Three pending cases – United States v. Martoma, and the habeas corpus cases Gupta v. United States and Whitman v. United States[1] – will allow the U.S. Court of Appeals for the Second Circuit to examine United States v. Newman[2] in light of Salman v. United States.[3]  In Salman, the Supreme Court rejected a Newman-based argument and held that a banker’s gratuitous tips to his brother violated Dirks v. SEC’s[4] ban on insider gifts of information to trading relatives and friends.  However, Martoma, Gupta, and Whitman have argued that Newman remains good law and, absent the type of close relationship present in Salman, still requires a pecuniary or similar gain to satisfy Dirks’ personal benefit requirement.

The Second Circuit could decide these cases in a variety of ways.[5]  Any new appraisal of Newman, though, could entail an examination of its tension with Dirks in a way that was not possible before.  One possible outcome is adoption of U.S. District Judge Jed Rakoff’s view of Newman in the district court opinions in Gupta and Whitman.[6]  Judge Rakoff read Newman not as limiting personal benefit to pecuniary gain, but, instead, only requiring further evidence of gift-giving intent where a tipper-tippee relationship is casual or of low value.

Salman’s Impact on Newman.

The Salman opinion, issued only two months after the argument, was short and, somewhat surprisingly, unanimous.[7]  It did not purport to overrule Newman except as to the conduct in the case.  Salman, nonetheless, undermines any broad reading of Newman in two significant ways.

First, the Supreme Court dismissed vagueness, lenity and, implicitly, separation of powers objections to liability for gifts of information and insider trading generally.  These concerns had been emphasized in Salman’s briefs,[8] and marginalizing them undercuts part of the policy argument for restricting insider trading law.

Second, and more important, Salman affirmed Dirks and its gift language without the Newman limitation or other modification.  By reiterating Dirks, Salman allows a new assessment of Newman and, in particular, any potential conflict with Dirks.  The opinion, of course, stated that the decision was only as to Maher Kara’s tips to his brother.[9]  But it did not purport to limit Dirks to insider gifts between persons in close personal relationships.[10]  In re Arab Bank, PLC Alien Tort Statute Litigation and earlier cases, moreover, hold that logical inconsistency with an intervening Supreme Court decision can undermine recent Second Circuit precedent even if the precise issues differ.[11]

If one accepts that Salman revived Dirks for post-Newman purposes, the impact on Newman (or, rather, a broad reading of Newman) depends on whether gifts to persons other than family and close friends contradict Dirks’ holding on gifts of insider information.  While it can be credibly argued that a gift-giver personally benefits only when giving to family and close friends,[12] I think the better view is that, under Dirks, insider gifts can be illegal if gift intent is established.  Dirks seems to have viewed “personal benefit” as sometimes meaning something other than simply reward or payment.  The opinion’s quotation from In re Merrill, Lynch, Pierce, Fenner & Smith (itself using language from In re Cady Roberts & Co.) clearly used “personal benefit” to mean a selfish or personal purpose contrary to corporate interests.[13]  Gifts of confidential information, moreover, can exploit corporate assets and conflict with the duty of loyalty, regardless of the recipient’s relationship with the insider.  Dirks, in addition, emphasized the motive of a disclosure.  The opinion spoke of “intention to benefit a particular recipient.”[14] and also noted that the whistleblower Secrist did not intend to make a gift to Ray Dirks[15] (who is not mentioned as being a friend, close or otherwise).

Why Read Newman Narrowly?

Reading Newman as only requiring additional evidence of intent where a tipper-tippee relationship is casual or loose obviously reconciles Newman with Dirks.  But there are other reasons for a narrow reading.

The text of Newman suggests that common readings of it may be overbroad.  Despite the limitation on Dirks’ implications, Newman’s passage on pecuniary gain did not literally state that personal benefit was absent with gifts, but instead only addressed inferences of personal benefit from loose personal relationships.   The passage, moreover, quoted United States v. Jiau (which used language from Dirks) to state that the personal benefit requirement was met by insider intent to benefit a given recipient.[16]  If Newman actually intended to limit liability for intended gifts of confidential information, it also seems strange that it did not try to directly address the obvious conflict with Dirks.[17]  Given that the opinion was discussing the sufficiency of circumstantial evidence at trial, a more plausible reading of Newman may be that it merely holds that a loose friendship or other association, by itself, does not adequately show gift motive.

Newman also presented atypical facts and circumstances that make a narrow reading appropriate.  The portfolio managers Newman and Chiasson were, of course, remote tippees, multiple levels removed from the Dell and Nvidia tippers.  Since the tippers did not testify, their motives had to be inferred from casual friendships with the immediate tippees.  Moreover, the tipped earnings information was, according to Judge Parker at the argument, “virtually indistinguishable” from information routinely leaked by the companies to favored investors.[18]  Aside from their relevance to evidence of knowledge, the authorized disclosures implied that equivalent information in the tips was no longer confidential from the point of view of the tippers (and, arguably, as a practical matter), even if the information was at least partially nonpublic in the sense of not being widely disseminated.  In addition, the Second Circuit perceived that the government had circumvented the normal district judge selection process by using a superseding indictment to have Michael Steinberg tried before the preferred judge in Newman,[19] even though the Newman-Chiasson trial had ended.  At the argument, the court criticized the government for this, and for taking different positions before different district judges on the knowledge question.[20]  These factors help explain the court’s view of government overreach and absence of insider-recipient culpability,[21] and, together at least, make Newman an outlier.

Aside from the above reasons, a narrower reading would also preserve aspects of the decision worth keeping.   An arguable but interesting implication of Newman is that, if a corporation selectively leaks information to favored investors, that information is in the market and, even if not yet reflected in stock prices, should be fair game for other analysts and traders to ferret out.  Requiring additional evidence of motive, moreover, would still limit the slipperiness of Dirks’ gift language, and prevent it from being used as a catchall for innocent disclosures.  But limiting inferences from circumstantial evidence, unlike a hard and fast pecuniary gain requirement, would permit further factual inquiry where, despite a loose existing relationship, an insider gift-giver could be seeking a closer relationship, recognition, psychological benefit, or the possibility of a future tangible gain.

ENDNOTES

[1] U.S. v. Martoma, No. 14-3599 (2d Cir. Argued, Oct. 28, 2016); Gupta v. U.S., No. 15-2707 (2d Cir. Argued, November16, 2016); Whitman v. U.S., No. 15-2686 (2d Cir. Argued, Oct. 6, 2016).  The arguments in these cases took place prior to Salman.  The Martoma panel requested additional letter briefs on Salman’s impact and scheduled re-argument for May 9.  Similar actions have, so far, not been taken in Gupta and Whitman.

[2] 773 F.3d 438 (2d Cir. 2014).  Newman’s nut passage on personal benefit and pecuniary gain is as follows:

“To the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee, where the tippee’s trades ‘resemble trading by the by the insider himself followed by a gift of the profits to the recipient,’ see 643 U.S. at 664, we hold that such an inference is impermissible in the absence of proof of a meaningfully close relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.  In other words, as Judge Walker noted in Jiau, this requires evidence of ‘a relationship between the insider and the recipient that suggests a quid pro quo relationship from the latter, or an intention to benefit the [latter].’ Jiau, 734 F. 3d at 153.”

773 F. 3d at 452 (quoting and citing Dirks and U.S. v. Jiau, 734 F.3d 147 (2d Cir. 2013)).

Newman’s other holding on tippee knowledge of the tipper’s personal benefit was not decided in Salman.

[3] 137 S.Ct. 420 (2016), affirm’g U.S. v. Salman, 792 F.3d 1087 (9^th Cir. 2015) (Rakoff, J., sitting by designation).

[4] 463 U.S. 646, 664 (1983).

[5] See, U.S. v. Bray, 2017 U.S. App. Lexis 5109 at 7-8 (1^st Cir., No. 16-1579, Mar. 22, 2017) (Newman inapplicable because of close friendship and reputational gain); Rajaratnam v. U.S., 2017 U.S. Dist. LEXIS 30726 at 4 (S.D.N.Y., No. 15-5325, Mar. 3, 2017) (Salman overrules Newman).   Martoma, Gupta and Whitman also all involve other issues, with those in Gupta and Whitman compounded by the difficulty of habeas challenges.

[6] U.S. v. Gupta, 111 F.Supp.3d 557, 559 (S.D.N.Y. 2015), appeal filed, No. 15-2707, supra, n1; and U.S. v. Whitman, 115 F.Supp.3d 439, 444 & n5 (S.D.N.Y. 2015), appeal filed, No. 15-2686, supra, n1.  See also, Coffee, News from California: The 9^th Circuit and the SEC Challenge New York, CLS Blue Sky Blog, July 20, 2015.

[7] See, Transcript of Oral Argument at 33, Salman., No. 15-628 (Oct. 5, 2016) (Justice Sotomayor predicting “fight” over gift-giver intent).

[8] See, Salman, No. 15-628, Brief for Petitioner at 36-56, Reply Brief for Petitioner at 13-14, 17.  Justice Scalia made similar arguments in his concurring statement in Whitman v. U.S., 135 S.Ct. 352 (2014).

[9] This language led the First Circuit in Bray to state in dicta that Salman would not foreclose a defendant’s Newman argument.  See, 2017 U.S. App. Lexis 5109 at 7n5.

[10] It may also be noted that most of the Justices’ questions challenging the Government at argument concerned careless and reckless disclosures, and impulsive statements and acts of kindness to strangers. Transcript at 24-29, 31, 37-38, Salman.  While some imply doubt as to disclosures to strangers, the questions generally go to defining gift intent and do not obviously suggest concern over undisputed gifts to casual friends or even acquaintances.  One possible exception to this is Justice Breyer’s question about the “personal advantage” that a gift-giver obtains. Id. at 27-28.

[11] In re Arab Bank, 808 F.3d 144, 154-155 (2d Cir. 2015); see also, Wojchowski v. Daines, 498 F.3d 99, 109 (2d Cir. 2007); Union of Needletrades, Indus. & Textile Employees v. INS, 336 F.3d 200, 210 (2d Cir. 2003).

[12] See, Fisch, Family Ties: Salman and the Scope of Insider Trading, 69 Stan. L. Rev. Online 46, 50-52 (October 2016); Pritchard, Dirks and the Genesis of Personal Benefit, 68 SMU L. Rev. 857, 874 (Summer 2015).

[13] “[I]nformation intended to be available only for a corporate purpose and not for the personal benefit of anyone”. 43 S.E.C. 933, 936 (1968) (citing 40 S.E.C. 907, 912 (1961)). See also, Dirks, 463 U.S at 654.  Justice Kagan’s comments at the Salman argument indicated a similar understanding.  Transcript at 13-14, Salman (an insider’s theft of confidential information for use as a gift serves a personal purpose).

[14] 463 U.S. at 664.

[15] Id. at 667.

[16] Jiau, 734 F.3d at 153.

[17] Newman, however, also read Jiau to suggest that a tipper only benefits from friendship if there is at least potential reciprocal gain.  773 F.3d at 452.

[18] Transcript of Oral Argument at 31, Newman, No. 13-1837 (2d Cir. April 22, 2014) (question by Judge Parker).  See also, 773 F. 3d at 454-455.  The authorized leaks would have served a corporate purpose regardless of any Rule FD violation.

[19] Judge Sullivan had excluded tippee knowledge of personal benefit as an element in the jury instructions In the Newman-Chiasson trial.  Most of the other district judges in the S.D.N.Y. had taken a contrary position.

[20] Transcript at 22-30, Newman.  See also, CD of Oral Argument at 43:01 – 52:12 (critical tone of court’s questions).

[21] Neither tipper was charged criminally, and only one was civilly charged.  Newman, 773 F.3d at 443.

This post comes to us from Daniel N. Sang, a private investor and member of the New York and California bars. The author was previously a senior analyst at several hedge funds and bank proprietary trading desks.