The financial services industry is watching the Supreme Court closely in anticipation of a decision in Salman v. United States, which will be the Court’s first insider trading case since United States v. O’Hagan in 1997. Salman concerns the tipping violation the Court recognized in Dirks v. SEC in 1983 and calls on the Court to consider the requirement that an insider receive a personal benefit in exchange for disclosing material, nonpublic information to a tippee. The meaning of the personal benefit requirement has been controversial and led to a difference between the Ninth Circuit in United States v. Salman and the Second Circuit in United States v. Newman. At the time of this writing, the Court has heard oral argument but not yet issued a decision. Indications at the oral argument were that a majority of justices are prepared to confirm Dirks and a broad test for the tipper’s personal benefit.
The legal foundation for the prohibitions on both insider trading and tipping has been Rule 10b-5, which is the general anti-fraud regulation the SEC issued under the authority of Section 10(b) of the Exchange Act. The Supreme Court described the insider trading violation in Chiarella v. United States. The question was whether a defendant engaged in a deceptive or manipulative device within the meaning of Section 10(b) and Rule 10b-5 when he had material, nonpublic information but was silent about the information when purchasing a security. The Court concluded that a person’s silence was fraud proscribed by Section 10(b) when the person had a duty to disclose arising from a relationship of trust and confidence between parties to a transaction. Corporate insiders had such a duty when buying or selling the corporation’s stock.
The Court recognized tipping as a fraud violation under Section 10(b) and Rule 10b-5 in Dirks. Tipping can occur when an insider discloses confidential, price-sensitive information to a third party who then trades on the information before the information becomes public. Dirks concerned a person who received material, nonpublic information from an insider and who had no duty to disclose before trading the security. The legal question was whether such an outsider somehow acquired a duty not to trade on the inside information. The Court constructed the violation as an extension of Chiarella on policies and laws other than Section 10(b) or Rule 10b-5 and developed elements of the violation to examine both the tipper and the tippee. A “tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information … when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach.”.
Whether a disclosure is a breach of duty depends on the purpose of the disclosure, and “the test is whether the insider personally will benefit, directly or indirectly, from his disclosure.” The need for proof of the tipper’s personal benefit was the connection of the fraudulent act in a standard insider trading case to a tipping violation. Dirks went on to discuss the personal benefit requirement. Courts must “focus on objective criteria, i.e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings.” The Court cited examples of pecuniary gain or future earnings, such as cash, reciprocal information, and other things of value.
Then the Court listed a few “objective facts and circumstances that often justify such an inference” of a breach of duty. One was a quid pro quo relationship between the insider and the tippee. Another was “when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.”
It is this discussion of personal benefit that caused the difference between Newman and Salman. Newman involved a lengthy chain of tippees between the original insider sources of information and the defendants. The defendants did not know whether the insiders received a personal benefit, and the court determined that the insiders had not received the necessary personal benefit. One insider was a family friend from church of his tippee, and the other insider received career advice and assistance from his tippee. The Second Circuit said that the mere fact of friendship did not show receipt of a personal benefit and refused to infer that the disclosure of information resembled the gift of trading profits to the tippee. It said an inference of personal benefit from a personal relationship between a tipper and tippee is not permissible unless the government proves “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.”
Salman involved a disclosure by an insider to his brother, who passed the information to the defendant, who traded. The insider had not received cash or anything of pecuniary value for making the disclosures. The court determined that the gift language in Dirks governed the case and refused to follow the reasoning in Newman. It said “the element of breach of fiduciary duty is met where an ‘insider makes a gift of confidential information to a trading relative or friend.’’’ The insider had disclosed information to benefit his brother and to fulfill his brother’s needs and had therefore breached his fiduciary duties.
The Supreme Court granted review to consider the different interpretations of the personal benefit requirement in Salman and Newman. In their briefs, the government and Salman took fundamentally different approaches. Salman was concerned about the judicial creation of the tipping crime and the vagueness and indeterminacy of the personal benefit requirement. He argued that the Court needed to construe the personal benefit test narrowly to require a tipper to receive a pecuniary gain because the alternatives failed to provide adequate notice of unlawful activity to market participants and gave law enforcement authorities too much discretion to charge insider trading.
The government argued that the Court should replace Dirks with an entirely new theory of tipping liability. The government proposed a corporate purpose test that did not require proof of any personal benefit to the tipper. It urged that the absence of any corporate purpose for a disclosure creates the consequent inference of personal benefit and that a personal benefit exists when a corporate purpose does not. The government also relied on the gift passages in Dirks to contend that a disclosure to a trading relative or friend satisfied the personal benefit test.
The Court could decide the case on a variety of different grounds. It could ratify the Dirks framework and narrow the personal benefit test along the lines that Newman did or that Salman proposed. It could clarify the gift sentences in Dirks in a way that did not apply to the insider in the Salman case. These outcomes would result in reversal of Salman’s convictions, which might not be acceptable if the justices do not view the defendant as a sympathetic character. The Court also could specify a broad version of the personal benefit test or even adopt the government’s corporate purpose test.
At oral argument, a majority of the justices sounded unlikely to venture very far from Dirks, narrow the personal benefit test as Newman did, or adopt the government’s new corporate purpose standard. The exchanges at the oral argument suggested that the Supreme Court is apt to retain the basic structure of Dirks and to reaffirm that an insider’s gift of confidential information to an outsider for purposes of a securities trade both violates Rule 10b-5 and is the premise for the tippee’s violation of Rule 10b-5.
One topic discussed at oral argument was whether the gift concept should be accepted for a disclosure to any person, even a stranger, or whether it should apply only to disclosures to close family members or to friends and close family members. Dirks discussed the idea of a gift of confidential information “to a trading relative or friend,” and my hunch is that the Court will go no further than that.
 Salman v. United States, 792 F.3d 1087 (9th Cir. 2015), cert. granted, (U.S. January 19, 2016) (No. 15-628).
 521 U.S. 642 (1997).
 463 U.S. 646 (1983).
 United States v. Newman, 773 F.3d 438 (2d Cir. 2014), cert. denied, 136 S. Ct. 242 (mem.) (2015).
 445 U.S. 222 (1980).
 Id. at 230. See also Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 153 (1972).
 Dirks, 463 U.S. at 659-60.
 Id. at 660.
 Id. at 662.
 Id. at 659, 662.
 Id. at 663-64.
 Id. at 664.
 Newman, 773 F.3d at 452.
 Salman, 792 F.3d at 1093 (quoting Dirks, 463 U.S. at 664).
 Id. at 1092, 1094.
 The transcript of the oral argument is available at https://www.supremecourt.gov/oral_arguments/argument_transcripts/2016/15-628_p86a.pdf.
This post comes to us from Andrew N. Vollmer, Professor of Law, General Faculty, and Director of the John W. Glynn, Jr. Law & Business Program at the University of Virginia School of Law. He was Deputy General Counsel of the Securities and Exchange Commission and a partner at Wilmer Cutler Pickering Hale and Dorr LLP. The statements in the post are his own and do not necessarily reflect the views of any other person.