The Supreme Court’s unanimous decision this week in Salman v. United States, No. 15-268, 580 U.S. __ (Dec. 6, 2016), clarified what constitutes a “personal benefit” for purposes of insider trading liability. In its first merits ruling in an insider trading case in two decades, the Court affirmed the Ninth Circuit’s holding that the personal benefit requirement may be met when an inside tipper simply gifts confidential information to a trading relative or friend. In so holding, the Supreme Court significantly narrowed a key aspect of the Second Circuit’s landmark insider trading decision in United States v. Newman, which had required prosecutors to prove that the tipper received something “of a pecuniary or similarly valuable nature”—a more difficult standard to meet.
Before Newman was decided, the United States Attorney’s Office for the Southern District of New York had prioritized insider trading prosecutions, obtaining dozens of convictions and over a billion dollars in fines since 2009. After Newman, however, prosecutors were forced to dismiss several indictments, and some commentators wondered what the future held for insider trading prosecutions. The Supreme Court’s recent decision should reduce that uncertainty and may bring a renewed focus on insider trading investigations.
To establish liability for insider trading, the government must prove that a defendant: (i) traded in securities while (ii) in possession of material, nonpublic information, which was (iii) obtained as a result of a breach of duty. The Supreme Court first addressed the question of tipper-tippee liability in the seminal case Dirks v. SEC, 463 U.S. 646, 649 (1983), in which an employee of a broker-dealer received information from a former officer for an insurance company about a fraud at the company. Dirks investigated, and discussed the findings of his review with his clients, who traded on the information. In considering whether there had been a breach of duty, and thus an insider trading violation, the Supreme Court held that, to show a breach of a duty through tipping, the insider must “personally  benefit, directly or indirectly, from [the] disclosure.” The Court explained that insiders derive a personal benefit when, for instance, they make a “quid pro quo exchange” for the tip or “gift the confidential information to a trading relative or friend.” Because the corporate insider who provided the information to Dirks received no personal benefit (and in fact sought to expose a fraud by disclosing the information), the Supreme Court concluded that there was no breach of a duty.
Thirty years later, the Second Circuit weighed in on the definition of “personal benefit” in Newman, which involved two hedge fund portfolio managers, Newman and Chiasson, who were “remote tippees” that received confidential information through a chain of tips about technology companies. 773 F.3d 438 (2d Cir. 2014), cert. denied, 136 S. Ct. 242 (2015). The Second Circuit reversed both convictions in a much discussed opinion, finding that the Government failed to prove at trial that the tippers received a personal benefit in exchange for their disclosures. Noting that the evidence showed nothing more than mere casual friendships between the insiders and the initial tippees—who knew one another as former classmates and as church acquaintances, respectively—the Second Circuit held that this was insufficient to show a personal benefit. The court explained that a personal benefit requires “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.” Because the insiders received nothing of value from providing the tips, they did not personally benefit from the tip.
Less than a year after the Second Circuit decided Newman, the Ninth Circuit weighed in on the definition of “personal benefit” in United States v. Salman, 792 F.3d 1087 (9th Cir. 2015), aff’d, 580 U.S. __ (Dec. 6, 2016). A jury convicted Bassam Salman of securities fraud for trading on material nonpublic information that he received as a “remote tippee.” The information originated with Salman’s brother-in-law, Maher Kara, who worked for Citigroup’s healthcare investment group. The inside information was passed from Maher to his own brother Mounir (“Michael”) Kara, who both traded on the information himself and provided it to Salman, who in turn also traded on the information, netting hundreds of thousands of dollars and an insider trading conviction.
On appeal, the Ninth Circuit addressed the question of whether Maher, the insider, had received a “personal benefit” that would subject Salman to liability as a tippee. Rejecting Salman’s argument, based on Newman, that a personal benefit requires at least the potential for pecuniary gain or something of a similarly valuable nature, the Ninth Circuit found liability where an “insider makes a gift of confidential information to a trading relative or friend.”
The Supreme Court granted a writ of certiorari in Salman to resolve this split between the Second and Ninth Circuits and address what constitutes a “personal benefit” received by an insider for purposes of insider trading liability. Specifically, is the government required to prove “an exchange that is objective, consequential, and represents at least a potential gain of pecuniary or similarly valuable nature” as the Second Circuit held in Newman, or is it enough that the insider gave a gift of confidential information to a trading relative or friend, as the Ninth Circuit held in Salman?
The Supreme Court unanimously agreed with the Ninth Circuit’s interpretation, concluding that an insider receives a personal benefit by gifting confidential information to a trading relative or friend even if there is no exchange of something of pecuniary or similar value. The Court closely followed its ruling in Dirks, which “ma[de] clear that a tipper breaches a fiduciary duty by making a gift of confidential information to a ‘trading relative.’” Applying the Dirks rule here, the Court determined that Maher breached a duty of trust and confidence to Citigroup and its clients when he gifted the confidential information to his brother with the knowledge that he would trade on it. Moreover, the Court found that, to the extent Newman required that the tipper receive something of a pecuniary or similarly valuable nature in exchange for the tip, such a rule was “inconsistent with Dirks.”
While the Supreme Court’s decision in Salman resolved the “narrow issue” of whether a gift of confidential information to a trading relative constitutes a personal benefit, several key questions remain open. Most significantly, the Court’s standard does not provide much guidance regarding gifts of material nonpublic information to casual acquaintances—the particular facts at issue in Newman. Nonetheless, the Court’s opinion eliminates any doubt that “gifts” of material nonpublic information can serve as a basis for insider trading liability. In particular, federal prosecutors can now establish a personal benefit when, even in the absence of an exchange of something of pecuniary or similar value, an insider gifts confidential information to trading relatives or friends. While it remains to be seen whether this wider latitude in tipper-tippee insider trading liability will see a return to pre-Newman levels of insider trading prosecutions, it is clear that such cases will face an easier path after the Supreme Court’s decision in Salman.