Today, the United States Supreme Court held that an individual may be convicted of insider trading after receiving an investment tip from an insider who obtained no direct financial benefit from the disclosure. In a unanimous opinion written by Justice Alito, the Court held in Salman v. United States that the recipient of the information, the tippee, may be criminally liable when the insider initially gave the information to a relative or friend and thereby benefitted personally.
Salman concerned the prosecution of a Chicago grocery wholesaler, Bassam Salman, who received insider tips from an extended family member. The family member, in turn, obtained the information from his brother who was a Citigroup investment banker. Salman made more than $1.5 million from trades using the tips and was convicted of insider trading under Section 10(b) of the Securities Exchange Act.
The question before the Supreme Court was whether Salman's conviction could stand even though the investment banker who first passed the tips to his brother did not receive a pecuniary benefit from the disclosure.
In upholding Salman's conviction, the Supreme Court held that the answer is squarely controlled by its prior decision in Dirks v. SEC.
As Dirks recognized, tippees do not necessarily violate insider trading laws. Instead, criminal liability only exists when the insider violates his or her fiduciary duties by disclosing the information in the first place. A violation of fiduciary duties occurs when the insider receives "a direct or indirect personal benefit from the disclosure."
Regarding tips passed to friends and family, the Court held in Dirks that "[t]he elements of fiduciary duty and exploitation of nonpublic information . . . exist when an insider makes a gift of confidential information to a trading relative or friend." In that circumstance, "[t]he tip and trade resemble trading by the insider followed by a gift of the profits to the recipient."
In Salman, the Supreme Court agreed with the Ninth Circuit's conclusion that Dirks squarely controlled the outcome, because the insider had personally benefitted by giving information to his brother and allowing the brother to trade on it.
As the Supreme Court noted, the Ninth Circuit's conclusion was in some tension with the Second Circuit's 2014 decision in United States v. Newman. Newman held that passing information to a friend does not, by itself, create the necessary personal benefit for the insider. Regarding Dirks, the Second Circuit remarked that "[t]o the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and the tippee . . . we hold that such an 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."
The Supreme Court's decision in Salman does not directly overrule the Second Circuit's approach in Newman. Instead, the Supreme Court held 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."
After today's decision, a significant question remains about how close a relationship the tipper and tippee must have for a jury to infer that the tipper personally benefitted by giving the tippee information. As Justice Alito suggested at oral argument in Salman, it is one thing to say that an insider receives a personal benefit by giving information to his brother. But it is quite another to say that there is the same personal benefit if the trader instead gives the information to a stranger. At what point is the benefit to the insider simply too attenuated under the standard established by Dirks?
In its decision, the Supreme Court acknowledged that courts will have to confront closer questions about "whether an insider personally benefits from a particular disclosure." The Court did not address those more challenging circumstances and instead confined its holding to a direct "'gift of confidential information to a trading relative' that Dirks envisioned."
Notwithstanding these open issues related to the precise contours of the "personal benefits" test, one likely result of the Court's decision in Salman is an increase in tipper/tippee enforcement activity in the Second Circuit. Earlier this year Preet Bharara, United States Attorney for the Southern District of New York, expressed the view that, "[Newman] make[s] it hard and arguably, very very hard if not impossible to bring a certain kind of insider trading case." Whether that interpretation of Newman was accurate or not it undoubtedly informed the Southern District of New York's view on insider trading enforcement and appeared to chill prosecution of certain cases. The Supreme Court's clarification today in Salman would seem to reopen the door to prosecution of those cases that Bharara previously viewed as foreclosed by Newman.
Orrick will continue to monitor changes in insider trading laws and report developments that shed light on relevant standards moving forward.