U.S. Supreme Court Clarifies Tipper-Tippee Liability under the Securities Laws
On December 6, 2016, the Supreme Court addressed insider trading for the first time in over 20 years. In the 1983 case of Dirks v. SEC, the Court previously found that a tippee commits insider-trading fraud when the tipper discloses inside information to the tippee and receives a personal benefit. In its most recent decision, Salman v. United States, the Supreme Court made clear that a tipper obtains a personal benefit when the tipper “‘makes a gift of confidential information to a trading relative or friend,’” thus rejecting the Second Circuit Court of Appeals’ finding that a personal benefit arises in this context only when the tipper receives financial or other tangible value in return.
Under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, individuals who owe a fiduciary duty to a corporation are prohibited from trading on that corporation’s undisclosed inside information. Violators may face criminal and civil penalties for trading on inside information unless they make proper disclosures before trading.
These individuals are also prohibited from tipping this inside information with others—tippees—for trading. In the Dirks case, the Supreme Court found that a tippee is liable for insider trading when he or she knows the tipper breached a fiduciary duty to the corporation by disclosing the information. A tipper breaches this fiduciary duty “when the tipper discloses the inside information for a personal benefit.” Juries can infer that a tipper received a personal benefit when “the tipper receives something of value in exchange for the tip or ‘makes a gift of confidential information to a trading relative or friend.’”
From 2004 to 2007, Bassam Salman’s extended family was engaged in an insider-trading scheme. Maher Kara was an investment banker with Citigroup in its healthcare investment banking group. Possessing highly confidential information, Maher began sharing that information with his older brother, Michael Kara. At first, Maher would talk with Michael about scientific concepts, as Michael held an undergraduate degree in chemistry. Soon, however, Maher realized that Michael was trading on the information Maher shared with him. Instead of ceasing to share further information, Maher continued to regularly disclose to Michael inside information regarding upcoming mergers and acquisitions. He did so to help Michael and “fulfil[l] whatever needs he had.”
Without Maher’s knowledge, Michael was sharing this information with others, including Salman, Maher’s brother-in-law and Michael’s friend. Being Maher’s brother-in-law, Salman was aware of Maher’s and Michael’s close fraternal relationship. Further, Michael told Salman that the inside information was coming from Maher.
After accumulating over $1.5 million in profits, which he split with his friend Karim Bayyouk, Salman was indicted for conspiracy and insider trading and was later convicted.
Salman’s appeal from the Ninth Circuit Court of Appeals to the Supreme Court was largely based on the Second Circuit’s decision in Newman v. United States. There the court found that the defendant tippees were “several steps removed from the corporate insiders” and that they were not “aware of the source of the information.” The Newman court also recognized that Dirks allows a jury “to infer a personal benefit to the tipper from a gift of confidential information to a trading relative or friend.” The Newman court ruled, however, that “such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” Therefore, Salman argued that, because Maher did not receive “money, property, or something of tangible value,” Maher’s gift of information to his brother, Michael, was not enough to establish securities fraud.
Neither the Ninth Circuit nor the Supreme Court viewed Salman’s situation as one that would be covered by the Second Circuit’s finding in Newman. Instead, the Supreme Court rejected as inconsistent with Dirks the Second Circuit’s conclusion that the tipper must receive “a potential gain of pecuniary or similarly valuable nature” in exchange for a gift to family or friends. The Supreme Court reasoned that by disclosing the inside information to Michael, Maher achieved the same result as if he traded on the information himself, obtained the profits, and then doled them out to his brother. As a result, Maher received a personal benefit in disclosing the inside information.
Based on the reasoning explained above, the Supreme Court affirmed the Ninth Circuit’s decision that Maher’s disclosures of inside information to Michael, who then disclosed it to Salman, were “precisely the gift of confidential information to a trading relative that Dirks envisioned.” Because Maher breached his duty to Citigroup and its clients, and Salman acquired that duty by trading on the information he knew had been improperly disclosed, the Court upheld Salman’s convictions.
What This Means for the Future
The Supreme Court narrowly limited its decision to the tipping of a trading friend or relative and failed to address more broadly the “personal benefit” requirement outside of that context. Thus it is uncertain whether a tipper’s gift of inside information to anyone who is not a trading relative or friend without receiving pecuniary or other gain would result in a personal benefit to the tipper that would support a conviction for insider trading. After noting that determining whether an insider personally benefits from a particular disclosure will not always be easy for courts, the Supreme Court opined that “there is no need for us to address those difficult cases today, because this case involves precisely the gift of confidential information to a trading relative that Dirks envisioned.” [Internal quotation marks omitted.] We expect the government to continue to be aggressive in pursuing insider trading cases against tippers and tippees in the future, even when the Dirks case does not “easily resolve the case at hand.” That said, the new Administration could take a different approach and have different enforcement priorities.
 All quotations in this Client Alert are from the Salman v. United States slip opinion unless otherwise noted.
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