On December 6, 2016, the United States Supreme Court issued its much-anticipated opinion in Salman v. United States, an appeal of conspiracy and insider trading convictions. The decision focused on the correct standard to determine whether a provider of material nonpublic information (a “tipper”) to someone else (a “tippee”) had received a “personal benefit” in exchange for his disclosure of such information, which is one element required to establish insider trading liability of a tipper or his tippee.
In declining to overturn the petitioner’s convictions, the Court held that the “personal benefit” to a tipper that is required to establish liability for insider trading can consist of the “gift” of that material, nonpublic information to a family member or friend. As such, the Court affirmed the “personal benefit” analysis articulated in the landmark 1983 case Dirks v. SEC and applied in the Ninth Circuit’s decision to uphold petitioner Salman’s convictions. In doing so, the Court rejected in part the Second Circuit’s interpretation of the “personal benefit” standard in its recent, well-publicized decision of United States v. Newman, where the Second Circuit overruled a tippee’s conviction on the basis that the tipper had not received “at least a potential gain of a pecuniary or similarly valuable nature” as a result of providing the tip.
Factual Background of Salman v. United States
The petitioner, Bassam Salman, was convicted of conspiracy and insider trading based on information from his brother-in-law, Maher Kara, who was at the time a member of Citigroup’s health care investment banking group. Maher Kara (the tipper) had provided the information to his brother, Mounir Kara, known as Michael, who then passed the information to Mr. Salman (the tippee).
The evidence at trial showed that the tipper and his brother “enjoyed a close and mutually beneficial relationship.” The tipper testified that he “love[d] his brother very much” and that he gave him the inside information in order to “benefit him” and to “[fulfill] whatever needs he had.” The evidence also showed that Michael had once called Maher and told him that “he needed a favor.” When Maher offered his brother money, Michael asked for information instead. Michael then disclosed an upcoming acquisition, expecting that Maher would trade on that information. Importantly, the evidence also showed that Salman had been aware of the brothers’ close relationship and knew that the Maher had made a gift of trading information to his brother.
Analysis of Insider Trading Liability
Under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 thereunder, individuals who owe a fiduciary duty to an issuer may not use inside information as the basis for their own trading activities. Those individuals are also prohibited from tipping inside information to others for trading purposes. A tippee may be held liable for insider trading if the tippee is aware that the tip is inside information, but trades anyway.
The Supreme Court established the framework for insider trading liability in Dirks v. SEC. There, the Court held that a tipper will be liable only if he breaches his fiduciary duty to a company’s shareholders. The test for whether the tipper breached his fiduciary duty is “whether the insider personally will benefit, directly or indirectly, from his disclosure.” The Court added that a jury may infer a personal benefit – and thus a breach of the tipper’s fiduciary 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.” The Court likened such a gift to “trading by the insider followed by a gift of the profits to the recipient.” If the tipper has breached his fiduciary duty in this manner, the tippee may also be held liable for insider trading when he breaches a duty to the shareholders by trading on that information with the knowledge that it is inside information.
Ninth Circuit’s Decision and United States vs. Newman
While Salman’s appeal was pending with the Ninth Circuit, the Second Circuit decided United States v. Newman, overturning the convictions of two insider trading defendants and applying a narrow definition of “personal benefit.” To prove a “personal benefit” to the tipper sufficient to establish a breach of fiduciary duty, the Court in Newman held that something more than a mere personal relationship was required. Instead, the Court held that the Government must prove a “meaningfully close personal relationship [between the tipper and the tippee] that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”
Salman challenged his convictions for conspiracy and insider trading on the basis that the tipper (Maher Kara, Salman’s brother-in-law) did not personally receive money or property in exchange for the tips and thus did not “personally benefit” from them.
In deciding Salman’s appeal, the Ninth Circuit declined to follow the Second Circuit’s restrictive view of the Dirks “personal benefit” analysis. It upheld Salman’s convictions, concluding that under Dirks, the element of breach of fiduciary duty is met where an “insider makes a gift of confidential information to a trading relative or friend.” The Ninth Circuit therefore 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 element of insider trading,” with no proof of something resembling a “pecuniary” benefit required.
Supreme Court’s Decision
The Supreme Court affirmed the Ninth Circuit’s decision by applying Dirks’s holding that “a tipper breaches a fiduciary duty by making a gift of confidential information to ‘a trading relative,’” and concluding that, “when a tipper gives inside information to ‘a trading relative or friend,’ the jury can infer that the tipper meant to provide the equivalent of a cash gift.” It also ruled 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 friends, … we agree with the Ninth Circuit that this requirement is inconsistent with Dirks.”
The Supreme Court also applied principles of remote tippee liability established in Dirks, finding that it was no bar to liability that Salman did not directly receive the tip from Maher Kara (the original tipper) or that Maher Kara did not know that Salman had received the information. Maher Kara breached his fiduciary duty when he disclosed information to Michael Kara with the expectation that Michael would trade on it. Salman knew that the information he received from Michael was inside information. In receiving that information with the knowledge that it was inside information, Salman acquired a fiduciary duty. By trading on this information, he breached this duty.
Implications of Salman
The Salman ruling resolves the conflict between the Second Circuit (where many insider trading cases are heard) and the Ninth Circuit on the narrow issue of whether a “personal benefit” may be inferred in the case of a close family relationship between the tipper and the tippee when the tipper “mak[es] a gift of confidential information to a trading relative.” However, it leaves many more questions unanswered.
First, it is unclear how close a personal relationship must be for a fact-finder to infer a “personal benefit.” In citing the Dirks standard that “[t]he 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,” the Court seemed to imply acceptance that a friendship could be sufficient, even though there was a family relationship between the tipper and the tippee in Salman. However, beyond family and friendship, Salman does not provide guidance for determining when a different kind of relationship is meaningful enough to permit inference that the tipper received a benefit. For example, the Court does not offer a framework to analyze more equivocal fact patterns where the relationship between the tipper and the tippee is not as easily defined as either relative or friend. Citing Dirks, the Court acknowledges that “[d]etermining whether an insider personally benefits from a particular disclosure, a question of fact, will not always be easy for courts.” The Court declined, however, to adopt the Government’s position that “a gift of confidential information to anyone, not just a ‘trading relative or friend,’ is enough to prove securities fraud.
It also remains to be seen whether the “personal benefit” requirement could be met if a source of material nonpublic information (the would-be “tipper”) did not clearly intend to provide a “gift” of information to the putative “tippee,” but instead was merely engaging in loose talk. The Court, citing its opinion in Dirks, noted that whether the tipper breached his fiduciary duty “depends ‘in large part on the purpose of the disclosure’ to the tippee.” In this sense, there remains uncertainty after Salman as to when the communication of confidential information will be deemed a personal benefit to the tipper and may therefore constitute a breach of the tipper’s fiduciary duty.
Insofar as there is no statutory definition of insider trading, and the SEC and courts have wide room to apply general principles as they believe appropriate, Salman requires the trading community to refocus on the dangers of accepting information from corporate insiders or others who appear likely to have received the information from corporate insiders.
Luis F. Ruiz