The dominant narrative about Salman v. United States, the first insider trading case decided by the U.S. Supreme Court in almost 20 years, is that it was a big win for federal prosecutors. That is only part of the story.
There is certainly good news in the Salman decision for prosecutors. It reaffirms the prohibition against trading based on material nonpublic information provided to a friend or family member as a gift. Moreover, the opinion explicitly rejects the suggestion in United States v. Newman, a 2014 federal appeals court decision, that a tip made to a friend or family member cannot trigger liability unless the tipper receives something of a “pecuniary or similarly valuable nature” in return. Instead, the justices reaffirmed their 1983 holding in Dirks v. SEC that a personal benefit “also exist[s] when an insider makes a gift of confidential information to a trading relative or friend.”
The Salman opinion is, however, most notable for how studiously the Court avoids addressing issues related to insider trading law more generally. There are only two footnotes in the opinion, and both are dedicated to clarifying the extent to which it does not address other related topics. Similarly, the opinion uses one paragraph to summarize the Government’s argument that the test for tipper liability should be whether a tip was made for a “noncorporate purpose,” without the additional requirement that the tipper receive a personal benefit. The rest of the opinion ignores the Government’s proposal without explanation.
Another example of this minimalist approach is the Court’s explanation of why it chooses to continue to rely on the Dirks personal benefit test to determine whether there was wrongdoing by the tipper. What little explanation is provided is problematic. The justices cite Dirks for the proposition that a prohibition against insider trading needs to include tipping, “because giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds.” But this rationale suggests that any gift of material nonpublic information should trigger insider trading liability, and Dirks prohibits only gifts to “a trading relative or friend.” That seems a significant gap in the logic of Dirks, as some commentators have noted. Yet there is no mention of this disconnect in the Salman opinion.
So why did the Supreme Court even agree to hear the case? There’s no way to be sure, but some justices (read: Antonin Scalia and Clarence Thomas) may have initially voted to grant certiorari as a way to rewrite insider trading law, given their skepticism of laws made by judges rather than Congress. The case also offered a way to provide prosecutors in the Second Circuit, where Newman was decided, relief from that decision’s dicta about the need for a “pecuniary” benefit. In any event, with Scalia’s death, the second option became the clear choice.
Of course, Salman’s minimalism need not be bad news for federal prosecutors. Perhaps there is nothing especially problematic about limiting the prohibition against gift-giving to family or friends. After all, who else would a tipper want to give this kind of valuable information to?
But there is a significant problem with preserving the Dirks personal benefit test when it comes to prosecuting tippees, and particularly remote tippees. It is going to be quite easy for a remote tippee to plausibly deny knowledge of the particulars of the relationship between the original tipper and tippee. Moreover, Salman did modify, without discussion, the scienter standard in Dirks in a way that may make it even easier for a remote tippee to have plausible deniability. The opinion cites Dirks for the proposition that the “tippee acquires the tipper’s duty to disclose or abstain from trading if the tippee knows the information was disclosed in breach of the tipper’s duty and the tippee may commit securities fraud by trading in disregard of that knowledge.” But the Dirks opinion is quite explicit in stating that the test is whether “the tippee knows or should know” of the tipper wrongdoing.
The Court’s rubber-stamping of the 33-year-old Dirks precedent is likely to create significant challenges in prosecuting cases involving tipping chains and remote tippees. This is a real cost to prosecutors resulting from the Court’s failure to update the federal common law standard for identifying tipper wrongdoing. And the common law very much needs updating.
Much has changed since Dirks was decided. The SEC has enacted Regulation Fair Disclosure, prohibiting public companies from making precisely the types of selective disclosures to Wall Street analysts that the Dirks personal benefit test was designed to protect. Delaware has substantially expanded the types of violations that constitute a breach of the fiduciary duty of loyalty. Most firms have adopted policies prohibiting employees from selectively disclosing any material nonpublic information that they receive at work. The opinion in Salman ignores these developments.
In 2016, someone working on Wall Street who receives and trades on detailed earnings forecasts just before their public release, as the defendants in Newman did, almost certainly knows or should know this information is being provided in violation of securities regulations, in breach of a duty of trust and confidence, or both. Sadly, under Salman, that’s not enough to be guilty of insider trading.
 See, e.g., Richard A. Epstein, Returning to Common-Law Principles of Insider Trading after United-States v. Newman, 125 Yale. L. J. 1482, 1504-10 (2016); Michael D. Guttentag, Selective Disclosure and Insider Trading: Tipper Wrongdoing in the 21st Century, 69 Fla. L. Rev. (forthcoming, 2017), at 12-16, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2830735.
This post comes to us from Professor Michael Guttentag at Loyola Law School in Los Angeles. It is based in part on his recent paper,“Selective Disclosure and Insider Trading: Tipper Wrongdoing in the 21st Century,” available here.