The U.S. Supreme Court May Address the Scope of "Personal Benefit" Under Insider Trading Law

January 28, 2016 Advisory

The U.S. Supreme Court has agreed to hear a case that might clarify the scope of the "personal benefit" prong of insider trading law.[1] As we have written in the past, clarity of insider trading law could be a welcome development for prosecutors, defendants, traders and compliance professionals. The Supreme Court's case also has the potential to upend the most significant insider trading case in recent history.

First, there was Newman

On February 9, 2015, we published an article in the New York Law Journal entitled "The Gift of ‘Newman.'" We addressed the momentous Second Circuit Court of Appeals decision in United States v. Newman and Chiasson, 773 F.3d 438 (2d Cir. 2014), in which the Court overturned the insider trading convictions of two individuals. Significantly, the Court held that, to prove the personal benefit prong of insider trading law, prosecutors must prove that a tipper and tippee had "a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of pecuniary or similarly valuable nature." Id. at 452. In other words, as the Court said, the exchange of information had to include a quid pro quo from the tippee or an intention to benefit the tippee because of the relationship between the tipper and tippee. Id. The Court noted that the "mere fact" that the tipper and tippee are friends is not always enough to prove a personal benefit to the tipper, especially if the relationship between them is casual or social in nature. Id. Newman also held that all tippees, including remote tippees as the defendants in Newman were, must have knowledge of the personal benefit to the tipper.

Newman was important because it seemed to scale back what had previously been interpreted as a very broad definition of "personal benefit." In Dirks v. S.E.C., 436 U.S. 646 (1983), the Supreme Court held that a personal benefit to the tipper could exist when "an insider makes a gift of confidential information to a trading relative or friend." Id. at 664. Courts across the country subsequently interpreted Dirks broadly, allowing many types of relationships between tippers and tippees to qualify as a personal benefit to the tipper. Those cases theorized, very generally speaking, that a tipper necessarily benefited from sharing information with a friend or relative by the mere fact of furthering the relationship. But Newman held that mere friendship, or a social or casual relationship, is not always enough.

After Newman, we questioned how its personal benefit standard would be applied in future cases. In particular, we wondered, how close must the relationship be between tipper and tippee to satisfy the personal benefit prong? Would courts conclude that some family relationships were closer than others, such as those between siblings versus those between cousins? Would factual issues arise as to the degree of "closeness" between family members or friends? Would courts infer an "intention to benefit" some close family members, but not other family members?

Then came Salman

The U.S. Supreme Court denied cert in Newman, leaving the case standing as the law in the Second Circuit, and as an important decision for other jurisdictions to consider. But in United States v. Salman, the U.S. Supreme Court may soon provide answers to the questions Newman left open. The Supreme Court granted cert on the following question:

Does the personal benefit to the insider that is necessary to establish insider trading under Dirks v. SEC, 463 U.S. 636 (1983), require proof of an "exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature," as the Second Circuit held in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), cert. denied, No. 15-137 (U.S. Oct. 5, 2015), or is it enough that the insider and the tippee shared a close family relationship, as the Ninth Circuit held in this case?

The case is an appeal from a Ninth Circuit Court of Appeals decision, U.S. v. Salman, 792 F.3d 1087 (9th Cir. 2015). Salman's brother-in-law, Maher Kara, worked at Citigroup. He regularly shared confidential inside information about upcoming mergers and acquisitions with his brother, Michael Kara, who traded on the information. After Maher married Salman's sister, the families grew close and Salman and Michael became friends. Michael began to share with Salman the inside information that he learned from Maher, and Salman also began to trade on the information. Id. at 1089.

The government presented evidence that Salman knew Maher was the source of the information. The government also presented evidence that Maher and Michael enjoyed a "close and mutually beneficial relationship," including that "Michael helped pay for Maher's college, that he stood in for their deceased father at Maher's wedding," and that "Michael coached Maher in basic science to help him succeed at his job." Id. Furthermore, Maher testified that he loved Michael very much, and that he gave Michael the inside information to benefit him and fulfill whatever needs Michael had. For example, Michael once asked Maher for money, and instead of providing the money, Maher gave Michael a tip about an upcoming acquisition. Id. The government further presented evidence that Salman knew of Maher and Michael's close relationship. A jury convicted Salman of conspiracy and insider trading based on these facts.

Salman appealed his conviction, arguing, among other things, that the evidence was insufficient to satisfy Newman's personal benefit test, which he urged the Ninth Circuit to adopt. In particular, he contended that the evidence was insufficient to find that Maher disclosed information to Michael in exchange for a "tangible" personal benefit, which he claimed Newman required. Id. at 1090, 1093. The evidence of the close relationship between Maher and Michael was not enough according to Salman's interpretation of Newman, because Maher did not receive a tangible benefit from Michael in exchange for the information Maher shared.

The Ninth Circuit declined to adopt Newman (at least, Salman's interpretation of it), and relied instead, on Dirks' holding that a personal benefit is satisfied by "a gift of confidential information to a trading relative or friend." Id. at 1092 (quoting Dirks, 463 U.S. at 664). The Court easily held that the evidence satisfied Dirks.

As to Salman's reading of Newman, which would have required a "tangible" benefit from Michael to Maher in exchange for information, the Ninth Circuit held that such a reading would require an impermissible departure from Dirks. Moreover, under Salman's reading of Newman, "a corporate insider or other person in possession of confidential and proprietary information would be free to disclose that information to her relatives, and they would be free to trade on it, provided only that she asked for no tangible compensation in return." Id. at 1094. But that is not the Dirks test. Rather, the Ninth Circuit 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." Id.

Newman, Salman and the Supreme Court

Arguably, the outcomes in Salman and Newman are entirely consistent. While the Salman Court declined to adopt the defendant's interpretation of Newman as requiring a tangible benefit, it is likely that Salman's conviction would have been upheld under the Newman test. After all, Newman acknowledged that the personal benefit prong could be satisfied by evidence that the tipper and tippee had such a close relationship that the tipper intended to benefit the tippee because of the relationship. Newman, 773 F.3d at 452. That standard is likely satisfied where one sibling tips another and testifies that he did so in order to benefit his sibling, which is what occurred in Salman. (The tougher question from Newman is whether the outcome would be the same for a less "close" family relationship.)

Nevertheless, the U.S. Supreme Court's decision to take on Salman and the personal benefit question presents the Court with the opportunity to clarify what the personal benefit standard is for courts across the country. Its decision has the potential to be groundbreaking. One only needs to consider the immediate impact Newman has had on the federal government's pending and concluded insider trading cases – resulting in guilty pleas being reversed and cases being dropped – to realize that Newman raised the bar for prosecutors and likely slowed their efforts to prosecute insider trading.

If the Supreme Court rejects the Newman standard, or announces a standard that is more lenient than Newman has been interpreted to be, prosecutors may be given renewed motivation to pursue insider trading cases. In all events, we expect the Supreme Court's Salman decision to clarify the scope of the personal benefit test so interested parties – prosecutors, defense lawyers, traders, and compliance professionals – have a better idea of the scope of insider trading law. We look forward to watching this case develop and will report back one day with our view of the results.

[1] For background, it is worth briefly stating the pertinent elements of tipper/tippee liability in insider trading cases. A "tipper" is forbidden by a fiduciary duty to the source of inside information from sharing that information with others in exchange for a personal benefit. Absent a personal benefit to the tipper in exchange for information, the tipper has not breached his fiduciary duty to the source of the information by sharing it. The tippee's liability is derivative of the tipper's. That is, the tippee is only liable if the tipper breached a duty to the source of the information and the tippee knew or should have known about the breach. Consequently, the tippee is only liable if the tipper received a personal benefit in exchange for the information, and the tippee knew or should have known about the benefit. See generally Dirks v. S.E.C., 463 U.S. 646 (1983).