Insider Trading Before the Supreme Court: Dirks and Salman, Part III

This is the third part of an occasional series examining the issues in Salman v. U.S., No. 15-628, which will be argued before the Supreme Court on October 5, 2016.

Petitioner’s Reply Brief centers on two themes: 1) The Dirks personal benefit test requires a pecuniary benefit; and 2) insider trading is essentially a common law crime and as such cannot be expanded beyond its current boundaries by the courts without infringing on constitutional limitations.

The opening paragraph of the brief focus on these themes: “The government’s brief illustrates the dangers of common-law crimes. A personal benefit test that extends beyond pecuniary gain presents vagueness dangers, so the government asks the Court to refashion the judge-created tipping crime by replacing the personal benefit element with a broader ‘lack of corporate’ requirement. The government invites the Court to create this new rule long after Petitioner acted, thus ensuring that he had no notice of the proposed retroactive judicial expansion of the crime.”

First, the government’s position is “squarely at odds with Dirks,” according to Petitioner. That decision did not fashion the “corporate purpose” test advanced by the government. Section 10(b) liability for tipping does not hinge on “whether the insider had a corporate purpose for making his disclosure.” To the contrary, under Dirks the question is whether the “insider personally will benefit, directly or indirectly from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders,” according to Petitioner (emphasis original). Lack of a corporate purpose is not the question. Only personal gain triggers liability under Dirks.

This approach is tied to the Court’s quid pro quo theory of liability that the insider is in effect selling the information selectively “for cash, reciprocal information, or other things of value for himself” (internal quotes omitted). The personal benefit test hinges on whether the insider receives a benefit from the disclosure such as a pecuniary gain or “a reputational benefit that will translate into future earnings.”

The predicate for the Dirks approach is the Section 10(b) requirement of deception. As the Court made clear in Santa Fe v. Green, 430 U.S. 462 (1977), a breach of fiduciary duty is not sufficient to violate the Section. Rather, there must be manipulation or deception. The tip must thus be “a fraudulent breach” that “takes advantage of information intended to be available only for a corporate purpose and not for the personal benefit of anyone.” Viewed in this context, a disclosure is fraudulent only when the tipper’s motive is pecuniary. The government’s claim that disclosing the information when the tippee will trade is inconsistent with this notion. Indeed, under this test Dirks would have come out the other way because the Court only found that the tipping insider did not receive a personal benefit, not that those receiving the information would not trade.

Second, the government’s claim that the pecuniary gain standard is inconsistent with the gift language of Dirks is incorrect. In view of the emphasis in Dirks on pecuniary gain, the Court “could not have intended to equate ‘gift’ with situations in which the tipper receives nothing with personal benefit to the tipper.” Also incorrect it the government’s contention that the phrase “trading relative or friend” which apples to “gift” does not mean what it says and fails to limit the notion of gift. That suggestion leaves the concept open ended, ignoring the fact that Dirks established a limiting principle.

Third, the government’s position is inconsistent with the text of the statute, its history and constitutional limiting principles. There is nothing in the text of Section 10(b) about insider trading. While the government cites to various amendments to the statute, those provisions do not address the situation here. Likewise, the legislative history to those sections does not support that position.

Finally, the open ended position of the government highlights the need to narrowly construe the personal benefit test. Here the “government seeks unbounded license to prosecute people for trading with an informational advantage . . . [which is] why the Constitution commits the power to define crimes to the legislature, and why it requires Congress to provide clear notice about what conduct is barred . . . The need for a narrow construction is even greater here, because §10(b) does not expressly prohibit any insider trading” (emphasis original). Under similar circumstances in other areas such as “honest services fraud” the Court has rejected attempts to utilize broad concepts to impose criminal liability. See, e.g. McNally v. U.S., 483 U.S. 350 (1987). That same approach is required here – the personal benefit test must be cabined to its Dirks defined contours, not left as the open ended concept suggested by the government which would impose the long rejected “parity of information” rule.

Under the facts here there is no legal basis for imposing liability using the government’s “novel lack-of-corporate-purpose” approach. Indeed, there is “no legal basis to expand the tipping crime to cover ‘remote tippees” who have not participated in the tipper’s breach of duty. The government does not dispute Salman’s lack of involvement in the breach . . .” And, the jury was not instructed on the “lack of corporate purpose” standard. Thus, the conviction must be reversed.

Next: Oral argument

Program: The Dorsey Private Funds Symposium, Sept. 28 2016, New York City. For further information click here.