Yesterday, the Supreme Court issued its first insider trading decision in more than two decades, Salman v. United States. The decision clarified uncertainty in insider trading prosecutions that arose following a 2014 lower court decision and removed a significant hurdle for prosecutors and the SEC in the Second Circuit. In the Salman decision yesterday, the unanimous Court rejected a restrictive approach to tippee liability, which it concluded was in conflict with the Court’s last insider trading case – Dirks v. SEC, 463 U. S. 646 (1983).
Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b–5 promulgated thereunder prohibit insider trading by individuals who owe a duty of trust and confidence to an issuer. Corporate insiders also violate the provisions if they provide inside information to others. The recipient of inside information (a “tippee”) can be held liable for securities fraud where he knows information was disclosed in breach of the insider’s duty of confidentiality and nonetheless trades on the basis of the confidential information. Tippee liability hinges on whether the insider breached a fiduciary duty by disclosing the information. In Dirks, the Court had ruled that an insider breaches such a fiduciary duty when he discloses inside information for a personal benefit.
The question in Salman was just what constitutes such a “personal benefit.” Bassam Salman made lucrative trades using inside information that he received from Mounir Kara, who had received the information from his brother, Maher Kara, who was Salman’s brother-in-law. There was no dispute that Maher (the insider who was the source of the information) did not obtain any tangible personal benefit as the result of the disclosure. Salman argued that the Dirks “personal benefit” test required a showing that a tipper received money, property, or something of tangible value in return for disclosing confidential information. Prosecutors took a much broader view, arguing that for a tippee to be liable they only needed to show the tipper disclosed confidential information to the tippee for a noncorporate purpose -- so “a gift of confidential information to anyone, not just a ‘trading relative or friend,’ is enough to prove securities fraud.”
The Court rejected both extremes, concluding that its earlier opinion in Dirks “easily resolves” the issue. The Court pointed out that in Dirks it 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” and that, “in such cases, ‘[t]he tip and trade resemble trading by the insider followed by a gift of the profits to the recipient.’” Dirks made clear, the Salman Court emphasized, 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 the facts presented, Salman was liable because he traded on the information with full knowledge that it had been improperly disclosed by Maher.
This decision resolves a hotly disputed issue of insider trading jurisprudence brought to the forefront by the Second Circuit’s decision in United States v. Newman. There, the Second Circuit interpreted Dirks to require “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” before a personal benefit could be “inferred from a personal relationship between the tipper and tippee.” The Newman decision sparked controversy with its heightened standard for a personal benefit, and had immediate and significant consequences on insider trading cases in the Second Circuit − resulting not only in the convictions in Newman being reversed but also signaling the death knell for several other indicted cases, which DOJ was forced to dismiss.
Newman led to a circuit split over the “personal benefit” test when the Ninth Circuit, in Salman, rejected the Second Circuit’s interpretation of Dirks and held that “[p]roof that the insider disclosed material nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish the breach of fiduciary duty element of insider trading.” The Supreme Court affirmed the Ninth Circuit decision, holding that “[t]o 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.” Although the Supreme Court did not go as far as the government urged, Salman is still a big win for DOJ and the SEC.
There are several key takeaways from the Salman decision:
- Despite the Supreme Court’s clarification of the test for tippee liability, the court-made law of insider trading still lacks the clarity that could come from the enactment by Congress of a statute defining the offense, which many have advocated for years. Indeed, the Circuit divergence on the personal benefit test underscores how difficult and confusing insider trading jurisprudence can be.
- Remote tippee cases (e.g., where a defendant or respondent is multiple layers removed from the insider source of the tip) will continue to present evidentiary challenges to prosecutors and SEC trial attorneys, particularly when it comes to proving the tippee’s knowledge of the personal benefit to the insider tipper, as required by Newman and left undisturbed by Salman.
- The “personal benefit” element is defined broadly, to include intangible benefits, and therefore companies must ensure that their compliance programs and internal polices put employees on notice of the restrictions that apply to the use and transfer of material nonpublic information and clearly forbid them from misappropriating such information.
- We can expect that investigations that were on the backburner pending this decision may become active again, and new cases that might have been scrapped under Newman will gain new life with prosecutors and regulators.