The Supreme Court handed down its first decision on insider trading in years, affirming the conviction of Bassam Salman for insider trading in violation of Exchange Act Section 10(b). Salman v. United States, No. 15-628 (December 6, 2016). The unanimous opinion, written by Justice Alito for the Court, hewed closely to the Court’s earlier decision in Dirks v. SEC, 463 U.S. 646 (1983). While the Court concluded that the facts in Salman came within the “heartland” of Dirks it rejected the positions of both parties while noting that the Second Circuit’s decision in U.S. v. Newman, 773 F. 3d 438 (2nd Cir. 2014) had gone to far.
The case centers on three relatives, brothers Michael and Maher Kara and their brother-in-law, Bassam Salman. Maher was an investment banker in Citigroup’s healthcare group. His work focused on mergers and acquisitions. After beginning work at Citigroup Maher discussed his work with Michael, with whom he had a close relationship, relying in part on his background in chemistry to assist him.
Initially Maher was not aware that Michael was trading securities. Later Maher assisted Michael’s trading by sharing information with him about pending deals. Michael in turn began furnishing the inside information to brother-in-law Salman who also traded. Later Maher tried to discourage his brother’s requests for information but continued to transmit inside information. By the time the authorities discovered the trading Mr. Salman had over $1.5 million in profits that he split with another relative who had executed trades on his behalf.
Mr. Salman was indicted on one count of conspiracy to commit securities fraud and four counts of securities fraud. The two brothers, also charged, pleaded guilty and testified against Mr. Salman at his trial. The evidence established the close relationship between the two brothers. There was also testimony that Michael once asked Maher for a favor but rejected an offer of money in favor of information. While Maher acceded to the request, he regretted it and asked his brother not to trade. Michael traded. Indeed, Michael testified that his brother’s tips gave him access to information that was not available to the typical trader and that he passed it to Mr. Salman.
The jury returned a verdict on all counts. Mr. Salman was sentenced to serve 36 months in prison. On appeal Mr. Salman argued that Newman required the reversal of his conviction. The Ninth Circuit rejected that claim, affirming the convictions.
The Court began with a recitation of basic principles regarding insider trading, drawn largely from Dirks. Exchange Act Section 10(b) prohibits “undisclosed trading on inside corporate information by individuals who are under a duty of trust and confidence that prohibits them from secretly using such information for their personal advantage,” Justice Alito wrote for the Court. A tippee acquires the duty to disclose or abstain from trading. Liability for the tippee hinges on whether the tipper breached a fiduciary duty and “disclosed the information for a personal benefit” under Dirks. That benefit can be inferred when the tipper receives something of value in exchange for the tip or if there is a gift of confidential information to a trading friend or relative under Dirks.
Mr. Salman argued that an insider’s gift of confidential information to a trading relative or friend does not establish a violation of Exchange Act Section 10(b). Rather there is only a violation of duty if the tipper received a benefit in the form of money, property or something of tangible value. This result is demanded by Dirks, according to Petitioner Salman. The point is also consistent with other criminal fraud decisions of the Court, according to Mr. Salman, which require a pecuniary benefit.
The Government disagreed. Relying on Dirks, the Government claimed that a gift of confidential information to anyone, not just a trading relative or friend, may be prohibited. Under this rule, furnishing inside information to any person who intends to trade is insider trading. This is because the tipper personally benefits whenever there is a disclosure of corporate information for a non-corporate purpose, according to the Government. Thus a gift of inside information to anyone can violate the rule.
“We adhere to Dirks,” Justice Alito wrote, rejecting the position of each party. In that decision “we explained that a tippee is exposed to liability for trading on inside information only if the tippee participates in a breach of the tipper’s fiduciary duty. Whether the tipper breached that duty depends in large part on the purpose of the disclosure to the tippee,” according to the Court (internal citations omitted). The test is whether the insider will personally benefit from the disclosure. If there is no personal benefit, there is no breach of duty. Under Dirks the determination of whether there is a personal benefit from the disclosure is based on objective criteria such as a pecuniary gain or a reputational benefit that may translate to such a benefit in the future. That benefit may be inferred from the facts.
The exploitation of inside information can also occur where there is a gift of that information to a trading relative or friend under Dirks, the Court held. This is because in “such cases, the tip and trade resemble trading by the insider followed by a gift of the profits to the recipient, the Court stated (internal quotes omitted). In Dirks the tipper did not receive any money or benefit and their purpose was not to make a gift. Thus, there was no liability.
The gift giving principles of Dirks resolve this case, according to the Court. “As Salman’s counsel acknowledged at oral argument, Maher would have breached his duty had he personally traded on the information here himself then given the proceeds as a gift to his brother.” In this case “Maher effectively achieved the same result by disclosing the information to Michael, and allowing him to trade,” the Court concluded. Under these circumstances the tipper benefits. To the extent Newman required that the benefit be pecuniary or something similar, “we agree with the Ninth Circuit that this requirement is inconsistent with Dirks” the Court held.
In Salman the Court adhered closely to Dirks, affirming and reiterating its basic principles regarding tipper liability. Those principles make it clear that liability stems from a breach of duty resulting in a personal benefit, measured by an assessment of the objective facts. Liability also results from gifting inside information to a trading friend or relative – circumstances which support an inference that the insider obtains a personal benefit. By reiterating these principles, the Court adhered to the bright line drawn in Dirks between the permissible and the impermissible — not every communication of inside information is a violation of Section 10(b). Rather, there is only a violation where there is a breach of duty and a resulting personal benefit or a gift to a friend or relative.
In reaching its determination the Court rejected the claim of each party despite suggestions that their respective positions some how echoed Dirks. Petitioner claimed that when gifting information there must be a pecuniary type benefit to the tipper – a position which to some extent echoed Newman. The Government argued that any communication of inside information to a trader resulted in liability – a position which tended to eliminate the line drawn by Dirks. The Justices noted during oral argument, and reiterated in its opinion, that neither position was consistent with Dirks.