The judge-made law of insider trading is back before the U.S. Supreme Court with far-reaching implications for both federal prosecutors and Wall Street traders. On October 5th, the Supreme Court heard oral arguments in a highly anticipated case, Salman v. United States,[1] centering on the question of tipping inside information as gifts. This case was brought forth two decades after the seminal case Dirks v. SEC.[2] Salman presents the question of what kind of benefit a source of inside information must receive to violate the law when passing such information on to a stock trader. According to prosecutors, a Chicago grocery wholesaler Bassam Yacoub Salman and his partner earned more than $1.5 million in profits through trades based on inside information. The tips originated with Maher Kara, then Citigroup Inc. investment banker. The information was passed to his brother, who in turn passed it onto his brother-in-law, Salman.[3] A majority of the Court voiced willingness to uphold the conviction. However, experts predict that it is unlikely the Court would stray from its past decisions, leaving lower courts and prosecutors grappling with the Gordian knot of insider trading law.[4]
The Dirks Decision
The law of insider trading is notoriously murky. Congress has never defined the crime of insider trading, leaving it to the courts and regulators to draw the line between what is legal and what is not. The Supreme Court first took issue with the “personal benefit” in Dirks v. SEC in 1983. There, the Supreme Court made it clear that a tippee has a duty “not to trade on material nonpublic information only when the insider has breached his fiduciary duty … by disclosing the information to the tipee….”[5] Whether the insider has breached his duty turns on “whether the insider will benefit, directly or indirectly, from his disclosure.”[6] The Court adopted an objective standard, querying “whether the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings.”[7]
Instead of drawing boundaries, however, the Court articulated an elastic and inclusive test to examine “personal benefit,” requiring a quid pro quo from the recipient, or an intention to benefit the particular recipient. In addition, an insider is subject to liability when he or she, “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.”[8]
The Circuit Split
The circuit split between the Second and Ninth Circuit turns on the ability to prove the existence of a “personal benefit.” The argument centers upon whether the government has to prove that an insider received a gain of a pecuniary or similarly valuable nature, or whether it is sufficient to show that the insider shared confidential information with a tipee who is a family member of friend?
Before Mr. Salman, a man convicted under the Ninth’s Circuit’s insider trading standard, challenged in the Supreme Court, the Ninth Circuit held that the “personal benefit” should be broadly construed and could either be a direct benefit to the insider, such as “a pecuniary gain or reputational benefit that will translate into future earnings,”[9] or an indirect benefit, such as “a gift of confidential information to a trading relative or friend.” Applying this standard, the Ninth Circuit affirmed Salman’s conviction, finding that the proof amply established that the insider provided “a gift of confidential information” to his brother. The court added that, if evidence of a desire to benefit a friend or relative could not suffice to establish a tipper’s breach of duty, insider trading would proliferate.
In so holding, the Ninth Circuit expressly refused to follow the Second Circuit’s approach embodied in its 2014 decision United States v. Newman.[10] In Newman, the court heightened the requirement for showing a benefit by requiring “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”[11] In other words, being friends, or another familial relation was not enough to trigger a violation if there was no evidence that the tipper received something of value in return.
In the present case, Mr. Salman’s lawyer, Alexandra A.E. Shapiro, argues that the insider trading law is too ill-defined to permit a criminal conviction based on something as ephemeral as a gift of inside information made between family or friends. She said that Kara gave the information to his brother only because he was being “pestered.” Unsurprisingly, she immediately received skeptical questions from the Justices because her argument would call for a significant change of law. The government’s lawyer, Michael R. Dreeben, similarly had a hard time with the justices. He argued that it is a violation any time confidential information is given for a non-corporate purpose with the expectation that the recipient will trade, without regard to the relationship between the tipper and the person receiving the tip. Mr. Dreeben budged at the end of the argument, telling the court that it should at least reaffirm the Dirks decision.
Hopefully, the Court will further flesh out the standard set in the Dirks decision regarding what is sufficient to show the requisite benefit when information is given outside a family or close friendship. It is unlikely, however, that the Court would articulate a bright-line test that would expand insider trading liability to situations in which a person merely passes information to someone else without any proof that something is received in return.
Impacts of Other Wall Street Figures
The Supreme Court’s final decision does not affect Mr. Salman alone. Among those watching the Supreme Court case are former Goldman Sachs Group Inc. director Rajat Gupta, hedge fund manager Doug Whitman, Omega Advisors founder Leon Cooperman and Galleon Group co-founder Raj Rajaratnam. They all have a vested interest in this case, as they are trying to overturn their convictions or fend off investigations on related grounds.[12]
[1] U.S., No. 15-628, oral argument 10/5/16.
[2] 463 U.S. 646 (1983).
[5] Dirks, 463 U.S. at 660.
[6] Id. at 662.
[7] Id. at 663.
[8] Id. at 664.
[9] 792 F.3d 1087, 1092 (9th Cir. 2015) (quoting Dirks, 463 U.S. at 663).
[10] 773 F.3d 438 (2d Cir. 2014).
[11] Id. at 452.
[12] See e.g., http://www.nytimes.com/2016/09/27/business/dealbook/sec-takes-different-strategy-in-insider-trading-case.html?_r=0.
