Last week, the United States Supreme Court issued its first decision in an insider trading case in nearly two decades to resolve a split between the Second and Ninth Circuit Courts of Appeal. In its unanimous decision in Salman v. United States, the Court upheld the Ninth Circuit's decision affirming a defendant's insider trading conviction. The Court found that, to the extent that the Second Circuit held in United States v. Newman that a "tipper" must receive something of a "pecuniary or similarly valuable nature," in exchange for a gift of insider information to family or friends, this requirement was inconsistent with prior Supreme Court precedent in insider trading cases.
Section 10(b) of the Securities and Exchange Act of 1934 and the Securities and Exchange Commission's Rule 10b-5 prohibit undisclosed trading on inside corporate information by individuals who are under a duty of trust and confidence ("tippers"), which prohibits them from secretly using such information for their personal advantage. These persons also may not tip insider information to others ("tippees") for trading purposes. A tippee acquires the duties of a tipper to disclose or abstain from trading if the tippee knows the information was disclosed in breach of the tipper's duties and then trades in disregard of that knowledge. Both tippers and tippees may face criminal and civil liability for trading on insider information under these circumstances.
In December 2014, the Second Circuit in Newman reversed the criminal convictions of two portfolio managers who traded on insider information. The defendants in Newman, the tippees, were several steps removed from the corporate insider tippers and there was no evidence that either tippee was aware of the source of the insider information. Nor was there evidence that the tippers provided insider information in exchange for a personal benefit. The Second Circuit reversed the defendants' guilty verdicts, rejecting the Government's position that knowledge of a breach of the tipper's duty of confidentiality without personal benefit is sufficient to impose criminal liability for insider trading. However, while acknowledging that prior case law allowed a factfinder to infer a personal benefit from a gift of confidential information to a trading relative or friend, the Second Circuit concluded that such an inference was "impermissible in the absence of proof of a meaningfully close personal relationship that generated an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature."
In Salman, the evidence showed that the tippee defendant knew who the source of the insider information was, that the tipper enjoyed a "close and mutually beneficial relationship" with the tippee's brother, and that the tipper had made a gift of the insider information to the tippee's brother. However, based on the Second Circuit's decision in Newman, Salman sought to have his criminal convictions overturned by the Ninth Circuit because there was no evidence that the tipper received anything of a pecuniary or similarly valuable nature or that Salman knew of any such benefit. Declining to follow the Second Circuit, the Ninth Circuit affirmed Salman's convictions.
In its unanimous decision in Salman, affirming the Ninth Circuit's decision, the Supreme Court found that, to the extent that the Second Circuit held in Newman that the tipper must receive something of a "pecuniary or similarly valuable nature" in exchange for a gift to family or friends, that requirement was inconsistent with the Supreme Court's 1983 decision in Dirks v. SEC. As the Supreme Court noted, Dirks specifies that when a tipper gives information to "a trading relative or friend" the jury can infer that the tipper meant to provide the equivalent of a cash gift - in other words, the tipper benefits personally in such situations "because giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds." Thus, in the case before it, the Supreme Court found that the tippee traded with full knowledge that inside information had been improperly disclosed by the tipper to the tippee's brother, and he was therefore properly convicted.
The Supreme Court's decision in Salman clears up an area of the law made murky by the Second Circuit's decision in Newman that has troubled prosecutors' efforts to pursue insider trading cases. Yet, while it cleared up this narrow point, it may have raised more questions, such as what constitutes a "friend"? Are "coworkers" always "friends"? Is someone one meets at church, a synagogue, or a mosque always a "friend"?
Further, these questions are not just limited to the "friend" relationship. The Salman decision does not touch on the murkier issue of inadvertent disclosure. For example, if a lawyer, accountant, or other professional mentions that he or she has been working on a merger, but does not expect or intend that the recipient of that information will trade based upon it, is he or she subject to insider trading liability?
Despite the questions left open by the Salman decision, the Supreme Court's ruling will undoubtedly be viewed as a victory for the Government.
