(Article from Securities Law Alert, January 2016)
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In Dirks v. S.E.C., 463 U.S. 646 (1983), the Supreme Court determined that an insider can only be held liable under Section 10(b) and Rule 10b-5 for disclosing material inside information to a third party, or tipping, if the insider “receive[d] a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings.” Notably, the Dirks Court stated that “[t]he elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend.” The Dirks Court found that if a tipper receives no personal benefit for disclosing the information to a third party (the tippee), then the tippee has no duty to abstain from trading on that information.
On January 19, 2016, the Supreme Court granted certiorari to address a circuit split on the scope of the personal benefit requirement. Salman v. U.S. (No. 15-628). The Court will consider whether the Government must prove “an exchange that is objective, consequential, and represents at least a potential gain [to the tipper] of a pecuniary or similarly valuable nature,” as the Second Circuit held in United States v. Newman, 773 F.3d 438 (2d Cir. 2014) (Parker, J.); or whether the Government may establish the existence of a personal benefit by presenting “evidence of a friendship or familial relationship between tipper and tippee,” as the Ninth Circuit found sufficient in United States v. Salman, 792 F.3d 1087 (9th Cir. 2015) (Rakoff, J.).
Second Circuit Holds That a Personal Relationship Between the Tipper and Tippee Is Not Enough, Standing Alone, to Satisfy the Personal Benefit Requirement
In Newman, 773 F.3d 438, the Second Circuit held that the Government cannot “prove the receipt of a personal benefit by the mere fact of a friendship, particularly of a casual or social nature.” The Second Circuit found that “[t]o the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tipper,” “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 [to the tipper] of a pecuniary or similarly valuable nature.”
The Second Circuit further stated that while “the tipper’s gain need not be immediately pecuniary, . . . the personal benefit received in exchange for confidential information must be of some consequence.” The court indicated that the personal benefit requirement may be satisfied if there is “evidence of ‘a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the [latter]’” (quoting U.S. v. Jiau, 734 F.3d 147 (2d Cir. 2013)).
Ninth Circuit Holds That the Personal Benefit Requirement Is Met Where an Insider Discloses Confidential Information to a Trading Relative or Friend, Even If the Insider Did Not Receive an Actual or Potential Financial Benefit
In Salman, 792 F.3d 1087, the Ninth Circuit held that the personal benefit requirement is satisfied where an insider discloses confidential information to a trading relative or friend, even if the insider did not receive a potential or actual financial benefit for that disclosure.
The Ninth Circuit expressly declined to follow the Second Circuit’s decision in Newman “[t]o the extent Newman can be read to go so far” as “to hold that evidence of a friendship or familial relationship between tipper and tippee, standing alone, is insufficient to demonstrate that the tipper received a benefit.” The Ninth Circuit reasoned that if it were to hold otherwise, “then a corporate insider or other person in possession of confidential and proprietary information would be free to disclose that information to her relatives, and they would be free to trade on it, provided only that she asked for no tangible compensation in return.”
The court concluded that “[p]roof that the insider disclosed material nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish the breach of fiduciary duty element of insider trading.”[1]
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The Court will decide Salman this term; a date for oral argument has not yet been set.
[1] The Seventh Circuit’s decision in SEC v. Maio, 51 F.3d 623 (7th Cir. 1995) also arguably conflicts with Newman. There, the court found that a tipper had violated Section 10(b) when he made “an improper gift of inside information to . . . a trading friend” even though the tipper “did not receive any direct or indirect personal [financial] benefit as a result of his tip.”