Insider Trading: Dirks, Newman, Salman and Payton – Part II
This is the second of two posts on the personal benefit test for tipping and insider trading. The first appeared yesterday.
The first segment of this post reviewed the Supreme Court’s decision in Dirks, the Second Circuit’s ruling in Newman and the Ninth Circuit’s opinion in Salman. This concluding segment begins with jury instructions in Payton, an SEC enforcement action presided over by Judge Rakoff who is also the author of the opinion in Salman and concludes with a discussion of the cases.
In Payton the court was also presented with a remote tippee case. Judge Rakoff denied a motion to dismiss the complaint based on Newman. Following discovery and trial each party proposed jury instructions that centered on Dirks and Newman.
The SEC proposed the following instructions, listing first the elements and then defining personal benefit:
“First, Martin was provided with material nonpublic information by Dallas [attorney working on the deal];
Second, that Martin breached a duty of trust and confidence to Dallas and benefited when Martin tipped, that is disclosed, material nonpublic information to Thomas Conradt.
Third, Conradt provided material nonpublic information to the defendant, and that defendant then bought SPSS securities [takeover target] on the basis of that information.
Fourth, that the defendant knew, or should have known, that Martin had violated a relationship of trust and confidence for a personal benefit . . .”
The Commission proposed to define personal benefit as follows:
“Benefit is established if there was a relationship between Martin and Conradt that suggests that Martin disclosed the information as part of a quid pro quo (meaning ‘something for something’), or Martin had an intention to benefit Conradt, or Martin made a gift of confidential information to Conradt. Such a gift is sufficient only if you find that Martin and Conradt had a meaningfully close personal relationship that generated an exchange that was objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature” (emphasis added).
Defendants Payton and Durant proposed the following instruction regarding personal benefit:
“If you find that Mr. Martin disclosed material nonpublic information to Mr. Conradt, you must then determine whether the SEC proved by a preponderance of the evidence that Mr. Martin received a personal benefit in exchange for his disclosure of the information that IBM was planning to acquire SPSS to Mr. Conradt . . . The benefit received does not need to be financial or tangible in nature; it could include, for example, maintaining or furthering a meaningfully close personal relationship if the maintenance or furtherance of that relationship generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature . . . The SEC may prove that Martin received a personal benefit in one of two ways: (1) that Martin tipped Conradt as part of a quid pro quo in which Mr. Martin provided the information in exchange for specific benefits Mr. Conradt provided to Mr. Martin or (2) that Martin and Conradt had a meaningfully close relationship and that Martin tipped Conradt to further or maintain that relationship.” (emphasis added).
The court defined personal benefit as follows:
“’Personal benefit’ is broadly defined to include not only monetary gain, but also, among other things, the benefit one would obtain from simply making a gift of confidential information to a trading friend. However, a personal benefit may be inferred from a personal relationship between Martin and Conradt only if there is proof that they had a meaningfully close personal relationship that generated an exchange that was objective, consequential, and represented at least a potential gain to Martin of a pecuniary or similarly valuable nature. In other words, the SEC may not prove the receipt of a personal benefit by the mere fact of a friendship, particularly of a casual or social nature. Instead, the SEC must prove a relationship between Martin and Conradt that supports the conclusion that the information was given in return for Martin’s receiving something from Conradt or that Martin in giving the information had an intention to benefit Conradt.” (emphasis added).
In Dirks the Supreme Court made it clear that a line was being drawn – the passage of inside information was not necessary illegal. To the contrary, that act only constitutes illegal insider trading under specific circumstances. The question really hinges on the breach of duty by an insider to obtain a personal benefit for himself or herself. Thus if the insider, who is entrusted with material, non-pubic information to be used for a corporate purpose diverts that information to his or her personal use or benefit, that act constitutes a breach of duty. That breach of duty is evidence of the deception element that is required to violate Section 10(b).
The Dirks court gave two examples of the type of evidence that would suffice. One is a quid pro quo and the other is a gift. Either has to be based on objective, established evidence.
Newman faithfully reproduces the Dirks test, focusing on the benefit to the insider and a quid pro quo or gift. The court’s discussion of the required relationship between the tippor an tippee is more concrete that in Dirks but appears to be consistent with the decision.
Salman also adopts the basic principles of Dirks. Indeed, the court’s opinion repeatedly cited Dirks rather that Newman as the predicate for its holding. Yet the ninth circuit seems to have redefined the benefit test used by Dirks and Newman. When analyzing the evidence the court states that the initial tip from the insider was a gift. Later in discussing the question of benefit, however, the court credits the fact that the “Kara brothers’ close relationship [one Kara brother was an insider and tipped the other], Salman could readily have inferred Maher’s intent to benefit Michael.” This has the benefit flowing not to the insider as part of the breach of duty as in Dirks but to the tippee. The inference also appears to be less than substantial, particularly for a criminal case. In any event, the benefit is supposed to be part of the breach, not something that goes to the tippee. The tippee presumably always benefits since he or she trades and makes profits. If there is no benefit to the insider then there is no breach as Dirks made clear. And, the tippee, here Mr. Salaman, would need to know about the breach, including the benefit received by the insider. That requirement appears to be missing, contrary to Dirks and Newman.
Payton appears to have adopted the broader reading of benefit from Salman. There the SEC proposed a definition of benefit that would permit it to prevail if the benefit flowed to the insider or the outsider, although in reciting the elements of insider trading the agency correctly listed benefit as part of the breah. In contrast the defendants proposed a standard that was consistent with Dirks on the definition of benefit but omitted the notion of a gift which is present in Dirks, Newman and Salman.
The court appears to have followed the lead of the SEC and Salman. Under the court’s charge, the SEC could prevail if either the insider or the outsider received the appropriate type of benefit. That appears to be inconsistent with Dirks and Newman.