Attorney: Jennifer Banner Sobers
Pomerantz Monitor January/February 2017
The past two years have seen a series of significant decisions on insider trading criminal liability, which all came to a head last month when the Supreme Court handed down its decision in Salman v. United States. The Court affirmed the conviction of a person who traded on inside information that he had received from a friend who was also a relative-by-marriage. It held that the recipient of inside information (the “tippee”) could be convicted even if the person who disclosed it (the “tipper”) did not receive any tangible financial benefit in exchange for tipping the information – a tipper is liable if s/he personally benefits by gifting confidential information to a trading relative or friend.
The issue started to percolate two years ago when, as we reported at the time, the Second Circuit issued a controversial decision in U.S. v. Newman. There, the court overturned the insider trading convictions of tippees who were several layers removed from the original tipper. The Second Circuit held, among other things, that in order to convict, the government had to provide evidence of a tangible quid pro quo between tipper and tippee. The court’s reasoning seemed to run afoul of the Supreme Court’s insider trading decision decided decades earlier, Dirks v. SEC, which held that tippee liability hinges on whether the tipper’s disclosure breaches a fiduciary duty, which occurs when the tipper discloses the information for a personal benefit. Further, the personal benefit may be inferred not only where the tipper receives something of value in exchange for the tip, but also if s/he makes a gift of confidential information to a trading relative or friend. The Second Circuit, by contrast, held that the government could not prove the receipt of a personal benefit by the mere fact of such intangible things as a friendship, or that individuals were alumni of the same school or attended the same church. The Supreme Court declined to review the Newman decision.
Less than a year later, the Ninth Circuit weighed in with its decision in U.S. v. Salman, in which it held that the “personal benefit” requirement did not always require that the tipper receive a financial quid pro quo. The court reasoned that the case was governed by Dirks’s holding that a tipper benefits personally by making a gift of confidential information to a trading relative or friend. With the split among the Circuits in place, this time the Supreme Court took up an appeal to settle the Circuit split on the “narrow issue” of whether the government must prove that a tipper received a monetary or financial benefit or whether gifting inside information to a trading relative or friend is enough to establish liability.
The Supreme Court upheld the Ninth Circuit’s analysis. Last month, SCOTUS found that Dirks “easily resolves” the narrow issue presented. It reasoned that under Dirks, when an insider makes a gift of confidential information to a trading relative or friend, the tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient. In these situations, the tipper personally benefits because giving a gift of trading information to a trading relative is the same thing as trading by the tipper followed by a gift of the proceeds – the tipper benefits either way. The Court consequently reasoned that by disclosing information as a gift to his brother with the expectation that he would trade on it, the former Citibank investment banker breached his duty of trust and confidence to Citigroup and its clients – a duty acquired and breached by Salman when he traded on the information with full knowledge that it had been improperly disclosed. Thus, SCOTUS decided that the Ninth Circuit properly applied Dirks to affirm Salman’s conviction.
This decision is in line with the direction most Justices seemed to be heading during oral argument, about which we most recently reported. At that time, SCOTUS seemed reluctant to side with Salman to find that a tipper does not personally benefit unless the tipper’s goal in disclosing information is to obtain money, property, or something of tangible value, which SCOTUS signaled during the argument would conflict with Dirks. Ultimately, the Court made clear in its decision that traders can be liable even if the insider does not receive a financial benefit for passing the tip as long as the insider makes a gift to a trading friend or relative.
In this decision, SCOTUS significantly noted that to the extent the Second Circuit in Newman held that the tipper con must also receive something of a pecuniary or similarly valuable nature in exchange for a gift to a trading relative, that rule is inconsistent with Dirks. It is hard to believe that anyone could be more pleased about that pronouncement than Preet Bharara, United States Attorney for the Southern District of New York. Since the Newman decision, Bharara’s office has dropped at least a dozen cases against alleged inside traders, including ones who had already pled guilty, largely because of the Second Circuit’s analysis. The day SCOTUS handed down its decision, Bharara issued a press release in which he said “the Court stood up for common sense” and that the “decision is a victory for fair markets and those who believe that the system should not be rigged.”
However, the Supreme Court declined to take its decision to the other extreme that the government proffered – that a gift of confidential information to anyone, not just a trading relative or friend, is enough to prove securities fraud because a tipper personally benefits through any disclosure of confidential trading information for a personal purpose.
Indeed, SCOTUS did not venture any further than the contours of this case – the “gift of confidential information to a trading relative” – that Dirks envisioned. SCOTUS reaffirmed its statement in Dirks that “determining whether an insider personally benefits from a particular disclosure, a question of fact, will not always be easy for courts.” The Court seemed relieved that it did not have to “address those difficult cases” in deciding this case.
So what does this all mean? Well, in the wake of this decision, we will probably see a ramp up of insider trading prosecutions by Bharara’s office and other prosecutors in 2017 against people who passed insider tips to their relatives and friends.
However, the Salman decision did not address the other reasons the Second Circuit reversed the Newman defendants’ convictions, and in many instances, those additional obstacles could prove daunting. The Second Circuit held that the government had to prove not only that the tipper received a personal benefit, but also that defendants knew the information they traded on came from insiders and that the insiders received a personal benefit in exchange for the tips. These issues provide a significant bar for the government to overcome with respect to proving remote tippee liability, where the original tip is passed around from the original tippee to his or her colleagues, and those further down the information chain may know nothing about where the information came from, much less whether the tipper benefited from leaking the information. This is exactly what happened in Newman as Bharara’s office had become renowned for pursuing pre-Newman. Moreover, courts gained no learning from SCOTUS as to where to draw the line regarding how close a friend must be or how far removed a relative can be to trigger insider trading liability. Indeed, the court consistently referenced the precise wording in the Dirks decision, “trading relative,” presumably to avoid elaborating on what that actually means. Given the dearth of Supreme Court insider trading cases, courts may continue to struggle with these issues for years to come.