Insider Trading: Supreme Court Broadens the Definition of Personal Benefit to Include Gifts Made to Relatives and Friends

 

Salman v. United States

No. 15-628

U.S. Supreme Court

Decided on December 6, 2016

 

Issue: Whether Dirks’ personal benefit requirement can be satisfied without Newman’s pecuniary benefit requirement where an inside tipper gifts corporate information to a family member or friend.

 

Holding: The U.S. Supreme Court held that the tipper’s sole gift of inside corporate information to a trading family member or friend meets Dirks’ personal benefit requirement, abrogating United States v. Newman.

 

Facts: Maher Kara, former investment banker at Citigroup, was giving confidential corporate information to his brother Michael Kara. Later, Michael started passing the information to Salman. Maher expected Michael to use the information for trade, and Michael expected Salman to do the same. Michael testified that Salman was aware that the information originated from Maher. Salman was convicted of federal securities fraud.

 

Salman appealed to the Ninth Circuit, and in the meantime, the Second Circuit inferred Dirks’ personal benefit requirement to mean that, during the exchange of information, the tipper must have received at least a potential gain of a pecuniary or similarly valuable nature, (United States v. Newman, 773 F .3d 438, 452 cert. denied). The Ninth Circuit denied Salman, declining to follow Newman.

 

Legal Analysis: Section 10(b) of the Securities Exchange Act of 1934 and the Securities and Exchange Commissions Rule 10b-5 prohibit undisclosed trading on inside corporate information by those obliged by a duty of trust and confidence that prohibits them from taking advantage of their position by exploiting access to inside information. These individuals with inside corporate information access are also prohibited from tipping outsiders for trading purposes. When the tippee is aware that the tipper has breached his duty by disclosing such information, the tippee may be liable for securities fraud.

 

Dirks v. SEC clarified that in order for a tippee to be held liable for securities fraud, the tipper must have personally benefitted from the disclosure of inside information (Dirks v. SEC, 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911). Specifically, the Supreme Court held that a personal benefit can include a gift of confidential information to a trading relative or friend (Id., at 664, 103 S.Ct. 3255), which is the case here. In turn, the Court held that a jury may interpret this gift to a relative or friend as a personal benefit of the tipper.

 

Salman urged the Supreme Court to apply the rules of United States v. Newman to his conspiracy and insider trading convictions. As previously stated, in order for a tippee to be held liable for securities fraud, Newman requires that the tipper receive financial or similarly valuable gain from the exchange. Salman asserted that, based on the Newman rule, he could not be held liable for securities fraud since the tipper received no such gain. Unlike the case at bar, the Second Circuit found that defendants in Newman were unaware of the source of the inside information and ultimately reversed the convictions.

 

In Newman, the court acknowledged that both Dirks and Second Circuit case law allow a factfinder to infer a personal benefit to the tipper from a gift of confidential information to a trading relative or friend (773 F .3d, at 452). However, the court concluded that the Dirks inference is impermissible as it requires proof of a meaningfully close relationship and at least a potential gain of a pecuniary or similarly valuable nature (773 F .3d, at 452).

 

Salman asserted that his convictions should be reversed in accordance with the Newman rule. Although there was no question of whether Maher gifted information to Michael and that Salman had knowledge of it, there was no evidence that Maher had gained any pecuniary (or “anything of similar nature”) benefit. Salman urged that Maher’s gift of inside information to his brother Michael was not enough to establish securities fraud since Maher did not obtain money, property, or similar materials in exchange for the tip.

 

The Government not only argued that the gift of inside information to a relative or friend using the information for trading purposes can sufficiently prove securities fraud, but it went further to argue that the gift could be to anyone, not just a relative or friend. The Government asserted that the exploitation and disclosure of corporate information for a non-corporate purpose establishes a benefit for the tipper. Certainly, based on that inference, disclosing corporate information to a trading family member or friend would personally benefit the tipper.

 

The U.S. Supreme Court abrogated Newman and adhered to Dirks upon resolving the issue at bar. The Dirks test stems from whether the tipper breached his fiduciary duty, and then whether the tipper personally benefitted from the disclosure. The court also noted that in Dirks, it instructed courts to focus on direct and indirect benefits when determining whether a tipper derived a personal benefit. While an example provided in the court’s instructions included pecuniary gain, another factor the court instructed to consider was a reputational benefit that will translate into future earnings (Dirks, 463 U.S., at 663). In Dirks, the court held that the tip and trade resemble trading by the insider following by a gift of the profits to the recipient (Dirks, 463 U.S. at 664).

 

By upholding Dirks, it is clear that Maher breached fiduciary duty when he made a gift of inside corporate information to his brother Michael. The Supreme Court held that Dirks appropriately prohibits making a gift by disclosing such information, even if the tipper received no tangible financial gain. This interpretation allows a jury to consider a gift of inside information as an equivalent of a monetary gift. Dirks’ gift rule creates a broader definition of what constitutes a personal benefit for the tipper. Contrary to Salman’s argument for a stricter, more specific definition of what the court considers a personal benefit, the court’s decision pushes for a broader definition. The Supreme Court’s abrogation of Newman and its concurrence with Dirks ultimately allows for easier prosecution of securities fraud.