December 7, 2016
On December 6, 2016, in Salman v. United States, the Supreme Court unanimously resolved a circuit split between the Courts of Appeals for the Second and Ninth Circuits over the meaning of the "personal benefit" element of insider trading law. In doing so, the Court put to rest confusion on this aspect of insider trading jurisprudence. But the murky nature of other aspects of insider trading was left untouched, leaving market participants, courts, and lawyers generally "right back where we started from" before Newman.
Bassam Salman was convicted of trading on information he received from a corporate insider, after it was found that the insider had breached a fiduciary duty in giving the information. In order to find that the insider breached a fiduciary duty, the jury had to find that he had received a personal benefit in exchange for the information. It was from this finding, that the insider received a personal benefit, that Salman appealed to the Ninth Circuit, which affirmed his conviction and interpreted the "personal benefit" test broadly. This resulted in a circuit split with the Second Circuit’s ruling in United States v. Newman, 773 F.3d 358 (2d Cir. 2014), cert. denied, 577 U.S. ___ (2015). In Salman, the Supreme Court adopted the Ninth Circuit’s interpretation, finding that an insider-tipper receives a personal benefit where the tipper makes a gift of inside information to a trading relative or friend, and rejecting the additional requirements imposed by the Second Circuit in United States v. Newman. This resolves the confusion over one often-contentious element of insider trading.
Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 have been interpreted to prohibit individuals with material, nonpublic information who are bound by a duty of confidentiality from sharing that information with others for the purpose of trading. In Dirks v. SEC, 463 U.S. 646 (1983), the Supreme Court explained that an individual who receives such information from an insider (the "tippee") may be liable for securities fraud where the insider who provided the information (the "tipper") breached a fiduciary duty in providing it. The Dirks Court held that such a fiduciary breach occurs where the tipper receives a personal benefit in exchange for the information, a requirement known as the "personal benefit" test.
In 2014, the Second Circuit decided United States v. Newman. In Newman, the Second Circuit held that no personal benefit accrues to a tipper from the gift of information to a trading relative or friend unless there is "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." 773 F.3d at 452. The Newman standard established that providing inside information to a trading friend or relative is not by itself enough to satisfy the "personal benefit" test; there must be at least the potential of receiving some tangible benefit in return.
Courts, prosecutors, and the white-collar bar viewed Newman as a milestone decision. And its effect was immediate. In a number of pending insider trading cases that were underway in the U.S. District Court for the Southern District of New York, prosecutors dropped charges against defendants where the evidence may not have been sufficient to meet the heightened "personal benefit" standard articulated in Newman. Moreover, uncertainty regarding the scope of Newman quickly arose, with SEC civil enforcement actions moving forward against defendants whom federal prosecutors felt were now beyond their reach.
One year after Newman, the Ninth Circuit addressed the same question in United States v. Salman, 792 F.3d 1087 (9th Cir. 2015). The Ninth Circuit, however, reached the opposite conclusion. In an opinion authored by Judge Jed Rakoff, a Southern District of New York judge sitting by designation on the Ninth Circuit, the Ninth Circuit interpreted Dirks more broadly, and held that the prosecution can show that a personal benefit to a tipper exists where an insider makes a gift of confidential information to a trading relative or friend. To the extent that Newman required an additional benefit to the tipper, the Ninth Circuit declined to follow it.
Salman had been convicted of trading on material, nonpublic information about potential mergers and acquisitions activity, which he received from his brother-in-law, Mounir ("Michael") Kara, who, in turn, obtained the information from his younger brother, Maher Kara, an investment banker at Citigroup. Using this information, Salman made more than $1.5 million in trading profits. Salman promptly appealed his conviction to the Ninth Circuit, arguing that in light of Newman, his conviction should be reversed because there was no evidence that Maher received anything of "a pecuniary or similarly valuable nature" in exchange for the information he provided to Michael. The Ninth Circuit declined to follow Newman and affirmed Salman’s conviction. The Supreme Court granted Salman’s petition for writ of certiorari.
The Supreme Court unanimously affirmed the Ninth Circuit’s decision, upholding Salman’s conviction for insider trading. In relying squarely on the requirements of Dirks, the Court noted that a tipper’s "disclosure of confidential information without personal benefit is not enough" to constitute a breach of the tipper’s fiduciary duty, and thereby expose a tippee to liability for trading on such information. Salman v. United States, 580 U.S. ___ (2016), slip op. at 8. The Court described the Dirks test for whether a tipper derived a personal benefit as focusing "on objective criteria, i.e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings," but also allowing 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 an intention to benefit the particular recipient.’" Id. at 9 (quoting Dirks, 463 U.S. at 663-64). The Court emphasized that Dirks stands for the principle that the "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." Id. (emphasis in original) (quoting Dirks, 463 U.S. at 664, 667).
As such, the Court held that "Dirks makes clear that a tipper breaches a fiduciary duty by making a gift of confidential information to ‘a trading relative.’" Id. Giving a gift to a relative or friend–whether in the form of cash or a tip–benefits the insider. Id. at 10. If Maher had personally traded on the information and then gifted the proceeds to Michael, "[i]t is obvious that Maher would personally benefit in that situation." Id. at 9. By disclosing the information to his brother and letting him trade on it, "Maher effectively achieved the same result." Id.
The Court thus determined that Maher breached his fiduciary duty to Citigroup when he gifted inside information to his brother, Michael, knowing that Michael would trade on it. Salman inherited this duty, and subsequently breached it himself when, with full knowledge that the information had been improperly disclosed, he traded on it anyway. The Court rejected Newman‘s "pecuniary gain" requirement as inconsistent with Dirks. Id. at 10.
The Court agreed with Salman’s contention that, in some gift-giving cases, it may be difficult to assess whether an insider received a personal benefit for disclosing confidential information. However, the Court noted that these hypothetical difficulties do not "render shapeless" or unconstitutionally vague the tipper-tippee liability rules, as Salman claimed, because "Dirks created a simple and clear ‘guiding principle’ for determining tippee liability." Id. at 11. The Court also rejected Salman’s appeal to the rule of lenity, saying that Salman failed to show "grievous ambiguity or uncertainty that would trigger the rule’s application." Id. at 11. The Court saw no need to address "difficult" factual questions regarding whether an insider personally benefits from a particular disclosure, because Salman’s conduct falls within the "heartland" of Dirks, involving "precisely the ‘gift of confidential information to a trading relative’ that Dirks envisioned." Id. at 11-12.
The Court’s Salman decision effectively overrules the Second Circuit’s decision in Newman insofar as Newman required prosecutors to show that a tipper received something of a "pecuniary or similarly valuable nature" in exchange for a gift of information to family or friends. In a footnote, however, the Court stressed that its decision left untouched the secondary holding of Newman–that prosecutors must prove that downstream tippees had knowledge that the information was improperly disclosed. Id. at 5, n.1.
The Court’s holding in Salman already has been praised by prosecutors for its re-affirmance of the continued validity of Dirks, and for overruling the additional burdens imposed on insider trading prosecutions by Newman. Going forward, Salman is likely to reenergize prosecutors to vigorously pursue tipping cases. Preet Bharara, the U.S. Attorney for the Southern District of New York, lauded the "common sense" Salman opinion as a "victory for fair markets and those who believe that the system should not be rigged." SEC Chair Mary Jo White said the decision "reaffirms our ability to continue to aggressively pursue illegal insider trading and bring wrongdoers to justice."
Prior to the Court’s decision, prosecutors had been cautious about charging individuals criminally in certain tipping cases in the wake of the Newman ruling. For example, the SEC recently filed a claim against Leon Cooperman and his firm Omega Advisors, Inc. in the Eastern District of Pennsylvania, while prosecutors from the U.S. Attorney’s Office for the District of New Jersey explicitly reserved their decision whether to bring a criminal case pending the Supreme Court’s decision in Salman. Nevertheless, the Salman ruling is unlikely to mark a sea change for insider trading prosecutions. First, cases most directly affected by Salman‘s holding–that is, cases in which a tip is passed to a family member or friend in exchange for a nonpecuniary personal benefit–fall outside of the core subset of insider trading prosecutions. More typically, these prosecutions involve the provision of some consideration in exchange for inside information, or the misappropriation of inside information for trading purposes. For example, in United States v. Riley, 90 F. Supp. 3d 176 (S.D.N.Y. 2015) (Caproni, J.), the defendant was convicted of insider trading in connection with his receipt of "three concrete personal benefits" that satisfied the requirements of Newman: assistance with the defendant’s side business, investment advice, and help in securing the defendant’s next job. Id. at 186-89. These types of traditional insider trading cases will not be affected by the Supreme Court’s decision in Salman to re-affirm the Dirks "personal benefit" test.
Importantly, because the Supreme Court granted certiorari in Salman, but not in Newman, the Supreme Court’s ruling does not touch the more resonant portion of the Second Circuit’s ruling in Newman: namely, the high burden it imposes to prove a downstream tippee’s scienter in insider trading cases. As noted above, Justice Alito specifically stated that Newman‘s holding requiring evidence that defendants knew the information they traded on came from insiders or that the insiders received a personal benefit in exchange for the tips was not implicated in Salman. 580 U.S. ___, slip op. at 5 n.1. Therefore, for cases such as Newman itself, in which there was no evidence that the downstream tippees who were multiple levels removed from the tipper knew they were trading on information obtained from insiders or that those insiders received any benefit in exchange for inside information, 773 F.3d at 453, the government will continue to have a harder time proving a defendant’s scienter, notwithstanding the Court’s decision in Salman.
With its Salman decision, the Court laid to rest part of the uncertainty that arose after Newman. By reaffirming Dirks, the Court forcefully and resoundingly through its unanimous decision returned the legal landscape of tipper-tippee liability to its pre-Newman state. Moving forward, in cases involving insiders who allegedly disclose confidential information to family members or friends, the prosecution need not prove that the insider-tipper received something of a pecuniary or similarly valuable nature in exchange for a tip. Rather, in such cases, a personal benefit can be inferred merely by the close nature of the relationship.
While Salman likely will affect cases involving alleged insider trading by family members or friends of tippees, Salman‘s impact in the overall landscape of insider trading enforcement may be limited, as the bulk of insider trading cases involve parties who reap clear personal benefits (most often pecuniary in nature) from disclosing confidential information. Thus, Salman largely represents a return to the status quo that existed before Newman. And importantly, Newman‘s other holding–that downstream tippees must have personal knowledge that the inside information was improperly disclosed–remains untouched, and may continue to constrain prosecutorial appetite to pursue some cases.
The following Gibson Dunn lawyers assisted in the preparation of this client update: Avi Weitzman, Joel Cohen, Mark Schonfeld, Marc Fagel, Jason Halperin, Jaclyn Neely, David Coon, Mark Cherry and Sara Ciccolari-Micaldi.
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