The Obama Administration made aggressive enforcement of insider trading laws a centerpiece of its securities enforcement agenda, including high-profile prosecutions of prominent hedge funds such as Galleon Group and SAC Capital. This legacy and the future vigor of insider trading enforcement efforts has been in question since December 2014, when the Second Circuit issued its high-profile decision in United States v. Newman. In Newman, the Second Circuit overturned the convictions of two hedge fund portfolio managers, holding there was a lack of proof that the individuals who provided the material non-public information (the "tippers") received an "objective" and "consequential" personal benefit of a "pecuniary or similarly valuable nature."
Other courts, citing long-standing Supreme Court precedent, had rejected the Second Circuit's suggestion that a tipper must receive some tangible benefit.
On December 6, 2016, in Salman v. United States, the Supreme Court unanimously reaffirmed long-standing principles of insider trading liability, expressly rejecting the Second Circuit's ruling in Newman that someone who provides a tip to a family member or friend must receive something of a "pecuniary or similarly valuable nature." While the Salman decision did not expressly address or resolve several important questions, the decision is likely to embolden enforcement efforts.
Background on Insider Trading Enforcement
The government has long prosecuted insider trading by traditional corporate insiders (e.g., corporate officers) who trade based on material, non-public information, or where an individual "misappropriates" information to trade in breach of a duty owed to the owner of that information. The government has also prosecuted "tippers" and "tippees" where corporate insiders or others who misappropriate information (tippers) do not themselves trade, but instead provide the information to outsiders (tippees) who trade based on that information.
In Dirks v. SEC, the Supreme Court established the standard for assessing liability of an insider tipper, noting that "[t]he need for a ban on some tippee trading is clear" and that "[n]ot only are insiders forbidden by their fiduciary relationship from personally using undisclosed corporate information to their advantage, but they may not give such information to an outsider for the same improper purpose of exploiting the information for their personal gain."
Thus, the Court held that, in order to determine whether a tipper breached his fiduciary duty, the relevant test asks "whether the insider personally will benefit, directly or indirectly, from his disclosure." The Court stated that while a personal benefit could include pecuniary gains or reputational benefits that later result in future earnings, a breach may also occur when the tipper provides information to a trading relative or friend. Furthermore, the Court stated that a tippee is equally liable if he knows or should have known of the tipper's breach.
In Newman, the Second Circuit criticized "recent insider trading prosecutions, which are increasingly targeted at remote tippees many levels removed from corporate insiders." This statement was made in the context of the government's prosecution of remote recipients of material non-public information which, in Newman, involved material non-public information being disseminated by employees of two technology firms to investment analysts, who in turn provided it to hedge fund analysts, who in turn provided it to the defendants (who then traded on the information). In this context, the Second Circuit held that, to establish liability for a tipper, a "personal benefit" cannot be inferred from a personal relationship absent "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." The Second Circuit also held that a tippee must know that the tipper disclosed information in exchange for a personal benefit. Although the government sought further review, the Supreme Court denied certiorari.
The Salman Decision Below
The Salman case concerned the appeal of Bassam Salman, who was prosecuted and convicted of insider trading in 2013. The tipping chain proceeded as follows: an investment banker shared material non-public information about pending mergers and acquisitions with his brother, who both traded on the information and passed along the information to others, including Salman (the tipper's brother-in-law). Salman traded on the information and made over US$1.5 million in profits.
Salman appealed his conviction, arguing that there was no evidence that the source of the inside information (the investment banker) had received anything of "a pecuniary or similarly valuable nature" in exchange for the information, and citing the Second Circuit decision in Newman. The Ninth Circuit affirmed the conviction, relying on Dirks' holding that a tipper benefits personally by making "a gift of confidential information to a trading relative or a friend."
The Supreme Court granted certiorari to resolve the conflict between the Second and Ninth Circuits.
The Supreme Court's Decision
Writing for a unanimous court, Justice Alito held that the Supreme Court would "adhere to Dirks, which easily resolves" the case.
The Court noted that while Dirks held that the mere "disclosure of confidential information without personal benefit is not enough," Dirks squarely held that a "personal benefit can often be inferred from objective facts and circumstances . . . such as a relationship between the insider and the recipient that suggests a quid pro quo from the latter . . . [or] when an insider makes a gift of confidential information to a trading relative or friend." Without expressly overturning Newman, the Court observed that the Second Circuit's holding that a "tipper must also receive something of a pecuniary or similarly valuable nature" was inconsistent with Dirks.
As applied to the facts in Salman, the Court concluded that the investment banker made a gift of material non-public information to his brother, who both traded on the information and passed it along to Salman, and noted 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." The Court concluded that "Salman's conduct is in the heartland of Dirks's rule concerning gifts."
While the Salman decision signals strong support for established principles of insider trading, the Court took a narrow approach to the issue and did not expressly address or otherwise provide meaningful guidance outside the situation where the tipper and tippee are "friends or family." For example, the Court did not address how Dirks would apply to situations where:
- a tipper had only a business relationship with a tippee (which was the factual scenario presented in Newman);
- a tipper and tippee had only a casual social relationship rather than a close friendship (i.e., what level of friendship is required);
- a tippee who traded was several layers removed from the insider tipper and did not know whether the insider had received a personal benefit (a situation that also was present in Newman); or
- a tipper received a non-pecuniary benefit and is neither a friend nor family member of the tippee.
Indeed, the Court acknowledged that determining whether a tipper "personally benefits from a particular disclosure" is a question of fact that will not always be easy for a court to resolve.
What is clear, however, is that the Salman decision resolves (at least in part) a high-profile dispute between courts over the extent to which prosecutors and the SEC can enforce insider trading prohibitions, coming down firmly on the side of the government. This is evident from the emboldened reaction of Preet Bharara—the US Attorney for the Southern District of New York and the Obama Administration's leading proponent of vigorous insider trading enforcement—who called the decision "common sense" and a "victory for fair markets and those who believe that the system should not be rigged."
While there is some uncertainty in the approach the next administration will take on securities enforcement generally, it is notable that President-elect Trump reportedly has asked US Attorney Bharara to remain in his current position in the new administration. If this portends that the Trump Administration will continue to pursue insider trading cases aggressively, the Salman decision signifies that the government will continue to have ample legal tools and mechanisms available to enforce and prosecute insider trading.