Insider Trading Before the Supreme Court: Dirks and Salman, Part II
In Part I of this occasional series, the background to U.S. v. Salman and the arguments advanced by the Petitioner-defendant in his opening brief before the Supreme Court were examined (here). In this segment of the series, the position of the government will be considered.
The issue
The Solicitor General and the SEC present the issue for decision this way: “Whether, under Dirks v. SEC, 463 U.S. 646 (1983) a tipper personally benefits, and thereby breaches his fiduciary duty, by disclosing confidential information to a tippee as a gift for use in securities trading.” In analyzing this issue the SEC contends that the “essential quality of a gift of confidential corporate information – and the reason why a gift of such information for trading breaches the insider’s fiduciary duty – is that it serves personal, not corporate, purposes. Thus, when the objective facts show that information was provided as a gift for securities trading, and no corporate purpose exists for the disclosure, the personal-benefit is satisfied.”
The argument
The Commission’s brief begins and ends with Dirks with little mention of the Second Circuit’s decision in Newman. A corporate insider violates Section 10(b) of the Exchange Act, according to the government, by trading in the securities of his corporation on the basis of material, non-public information. Under the classic theory that trading is a deceptive device within the meaning of the statute because it “violates the relationship of trust and confidence that exists between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation.” (internal citations omitted). The misappropriation theory is also built on deception, tied to an outsider feigning loyalty to the duty owed to the source of the information.
Following these principles, in Dirks the Court concluded that analyst Ray Dirks did not violated the securities laws by disclosing material non-public information when he did not trade and sought only to expose a fraud. The Court disapproved of the “broad theory” which it viewed as implicit in the SEC’s censure of Dirks. . .” That theory would have required equal access to information by all traders. “Nevertheless, the Court confirmed, a corporate insider violates Rule 10b-5 when he possesses information intended to be available only for a corporate purpose and not for the personal benefit of anyone, and takes advantage of that information by trading without disclosure.” (internal quotations omitted). That action is contrary to the duty of the insider to the shareholders.
The duty of a tippee is derivative of the insider, Dirks explained. The tippee who received inside information assumes the fiduciary duty of the insider. The critical question becomes whether the insider will personally benefit from the disclosure. That question must be resolved by considering the objective facts. For example, there may be a relationship where the exchange is a quid pro quo. Likewise, when an insider makes a gift of inside information to a “trading relative or friend,” a situation in which ‘[t]he tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient’” may exist, quoting Dirks, 463 U.S. at 664.
Based on these principles, the Dirks personal benefit test is met when the insider discloses corporate information without a corporate purpose, according to the SEC. The personal benefit requirement is a means of determining if the insider has breached his or her fiduciary duty. The insider has access to inside information only for a corporate purpose – access is not provided for personal use. Thus, an “insider who trades for himself on material, non-public information inherently acts contrary to a corporate purpose, to the detriment of shareholders. That trading is a breach of his fiduciary duty. The same is true when an insider, while not trading himself, provides the information to a tippee for that person to trade.” Under Dirks the insider may not furnish the information to the tippee to do what he cannot – trade. Thus the “existence of ‘personal benefit’ is simply the flip side of the absence of a corporate purpose . . . and so a personal benefit exists when a corporate purpose does not,” according to the SEC.
Dirks also says that “a personal benefit ‘exist[s] when an insider makes a gift of confidential information to a trading relative or friend,’ [quoting Dirks at 664]. In that circumstance, as well, the insider acts for a personal purpose and – given that the tip is a ‘gift’ precisely because the tipper understands that the tippee intends to trade on the information and make money from it – sets a third party against the shareholders’ interest.” The critical point is that the insider breaches his fiduciary duty by disclosing the inside information to a “favored person, and does so knowing or expecting that the information will be used for securities trading.”
Under Dirks “a gift of information for trading intrinsically involves a personal gift.” Dirks emphasized that a gift of information with the expectation that the recipient will convert it into cash is the functional equivalent of the insider trading himself. Thus, in order “for a gift of information to trigger liability, the government need not show that the insider personally profited (or expected to) in a financial sense. The point of a gift is to transfer something of value without a quid pro quo . . . Thus, if the evidence establishes that the insider gave a gift of information for trading and that a business justification for the disclosure is absent, the fact finder need not investigate the exact nature of the personal reasons that drove the tipper to decide to confer such a gift.” And, the insider may benefit in intangible ways. The critical question is thus whether the tipper is “serving a corporate purpose, not . . . what the gifting tipper obtains for himself . . .”
Finally, the Dirks personal benefit test applies to a gift to any person. The “relative or friend” language in the opinion was not presented as a limiting principle.
Petitioner’s arguments are not consistent with Dirks. First, his claim that insider trading does not involve deception is directly contrary to the Court’s earlier decisions. Second, Petitioner’s claim that the personal benefit must be for a pecuniary gain misreads Dirks which states that “a gift of confidential information is sufficient to establish that the tipper has personally benefited and thereby breached his duty.” Third, the Dirks standard is not vague. To the contrary, it has been well understood for thirty years until the “erroneous” decision in Newman.
Next: Petitioner’s Reply.
Program: The Dorsey Private Funds Symposium, Sept. 28 2016, New York City. For further information click here.