On December 6, 2016, the Supreme Court unanimously held that a corporate insider who tips confidential information to a trading relative or friend creates liability for both the tippee and the tipper under Rule 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. In Salman v. United States, No. 15-628, the Court held that because Salman traded on a tip he received from a friend that originated from the friend’s brother—who also happened to be Salman’s brother-in-law—the jury properly inferred that the tipper received a personal benefit and the Court affirmed Salman’s conviction for securities fraud. A benefit to the tipper in the form of a pecuniary gain or similarly valuable nature was not required, as had been implied in the Second Circuit’s decision in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), in exchange for a gift of the confidential information to family or friends.
Insider trading liability derives from Section 10(b) of the Exchange Act and arises when a corporate insider breaches a fiduciary duty to their corporation by exploiting inside information for their personal advantage. In Dirks v. SEC, 463 U.S. 646 (1983), the Court held that a tippee’s liability for insider trading depends on whether the corporate insider’s disclosure of nonpublic information breaches a fiduciary duty, which occurs only when disclosure is made for a “personal benefit.” In Dirks, the Court held that 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.”
In December 2014, the Second Circuit construed Dirks’ language narrowly in its high-profile decision in Newman, where it reversed the insider trading convictions of two hedge fund traders who traded on third- and fourth-hand inside information. Among other items, the Second Circuit found the Government failed to prove the corporate insiders who initially disclosed the information received any personal benefit in exchange for their tips, much less that the defendants—so called “remote tippees”—knew of any benefit or even that the information they traded on originated from insiders. The Government’s evidence of a personal benefit in Newman was that one insider had tipped his “church friend” while the other had received “career advice” from a fellow alumnus (who testified that she would have given that advice notwithstanding the tip). In reversing the insider trading convictions, the Second Circuit explained that the Dirks standard, “although permissive,” does not allow the Government to prove an insider’s receipt of a personal benefit by “the mere fact of a friendship” and that, “to the extent Dirks suggests that a personal benefit may be inferred from a personal relationship,” the proof must establish a “relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”
Less than six months after Newman, the Court of Appeals for the Ninth Circuit affirmed the insider trading conviction of Bassam Salman. The panel distinguished Newman and held that Dirks’ personal benefit standard is satisfied by an insider’s gift of confidential information to a trading relative or friend, without any additional personal benefit.
In Salman’s case, the Government presented evidence that Salman had directed trades based on nonpublic information he obtained from his friend Michael Kara (Michael), who obtained it from his younger brother (and Salman’s brother-in-law) Maher Kara (Maher), a former insider at Citigroup. The Government also presented evidence that brothers Michael and Maher had a close personal relationship, and at trial Maher testified that he gave Michael nonpublic information to benefit and provide for his brother.
On appeal, Salman relied in part on Newman and argued there was no evidence that Maher received anything of a pecuniary or similarly valuable nature in exchange for Maher’s tips to Michael.
The Supreme Court’s Ruling
Justice Alito, writing for the Court, relied on Dirks to affirm Salman’s conviction: “Dirks . . . easily resolves the narrow issue presented here” because that decision “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.” In addition, as Salman’s counsel had acknowledged at oral argument, Maher, the tipper, would have breached a fiduciary duty had he personally traded on the nonpublic information and then gifted the proceeds to his brother Michael. As Justice Alito wrote, “[m]aking a gift of inside information to a relative like Michael is little different from trading on the information, obtaining the profits, and doling them out to the trading relative.”
The Court’s opinion also addressed the Second Circuit’s decision in Newman. Justice Alito wrote 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 friend, . . . we agree with the Ninth Circuit that this requirement is inconsistent with Dirks.”
Over thirty years after Dirks was decided, the Court’s decision to reaffirm that an insider’s gift of confidential information to a trading relative or friend violates securities law stands to ease the fears of prosecutors that the Second Circuit’s holding in Newman would be expanded. However, the Court declined to adopt the Government’s argument that a gift of confidential information to anyone is enough to prove securities fraud. Salman’s benefit to prosecutors may also be limited in light of the favorable facts presented to the Court. In Salman, the jury found that Salman knew that Maher had made a gift of confidential information to Maher’s trading relative Michael. In certain cases, and in particular those involving remote tippees like Newman or where tips might not be made to relatives or friends, prosecutors may continue to struggle to prove that a tippee had knowledge that an insider received a personal benefit in exchange for the disclosure of the confidential information.
It also bears watching how courts will handle relationships falling in the grey zone between the close relatives in Salman and the casual acquaintances in Newman, such as next-door neighbors, long-time work colleagues, and former friends. This fact-specific inquiry may provide prosecutors leverage to bring more insider trading prosecutions, even if they may ultimately fail in front of a jury or on post-verdict review. Until Congress ultimately defines what constitutes insider trading, the requirements for liability will continue to develop.