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(Article from Securities Law Alert, October 2016) 

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The Supreme Court heard oral arguments on October 5, 2016, in Salman v. United States, No. 15-628, a case in which the Court will consider a question at the center of many insider trading prosecutions: whether the personal benefit necessary to establish liability under Dirks v. SEC, 463 U.S. 646 (1983) requires proof of “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature,” as the Second Circuit held in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), cert. denied, No. 15-137 (U.S. Oct. 5, 2015),[1] or only that the insider and the tippee shared a close family relationship, as the Ninth Circuit held, United States v. Salman, 792 F.3d 1087 (9th Cir. 2015), cert. granted, 84 U.S.L.W. 3401 (U.S. Jan. 19, 2016) (No. 15-628).[2]

Although no federal statute or regulation expressly prohibits insider trading, courts have construed Section 10(b)—a “catch-all clause” in the Securities Exchange Act of 1934 (the “1934 Act”)—to prohibit insider trading as a type of securities fraud. Today, under Dirks, determining whether trades executed by someone who has received material nonpublic information (a “tippee”) qualifies as a type of fraud prohibited by the 1934 Act “depends in large part on the purpose of the [insider’s] disclosure.” 463 U.S. at 662. Dirks held that liability can only attach where the insider personally benefited directly or indirectly from the disclosure. Id. If the insider received no personal benefit from the disclosure, then there has been no breach of duty to stockholders, and no derivative breach can be attributed to tippees who trade on the information. Id. Thus, showing that the disclosing insider personally benefited from the tip is critical to establishing insider trading liability in this context.

Oral Argument Highlights  

The oral argument focused on each party’s test for determining when a tipper received a “personal benefit” in exchange for material nonpublic information. Petitioner contended that the insider must receive a concrete benefit. In particular, the insider must receive either a pecuniary benefit, or something that may translate into a financial benefit (e.g., a reputational benefit with monetary value). Petitioner offered two primary defenses for this formulation. First, criminal statutes are generally construed narrowly, and the elements ought to clearly demarcate what is and is not illegal. According to Petitioner, a broader formulation would be ambiguous, and thus would subject market participants to unpredictable prosecutions. Second, it is well-accepted that not all trading on material nonpublic information is unlawful. Petitioner reasoned that if the satisfaction one experiences from sharing information and helping another were sufficient, then the “personal benefit” element would always be satisfied when information is intentionally shared. All information sharing would ipso facto be illegal. But Petitioner cautioned that his rule would not permit all information sharing among family members. For example, because family members are often financially inter-dependent, benefiting a family member could, in some instances, financially benefit the tipping insider.

The government took a different view, arguing that the 1934 Act broadly prohibits giving information to another—whether a relative, friend, or even a casual acquaintance—“for that person to be able to profit on it.” Responding to questions from the bench, the government conceded that the tipping insider must know that the tippee will trade upon the information for criminal liability to attach. In support of its position, the government asserted that the obligation giving rise to the cause of action for insider trading tracks the common law duty of “loyalty,” which is breached when one uses information for a personal reason. In addition, the government argued that a broad construction is necessary as a policy matter to prevent insiders from freely sharing information with friends and family, which could disrupt markets.

During oral argument, the Justices posed several hypotheticals to evaluate how the parties’ competing frameworks would assign liability in different scenarios. For example, responding to Petitioner’s contention that an insider must receive some tangible gain in order to satisfy the personal benefit requirement, Justice Kagan asked about an insider who planned to give a friend money, but decided to provide valuable nonpublic information instead. By contrast, in a hypothetical posed to the government, Chief Justice Roberts underscored that not all information sharing is done for personal gain: suppose an individual asks a friend to join him for a weekend retreat, and the friend declines, explaining that he has to work on an important transaction for Google. In Chief Justice Roberts’ hypothetical, even if the tippee trades on the material nonpublic information, the insider did not offer the information as a gift or otherwise benefit from the disclosure. Throughout the oral argument, it was clear that the Justices were trying to reconcile two competing concerns. The Justices appeared to support the notion that an insider need not receive a tangible, immediate financial benefit in exchange for disclosing material nonpublic information. But certain Justices appeared wary of a test that could expose all sharing of material nonpublic information to potential liability. If the personal benefit element is to serve as a limiting principle, it must be given a more precise and workable definition.

The Justices also appeared to grapple with a number of other issues. In Dirks, the Supreme Court expressly stated the “elements of fiduciary duty and exploitation of nonpublic information . . . exist when an insider makes a gift of confidential information to a trading relative or friend” because the “tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.” 463 U.S. at 664. Although this clear pronouncement would appear to foreclose Petitioner’s narrow framing, it was not central to the Dirks holding and thus could be considered non-binding dicta. Additionally, Justice Breyer engaged in a line of questioning aimed at resolving whether information-sharing with a relative ought to

be treated differently. He posited that helping a relative may be analogous to helping one’s self, thus creating a special rule inapplicable to a scenario where an insider assists a friend or casual acquaintance. Given the number of issues in play, and the varied questions from the Justices, whether a clear majority exists in support of a particular formulation remains uncertain.