The U.S. Supreme Court has a number of options when it considers its first insider trading case in almost 20 years. The case is Salman v. United States, and oral argument will be held on October 5. The facts of Salman involve Maher Kara, an investment banker at Citigroup, who shared material nonpublic information from his job with his brother, Michael, in violation of firm policy. Maher knew that his brother would use that information to trade securities. The issue the Court has agreed to address is whether passing information from one brother to another can trigger insider trading liability, even if the brother providing the information received no tangible benefit in return.
One way for the Supreme Court to resolve this issue is to rely on a sentence that is directly on point in its 1983 decision in Dirks v. SEC. In Dirks the Court introduced a “personal benefit” test, which stated that a selective disclosure of material nonpublic information can only trigger insider trading liability if “the insider personally will benefit, directly or indirectly, from his disclosure.” The Dirks opinion went on to say that such a personal benefit exists “when an insider makes a gift of confidential information to a trading relative or friend.”
My article, Selective Disclosure and Insider Trading: Tipper Wrongdoing in the 21st Century, available here, identifies several problems with relying on this one sentence in Dirks to resolve the issues raised in Salman. Most important, a decision in Salman based on this one sentence in Dirks would endorse as valid precedent the personal benefit test introduced by the Court in Dirks. But when it was introduced in Dirks in 1983 the personal benefit test represented, at best, an imperfect effort to balance four competing rationales for determining when providing a tip should trigger insider trading liability: 1) the desire to establish objective criteria that judges and prosecutors could rely on, 2) the need to insulate legitimate corporate communications from liability, 3) the goal of preventing people from using tips to circumvent the insider trading prohibition, and 4) the links between receipt of a personal benefit and a fiduciary duty breach.
Two developments since Dirks was decided have made the problems with the personal benefit test insurmountable. First, the SEC’s enactment of Regulation Fair Disclosure in 2000 supplanted federal common law regulation of selective disclosures by public companies and, more pointedly, prohibited public companies from making precisely the types of selective disclosures to Wall Street analysts that the Dirks personal benefit test was, in part, designed to protect. Second, the adoption of the misappropriation theory of insider trading in United States v. O’Hagan greatly expanded the types of deceptive conduct that might lead to insider trading liability with important ramifications for how to identify tipper wrongdoing.
In 2016 the personal benefit test introduced by the Court in Dirks: 1) no longer plausibly establishes reliable objective criteria for determining when a selective disclosure is wrongful, 2) can no longer be justified as necessary to allow corporate communications, which, in 2016, would violate Regulation FD, 3) is poorly matched to efforts to prevent the circumvention of the insider trading prohibition, 4) does not reliably reveal the presence or absence of deceptive conduct, and 5) is and never was more than dicta.
The best approach going forward for identifying tipper wrongdoing would be to go back to the underlying statutory prohibition against deceptive conduct. Receipt of a personal benefit should be treated as a sufficient, but not necessary, condition for finding that a selective disclosure is sufficiently deceptive to trigger insider trading liability.
To highlight the benefit of resolving Salman based on the underlying statutory language, it is helpful to consider a scenario in which the approach I advocate would have more of an impact on the outcome of the case than in Salman. What if Maher and Michael, the brothers in Salman, were instead third cousins or only related to each other by marriage? Would either of these more distant relationships be sufficient to meet the test in Dirks of a gift of confidential information to a “trading relative or friend?” Observe that in either of these situations Maher’s conduct in leaking the information to Michael would be no less deceptive than when Maher and Michael are brothers, yet a court applying a personal benefit test to these new facts would be forced to make difficult determinations as to what kinds of familial relationships constitute a personal benefit.
This example shows that there is little reason to continue to force federal courts to resolve challenging questions about what constitutes a personal benefit where the legal issues can be more directly resolved by looking directly to the relevant statutory language prohibiting deceptive conduct in connection with the purchase or sale of a security. Receipt of a personal benefit might be sufficient to prove that someone passed along material nonpublic information in a deceptive manner, but other evidence might also show that information was leaked deceptively. Returning the question to the statutory prohibition against deceptive conduct obviates the need to contort a personal benefit test to address a disclosure and insider trading landscape that has significantly changed since Dirks was decided in 1983.
This post comes to us from Professor Michael Guttentag at Loyola Law School in Los Angeles. It is based on his recent paper,“Selective Disclosure and Insider Trading: Tipper Wrongdoing in the 21st Century,’ available here.