Issues
Does making a gift of confidential information to a close family member or friend for non-corporate purposes satisfy the “personal-benefit” test to establish insider trading or must the government show that the insider received a “personal benefit” that was monetary in nature?
The Supreme Court will determine whether a close family relationship between the insider and tippee shows “personal benefit” necessary to establish insider trading. Petitioner Bassam Salman argues that a casual or social friendship does not prove personal benefit but, rather, proof of personal benefit requires a showing of monetary gain by the tipper. The United States contends that a tipper personally benefits by giving a gift of information to a family member or friend, rendering proof of monetary gain by the tipper unnecessary. The United States maintains that a tipper breaches his fiduciary duty to shareholders whenever he discloses non-public corporate information for non-corporate purposes. The Court’s decision in this case may have a substantial impact on the scope of SEC’s authority to enforce securities-fraud laws in case of tipping and consequently influence investors’ interests and their confidence in securities markets.
Questions as Framed for the Court by the Parties
Does the personal benefit to the insider that is necessary to establish insider trading under Dirks v. SEC 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, or is it enough that the insider and the tippee shared a close family relationship, as the Ninth Circuit held in this case?
Facts
On September 1, 2011, Bassam Yacoub Salman was indicted for his involvement in an insider trading scheme involving members of his extended family. Specifically, the government charged Salman with conspiracy to commit securities fraud.
Salman received insider information from Mounir (“Michael”) Kara, whose brother, Maher Kara, worked for Citigroup’s healthcare investment banking group. Maher regularly discussed aspects of his job with Michael. Although Maher suspected that Michael was trading on the information he provided, Maher still disclosed information about upcoming mergers and acquisitions.
In 2003, Maher Kara and Salman’s sister became engaged. During this time, Michael Kara and Salman became good friends. In 2004, Michael began sharing the inside information he received from his brother with Salman. Salman’s trading often mirrored Michael’s in securities issued by Citigroup’s clients before major transactions were announced. At trial in the Northern District of California, the government presented evidence that Salman knew Maher was the source of the inside information.
The jury found Salman guilty, and he moved for a new trial. Salman claimed that the prosecution lacked evidence that Salman had known that Maher disclosed confidential information to obtain a personal benefit. The district court denied Salman’s motion, and he appealed.
Subsequently, the United States Court of Appeals for the Second Circuit vacated two insider trading convictions in United States v. Newman, 773 F.3d 438 (2d Cir. 2014); the Second Circuit held that the government had failed to present sufficient evidence to show that the insiders had received any “personal benefit.” Under Newman, the government must show that insiders had received “personal benefit” by presenting evidence 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.” The Ninth Circuit allowed Salman and the government to file supplemental briefs addressing the new Newman holding. Salman argued that the government’s evidence in his case was insufficient under Newman’s interpretation of the personal-benefit test. The Ninth Circuit, however, declined to follow Newman. The United States Supreme Court granted a writ of certiorari on January 19, 2016 in order to resolve a circuit split concerning whether an insider and tippee’s close family relationship is sufficient to establish insider trading.
Analysis
In this case, the Supreme Court may revisit its ruling in Dirks v. SEC, 463 U.S. 646 (1983) on the scope of “tipper-tippee” insider trading liability. Under Dirks, an insider may become liable under Section 10(b) of the Securities Exchange Act of 1934 and SEC’s Rule 10b-5 when he breaches his fiduciary duty by taking advantage of information “intended … only for a corporate purpose and not for the personal benefit of anyone” and “trading without disclosure.” An insider can become liable either by trading himself or disclosing confidential corporate information to others (“tippees”) who exploit it in trading. . In the latter case, the tippee who receives confidential inside information is liable if: (1) the insider (“tipper”) received a direct or indirect personal benefit for providing the confidential information—the “personal-benefit” test; and (2) the tippee knows or should know the tipper received such personal benefit. The Court further listed explanatory situations where the personal-benefit test would be met: (1) when the tipper will reap “a pecuniary gain or a reputational benefit that will translate into future earnings,” (2) when a tipper makes a gift of confidential information to a trading relative or friend, or (3) when there is a “quid pro quo” relationship between the tipper and the tippee—in other words, a situation in which the tipper is receiving something in return for the information. Circuits and the parties here are split on how to define “personal benefit” and interpret these illustrative examples.
LACK OF CORPORATE PURPOSE
Respondent, the United States, contends that the personal-benefit test is equivalent to an objective corporate purpose inquiry: if an insider discloses non-public corporate information without a corporate purpose, the personal-benefit test is satisfied. In essence, the United States proposes, “[t]he existence of ‘personal benefit’ is simply the flip side of the absence of a corporate purpose.” To support this contention, the United States suggests that insiders clearly are not acting for corporate purposes in the two most typical insider trading settings: where insiders either use undisclosed corporate information to their advantage or give information to an outsider to exploit the information for the insiders’ personal gain.
In contrast, Petitioner Salman opposes using the personal-benefit test and the corporate purpose inquiry interchangeably. Rather, Salman claims that even if a tipper exploits the corporate information for a non-corporate purpose, no breach occurs if he does not realize a resulting “tangible gain.” Thus, Salman limits “personal benefit” to monetary gain only. Salman asserts that the language and legislative history of Section 10(b) do not support the government’s creation of the “lack of corporate purpose” standard. Salman also points to analogous crimes under federal fraud statutes, such as mail fraud and wire fraud, which emphasize tangible gain as well. Furthermore, Salman maintains that the “pecuniary gain” limitation accords with the narrow construction principle applied to criminal statutes, including the ones involved here.
APPLICATION OF DIRKS V. SEC
The United States argues that Dirks supports interpreting the personal-benefit test as a corporate purpose inquiry. For example, the Court in Dirks found the personal-benefit test was met when there is a “quid pro quo” relationship between the insider and the tippee. In such a relationship, the insider exchanges the information for a return and is therefore acting not for a corporate purpose but for a personal one. Moreover, the United States claims that the outcome in Dirks is consistent with its corporate purpose reading—the tippers in Dirks did not breach their fiduciary duty because they had disclosed information for a corporate purpose: to expose corporate fraud.
Salman counters that the Dirks decision does not support the United States’ interpretation of the personal-benefit test, arguing that Dirks shows that the Court’s intention was to hold “tippers” liable under Section 10(b) only where they were trying to obtain a monetary gain. Salman argues that Dirks specifically held that a lack of a corporate purpose alone does not necessitate Section 10(b) liability but that the only purpose that Dirks was concerned with was that of obtaining personal gain. In fact, Salman points out that the Court did not find that the defendant in Dirks had a corporate purpose, yet still held that the defendant was not liable under Section 10(b). Salman also cites various other insider trading precedents to illustrate that “personal benefit” has historically depended on a monetary gain.
“GIFT LIABILITY”
The United States, submits that under Dirks, a tipper may obtain the requisite personal benefit not only when he reaps a pecuniary gain from disclosure, but also when he “makes a gift of confidential information to a trading relative or friend.” The United States believes that the additional “gift liability” captures the various occasions where tippers may benefit in intangible ways while making a gift of information for trading. For instance, a tipper who makes such a gift can save money if he intended to provide funds to the tippee anyway. Also, a tipper may give a gift “to impress his associates, or because of vanity about his generosity.” Therefore, the United States suggests that the “gift liability” approach is compatible with complex social and cultural realities.
In response, Salman challenges the “gift liability” approach for being vague and unduly broad. Salman points out that the vagueness arises when it comes to deciding whether a tippee qualifies as “a trading relative or friend” of the tipper; Salman asks: “Where is the line between a ‘friend’ and an acquaintance? Is an in-law a ‘relative’?” Inevitably, Salman maintains, courts would need to assess the relationship between the tipper and the tippee without clear guidelines. Moreover, Salman suggests that “gift liability” is unduly broad: if intangible benefits, such as emotional satisfaction from giving the gift suffice as a personal benefit, it would be difficult to discern “[w]hich emotions give rise to insider trading liability, and which do not.” For example, Salman proposes that the tipper in Dirks probably obtained emotional satisfaction from exposing the fraud, yet the Court had concluded that “[u]nder any objective standard, [the tipper] received no direct or indirect personal benefit from the disclosure.”
Discussion
JUDICIAL OR LEGISLATIVE CREATION?
The National Association of Criminal Defense Lawyers (“NACDL”) and the New York Council of Defense Lawyers (“NYCDL”), in support of Salman, argue that Congress, not the court, must define the offense of insider trading before penalizing conduct. NACDL and NYCDL suggest that Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) does not expressly prohibit insider trading. The Cato Institute, also in support of Salman, adds that the Court’s insider trading decisions have defined, on a case-by-case basis, conduct that constitutes insider trading in violation of Section 10(b)’s prohibition of securities fraud. NACDL and NYCDL claim that, as a result of this approach, the courts have failed to develop a comprehensible definition or clear standards for the average person to follow.
Richard Freer counters by asserting that Congress intended the SEC to help effectuate the aim of the Exchange Act through rules and regulations. Occupy the SEC (“OSEC”), agreeing with Freer, claims that Congress passed the Exchange Act to broadly prohibit insider trading. OSEC argues that the tipping crime is not judge-made but is well-supported by Section 10(b), a catch-all fraud provision prohibiting all types of securities fraud. OSEC suggests that the insider trading prohibition does not require a narrow interpretation of the personal-benefit test because Congress has continually emphasized an expansive view of liability. Moreover, the Petitioner’s interpretation itself “exacerbates any extant vagueness” in ways that are “neither supported by prior case-law nor contained within the body of Section 10(b).” Therefore, OSEC claims that the personal-benefit test is satisfied when an insider discloses secret company information to benefit someone of his choosing.
EFFICIENCY AND FAIRNESS OF THE U.S. SECURITIES MARKETS
The Cato Institute argues that the unpredictable risk of criminal liability would harm market efficiency because outside investors would hesitate to trade on rumors and tips about the company, even when it would be lawful and beneficial to the market. The Cato Institute argues that the Ninth Circuit’s broad interpretation of the personal-benefit test causes unpredictability because it criminalizes conduct that the average person would not consider fraudulent. As a result, insiders and market analysts will no longer disclose information; they would worry that their relationship would qualify as friendship under the personal-benefit test. The Cato Institute suggests that outside investors, by trading on rumors and tip information and moving the company’s stock price closer to its correct value, help provide the value to a corporation’s securities. The Cato Institute argues that a fair interpretation of the personal-benefit test imposes liability only if the disclosure of information represents a potential pecuniary gain for the insider. The distinction between the two interpretations of the personal-benefit test is significant because it directly affects the efficiency of the securities market, which best reveals information about a company’s value through traders’ use of confidential company information.
OSEC counters by asserting that the Exchange Act’s central purpose is to protect investors from insiders’ fraudulent trading. OSEC claims that trading on insider information is economically inefficient because it alters natural price trends and allows those with access to secret company information “to extract wealth from the marketplace.” OSEC also argues that, in response to this criminal behavior, disadvantaged investors will engage in corrupt practices “to overcome their disadvantage.” Therefore, OSEC suggests, insiders who disclose company information must be held liable regardless of proof of their pecuniary interest. OSEC maintains that the narrow interpretation of the personal-benefit test, which requires a showing of pecuniary gain, restricts the government’s ability to punish insiders.
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Acknowledgments
Additional Resources
- Daniel N. Sang, Salman v. United States and Insider Tipping: What Could be Decided?, The CLS Blue Sky Blog (June 17, 2016).
- Nicolas Morgan, Salman v. US: Will it Change the ‘Personal Benefit’ Test?, Law360 (Aug. 26, 2015).