Alert December 07, 2016

Supreme Court Weighs In On Insider Trading Law – Finds Giving Gifts Can Be Its Own Reward

Summary

In its decision issued yesterday in Salman v. United States, 580 U.S. __ (2016), the United States Supreme Court unanimously affirmed a criminal insider trading conviction even though there was no evidence that the tipper received any direct financial benefit for his tip to a relative.  Resolving the tension between the Second and Ninth Circuit Courts of Appeals as to what proof of benefit to the tipper is required, the Court explained that “the tipper benefits personally because giving a gift of trading information [to a relative or friend] is the same thing as trading by the tipper followed by the gift of the proceeds.” The opinion addressed the growing debate following the Second Circuit’s decision in United States v. Newman, which held that, where the tipper and tippee are not relatives or “close” friends, the Government must prove a relationship sufficient to give the tipper “at least a potential gain of a pecuniary or similarly valuable nature.” Following Newman, some questioned whether the Government could prosecute tippers who shared inside information with friends and family, but not for a direct financial gain. In Salman, the Government can claim a victory in obtaining reaffirmation that such cases may proceed. But as the Court noted, the issue presented was a “narrow” one and the question left for future cases is what constitutes a “friend” such that proof of some pecuniary benefit is unnecessary.

The Issue in Salman

The issue in Salman was whether traders who receive a “gift of confidential information” from a relative or friend can be held criminally liable where the tipper of the information did not receive a tangible financial benefit in return. 

In its 1983 decision in Dirks v. SEC, the Supreme Court explained that a tippee’s liability for insider trading turns on whether the tipper breached a fiduciary duty by sharing material, non-public information, which occurs when the tipper disclosed the inside information for a personal benefit. The benefit can often be inferred from “objective facts and circumstances”—including “when an insider makes a gift of confidential information to a trading relative or a friend.” The Dirks court explained that, in such circumstances where the tip is provided to a trading relative or friend, the jury can infer that the tipper meant to provide the equivalent of a cash gift. 

Salman was convicted for trading on inside information that he received from a friend, Mounir (“Michael”) Kara, who in turn received the information from his brother, Maher Kara, a former investment banker at Citigroup (also Salman’s brother-in-law). While Salman’s appeal was pending, the Second Circuit held in Newman that a factfinder cannot infer a personal benefit in Dirks’s gift-giving scenario unless there is “proof of a meaningfully close personal relationship” between the tipper and tippee “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 affirmed the conviction and declined to extend Newman in the circumstances presented, concluding instead that there was a sufficiently close personal relationship that obviated any need for establishing a tangible benefit. Salman’s petition for certiorari was granted, and the Court accepted the first insider trading case in nearly two decades.

The Court’s Decision

In its decision, authored by Justice Alito, the Court agreed with the Ninth Circuit that Dirks permits an inference of personal benefit where the tipper gifts information to a “trading relative or friend,” and refused to extend to the case at hand Newman’s requirement that the tipper must also receive something of a “pecuniary or similarly valuable nature” where there is no proof of “close” friendship or family relationship. 

The Court explained that Dirks “easily resolves the narrow issue presented here.” Evidence at trial—including testimony from both Maher and Michael—established that the two brothers in Salman enjoyed “a very close relationship,” that Michael was like “a second father to Maher” and the best man at Maher’s wedding. Additionally, there was direct evidence that Maher disclosed confidential information as a gift to his brother with the expectation that his brother would trade on it, consistent with Dirks’s explanation that the gift of information can be inferred as equivalent to a cash gift. Maher even testified that, in one instance, he offered Michael money as a “favor,” but Michael asked for information instead—a fact that the Court cited as indicative of the clear nature of the gift that Maher had bestowed on his brother. 

Challenges in Insider Trading Cases Following Salman

Notably, the Court’s opinion did not disturb Newman’s separate bases for reversing the defendants’ convictions in that case: that the Government failed to introduce evidence that those defendants, who were not the direct recipients of the inside information (e.g., remote tippees), knew that they were trading on inside information and knew that the tippers had received some personal benefit in exchange for sharing the information. The Court also recognized that “in some factual circumstances assessing liability for gift-giving will be difficult” and explained that “there is no need for us to address those difficult cases today, because this case involves ‘precisely the gift of confidential information to a trading relative’ that Dirks envisioned.” In fact, the Court noted that Salman’s conduct was in the “heartland of Dirks’s rule concerning gifts of confidential information to trading relatives.”

Some commentators may overstate the impact of Salman: as the Court itself noted, its prior decision in Dirks “easily resolve[d] the narrow issue presented here.” Still, Salman is notable as it puts an end to efforts by defense counsel to extend Newman’s requirement of a pecuniary benefit to those cases where inside information is provided to a trading relative or close friend. The Court, however, also refused the Government’s invitation to eliminate the benefit requirement altogether.

The question for courts to decide going forward is what constitutes a “friend” such that just providing the information is benefit enough to the tipper. Because if you are not on the “friends and family” plan, the Government still needs to prove some tangible, pecuniary benefit.