One of the most significant debates regarding insider trading in recent years centers on the personal benefit test adopted in U.S. v. Newman, 773 F. 3d 438 (2nd Cir. 2014) for tippee liability. The court in Newman held its test was a straight forward application of Dirks v. SEC, 463U.S. 646 (1983). The government, supported by the SEC, argued otherwise. While the Supreme Court declined to resolve the question in Newman now it has agreed to hear it, granting certiorari in Salman v. U.S., No. 15-628 (January 19, 2016). A key question is the reason the High Court declined to hear Newman but chose to hear Salman.
The Salman decision
Petitioner-defendant Bassam Salman is the brother-in-law of Maher Kara who joined Citigroup’s healthcare investment banking group in 2002. Over a period of years Mr. Maher began discussing information about his job with his brother Michael who traded while in passion of it. The year after Mr. Maher began at Citigroup he became engaged to Mr. Salman’s sister, Saswan Salman. As the families became close, Michael began sharing the inside information with Mr. Salman who traded through the joint account of his wife’s sister and her husband, Karim Bayyouk. The profits were split. At one point Mr. Salman asked Michael where the information came from and was told.
Brothers Maher and Michael had a close and mutually beneficial relationship, according to the evidence. For example, Michael helped pay for Maher’s college and aided him in a number of other ways. At one point Michael called and asked for assistance with a debt. Mr. Maher refused to furnish him with cash but did give him inside information. Mr. Salman was aware of this relationship, according to the evidence.
A jury found Mr. Salman guilty on one count of conspiracy and four counts of securities fraud. On appeal, Mr. Salman argued that the evidence was insufficient to meet the requirements of Newman. The Ninth Circuit affirmed.
The personal benefit requirement for tippee liability traces to Dirks v. SEC, 463U.S. 646 (1983), the circuit court stated. There the Supreme Court stated that imposing a duty to disclose or abstain simply because the person knowingly received inside information “could have an inhibiting influence on the role of market analysts, which the SEC itself recognizes is necessary to the preservation of a healthy market.” (citations/internal quotes omitted). The Dirks Court went on to hold that “’the test is whether the insider personally will benefit, directly or indirectly, from his disclosure,’” quoting Dirks at 662. In that case the insider has breached his fiduciary duty and the tippee is equally liable if “’the tippee knows or should have known about that breach,’’ Id. at 660, i.e. knows of the personal benefit.” This applies equally to cases based on the misappropriation theory, the circuit court held.
Key here is what constitutes a personal benefit. Quoting Dirks the court held that it includes “a pecuniary gain or a reputational benefit that will translate into future earnings . . . [the] 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.” (emphasis omitted).
This statement from Dirks governs here, according to the circuit court. Mr. Maher’s disclosures to Michael knowing that he intended to trade while in possession of the information is a Dirks gift to a relative. Indeed, Mr. Maher testified he intended to give Michael a benefit. Michael testified that he told Mr. Salman the source of the information. In addition, “[g]iven the Kara brothers’ close relationship, Salman could readily have inferred Maher’s intent to benefit Michael. Thus, there can be no question that, under Dirks, the evidence was sufficient . . .”
Finally, Mr. Salman argued that “because there is no evidence that Maher received any such tangible benefit [as described in Newman] in exchange for the inside information, or that Salman knew of any such benefit, the Government failed to carry its burden.” The Court responded, stating: “To the extent Newman can be read to go so far, we decline to follow it.”
Salman, like Newman, is built on Dirks. To establish tipping both require that there be a breach of fiduciary duty, a personal benefit and knowledge of those elements by the tippee. In resolving the case the circuit court presented its conclusions as a straight forward application of Dirks. Nevertheless, the court’s rejection of the defense contention about Newman appeared to delimit the scope of the decision, at least in the view of many commentators.
Whether that reading of Salman is correct is no longer the critical question however. Rather, the key point now is how the High Court will resolve the question. The answer to that may lie in the reason the Court chose to hear Salman and not Newman. The Court, of course, does not give reasons for granting or denying certiorari.
The answer to the Court’s case select — and perhaps the ultimate resolution of Salman –may lie in the record. In Newman the Second Circuit carefully reviewed the record and concluded not only did the district court fail to give proper instructions but there was no evidence of any Dirks personal benefit in the record. While the government argued otherwise in its Petition for Certiorari, virtually rewriting the record, debating what is and is not in the record is not likely an issue the Supreme Court wanted to tussle with.
Salman, in contrast, is not mired with the same factual difficulties as Newman. Rather, the question of what constitutes a personal benefit comes to the High Court on what appears to be a well developed factual record. This at least suggests the question is not if a personal benefit is necessary but what constitutes sufficient evidence. Stated differently, the factual record in Salman presents the Supreme Court with a better vehicle through which to discuss and define the Dirks personal benefit, suggesting that the test will continue but with a clearer definition following the Court’s decision.