The U.S. Supreme Court Rules on Scope of "Personal Benefit" Under Insider Trading Law
We previously wrote about the Supreme Court's decision to hear a case that would likely clarify the scope of the "personal benefit" prong of insider trading law - Insider Trading Showdown: "Personal Benefit" to be Tested at the U.S. Supreme Court, American Bar Association White Collar Crime Newsletter (Spring 2016). On December 6, 2016, the Supreme Court issued its decision and held, consistent with Dirks v. SEC, 463 U.S. 646 (1983), that a jury can infer a tipper received a personal benefit by giving "a gift of confidential information to a trading relative or friend," regardless of whether the tipper receives "something of a pecuniary or similarly valuable nature" in exchange. Salman v. United States, No. 15-628, 580 U.S. ___ (Dec. 6, 2016) (slip op. at 2, 10). In so doing, the Supreme Court affirmed the Ninth Circuit, and partially overruled a conflicting Second Circuit decision, United States v. Newman, 773 F.3d 438 (2d Cir. 2014), cert. denied, 577 U.S. __ (2015).
The Salman and Newman Circuit Split
A brief recap of Salman and Newman may be helpful. Bassam Salman was convicted of several counts related to securities fraud. The information he traded on originally came from his brother-in-law, Maher Kara, an investment banker at Citigroup. Maher gave his brother, Michael Kara, inside information about deals he was working on. Michael passed that information to Salman, who used it to make $1.5 million in profits. After his conviction, Salman appealed to the Ninth Circuit. While his appeal was pending, the Second Circuit decided Newman.
In Newman, the Second Circuit reversed the convictions of Todd Newman and Anthony Chiasson. The two former hedge fund managers had been convicted of trading on inside information, but were both several levels removed from the corporate insiders. The Second Circuit found that although a jury can infer a personal benefit when a tipper gives a gift of inside information to a friend or relative, that inference is "impermissible in the absence of 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." 773 F.3d at 452. (The Second Circuit also reversed the convictions on grounds that are not relevant here). Newman created an enormous roadblock for insider trading prosecutions in the Second Circuit. Before Newman, federal prosecutors had interpreted "personal benefit" broadly, bringing (and winning) insider trading cases where the tippers and tippees had a broad range of relationships. Newman put a stop to that, ending some ongoing investigations, and leading to the reversal or withdrawal of a number of insider trading convictions.
Salman asked the Ninth Circuit to adopt the reasoning in Newman. The Ninth Circuit declined, relying on Dirks, 463 U.S. 646. Dirks held that a tippee can receive a personal benefit by making "a gift of confidential information to a trading relative or friend." Id. at 664. Unlike the Second Circuit, the Ninth Circuit declined to require anything further to establish the tipper received a personal benefit. Because Maher had given a gift of confidential information to his brother Michael, he received a personal benefit without any further showing of a potential pecuniary or similarly valuable gain. The Supreme Court granted certiorari to resolve the circuit split between the Ninth and Second Circuits.
The Supreme Court in Salman
As we predicted in January of this year, the Supreme Court affirmed the Ninth Circuit. In a relatively short opinion, Justice Alito, writing for a unanimous Court, explained that Dirks "easily resolves the narrow issue presented here." Salman, 580 U.S. __ (slip op. at 8). The Supreme Court held that under Dirks, as long as the tipper gave a gift of confidential information to a relative who trades on it, he or she receives a personal benefit. Id. Justice Alito observed that if Maher had used inside information to make a trade, and then passed the profits onto his brother, he unquestionably would have received a personal benefit. Id. "Maher effectively achieved the same result by disclosing the information to Michael, and allowing him to trade on it." Id. Dirks does not distinguish between the two scenarios—in either one, the tipper has breached a fiduciary duty. Id. at 8. Justice Alito noted that the facts in Salman show the "commonsense" reason for this rule. Id. at 11. At one point during the conspiracy, Michael asked Maher for help. Maher offered Michael money, but Michael demanded inside information instead. Maher acquiesced. Id. at 4. Justice Alito observed that "[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 tipper benefits either way." Id. at 11.
Based on this reasoning, the Court partially overruled Newman. It found that the requirement in Newman that "the tipper must also receive something of a pecuniary or similarly valuable nature in exchange for a gift to family or friends" is "inconsistent with Dirks." Id. at 10. In short, as long as the tipper makes a gift of the information to a relative or friend, the jury can infer a personal benefit. There is no requirement that the tipper receive either money or something of "a similarly valuable nature" in return. The Court also rejected in a few sentences Salman's arguments that the ruling was unconstitutionally vague, or contrary to the rule of lenity, as the rule in Dirks was "simple and clear." Id. at 11.
What it All Means
The Supreme Court has now mostly closed the gap in insider trading law created by Newman. However, Newman is not totally dead. First, the Supreme Court explicitly did not overrule the portion of Newman holding that the convictions were improper because there was "no evidence that the defendants knew the information they traded on came from insiders or that the insiders received a personal benefit in exchange for the tips." Id. at 5 n.1. Newman therefore still has important consequences for "remote tippee" cases—cases where the person who trades on the information is many layers removed from the source of the information.
Second, Salman did not define what it means for someone to be a "friend." That was an issue in Newman, where the Second Circuit held that the tippers and tippees were simply acquaintances, with no close personal relationship. As we observed shortly after Newman was decided, questions still remain about when a tip to a friend (not a relative) qualifies as personal benefit. See Robert Hoff, Richard Levan & Ivana Greco, The Gift of "Newman," New York Law Journal (Feb. 9, 2015). For example, how close must the friendship be? Is a tip to an acquaintance enough to confer a personal benefit? And how will a factfinder distinguish between friend and acquaintance?
In short, the holding of Salman is critically important but relatively narrow. Trading professionals and their counsel are on notice that any gift of inside information made to a relative will count as a personal benefit under Salman. Likewise, gifts to "friends" similarly seem to implicate a breach of fiduciary duty. However, the precise scope of "friendship" may still have some ambiguities in it that will need to be defined.