Circuit Court of Appeals, and, today, by the Supreme Court. To the justices, it was not a hard call. Justice Alito’s unanimous opinion stated: “We adhere to Dirks, which easily resolves the narrow issue presented here.”
The tipper in Salman provided inside information to a close relative, his brother. The Court reasoned that the tipper would have breached his duty by personally trading on the information and then giving the proceeds as a gift to his brother. Tipping the brother achieved the same result. Dirks prohibits both, the Court held.
The Court referred to Newman in its analysis, stating that the decision, or at least the more expansive interpretations of its language requiring the tipper to have received something of a pecuniary nature, was foreclosed by Dirks. Justice Alito wrote: “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, Newman, 773 F.3d, at 452, we agree with the Ninth Circuit that this requirement is inconsistent with Dirks.”
Just as prosecutors were disappointed by the decision in Newman, they will strongly welcome the decision in Salman. It did not, however, give them everything they asked for. In describing the parties’ arguments, the Court noted that the government had argued that “a gift of confidential information to anyone, ‘not just a trading relative or friend,’ is enough to prove securities fraud.” But in that part of the opinion explaining its resolution of the issues, the Court simply relied on Dirks’ language concerning a “trading relative or friend,” neither rejecting nor accepting the government argument regarding gifts to “anyone.”