Judge Rakoff, Newman And Illegal Tipping
One of the questions regarding U.S. v. Newman, 773 F. 3d 438 (2nd Cir. 2014)(here) and its personal benefit test for illegal tipping is its application outside the Second Circuit. When applying Newman, Judge Rakoff has already attempted to distinguish SEC civil insider trading cases from criminal cases in SEC v. Payton, Civil Action No. 14 civ 4644 (S.D.N.Y. Opinion issued April 6, 2015)(here). Now the question is whether the Ninth Circuit in a criminal case applied a different personal benefit standard in U.S. v. Salman, No. 14-10204 (9th Cir. Filed July 6, 2015). Interestingly, the opinion for the Court was written by Judge Rakoff, sitting by designation.
Maher Kara joined Citigroup’s healthcare investment banking group in 2002. His brother-in-law is Defendant-Appellant Bassam Yacoub Salman. Over a period of years Maher began discussing information about his job with his brother Michael who traded on it.
The year after 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. Maher refused to furnish him with cash but did give him inside information. Mr. Salaman was aware of this relationship, according to the evidence introduced at trial.
The 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 stems from Dirks v. SEC, 463U.S. 646 (1983), Judge Rakoff wrote for the Court. There the Court concluded 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 then 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 knowns 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 Court held.
Key here, Judge Rakoff wrote, 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, the Court held. Maher’s disclosures to Michael knowing that he intended to trade in the information is a Dirks gift to a relative. 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.”
The analytical approach followed in Payton is tellingly absent here. There Judge Rakoff began by distinguishing between criminal and civil insider trading cases without citing any authority. He went on to draw – and many thing stretch to far – the evidence to reject a motion to dismiss an SEC insider trading case based on Newman. The Payton approach is not evident here.
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. Both apply to the classic and misappropriation theories of insider trading. And, the Circuit Court did not parse or even attempt to delimit Newman directly. Rather, the Court carefully discussed only Dirks in reaching its conclusion, citing evidence that the tippees knew about the source of the information and the personal benefit.
Nevertheless, Salman is troubling. In rejecting Appellant’s contention about Newman, and stating “we decline to follow it,” the Court seems to have undercut its own factual findings on tipping which seem to track Newman while leaving open the actual meaning of the decision. The conflict Judge Rakoff penned into the Court’s opinion dilutes its impact, leaving the actual meaning of the decision at best unclear.