Poetic Expansions of Insider Trading Liability

The courts have consistently held since the Supreme Court decided Dirks v. SEC in 1983[1] that tipper-tippee insider trading liability requires proof that the tipper personally benefited from the tip.

This personal benefit test can pose significant challenges to prosecutors in bringing tipper-tippee cases where the original tip may have been offered gratuitously.

In particular, the government’s recent efforts to bring insider trading actions against ever more remote tippees has been frustrated by the Second Circuit’s 2014 holding that tippee liability requires proof that the charged tippee had knowledge of the original tipper’s personal benefit.[2] This knowledge element can be very difficult to prove when a remote tippee is many levels removed from the original tip.

While circuits continue to differ in their interpretations of the scope and extent of the personal benefit test,[3] the Supreme Court’s unanimous reaffirmation of it in its 2016 decision, Salman v. United States, suggests that it will remain an element of tipper-tippee liability for some time to come.[4]

Concerned that the personal benefit test provides a worrisome loophole for predatory insider trading, some scholars have striven to identify novel theories of insider trading liability that would allow prosecutors to circumvent the test without the need for statutory revision.

For example, Professors Michael Guttentag and Donna Nagy have each offered arguments suggesting that the entire tipper-tippee framework laid out by the Supreme Court in Dirks, including the personal benefit test, has been rendered obsolete by subsequent common law and regulatory developments that have fundamentally transformed the U.S. insider trading enforcement regime.[5] These developments include: (1) the Supreme Court’s endorsement of the misappropriation theory in United States v. O’Hagan,[6] (2) recent state court decisions offering more expansive accounts of what conduct constitutes a breach of fiduciary duty of loyalty in the corporate context, and (3) the SEC’s adoption of Regulation FD in 2000.

Both Guttentag’s and Nagy’s arguments are erudite and creative. Such creativity is a virtue in law professors, but not in prosecutors. Exercising poetic license to expand common-law criminal liability risks violating the time-honored principal of legality and leaving citizens without adequate notice of the crimes for which they may be charged.

In what follows, I summarize what I take to be the most crucial aspects of Guttentag’s and Nagy’s arguments. I then offer some criticism.

I.  Poetic Expansions

First, both Guttentag and Nagy point out that when the Supreme Court endorsed the misappropriation theory in O’Hagan, it expanded the set of persons the deception of whom could trigger insider trading liability from just counterparties to sources of material nonpublic information.[7] In doing so, the Court opened the door to new types of deception that might trigger Section 10(b) insider trading liability.

Guttentag explains, the “types of deceptive conduct that a misappropriator might engage in when taking information from the source are far more numerous than the silence that constitutes the only type of deception that can take place on an impersonal securities market.”[8] For example, a misappropriator may gain access to material nonpublic information by affirmative conduct, such as making a false statement or by overt trickery.

If the fraud is affirmative, there would be no need to prove fraud by silence, and therefore no need to show the breach of a fiduciary relation of trust and confidence—and therefore no need to prove a personal benefit.

Second, even if courts were to continue to insist that the breach of a fiduciary-like duty is required for insider trading liability under the misappropriation theory, one’s fiduciary duties to the source of material nonpublic information (e.g., to one’s employer) are different from one’s duties as an insider to shareholders. So, according to Nagy, while the duty to refrain from self-dealing may be the only relevant fiduciary duty under the classical theory (where the beneficiary is a current or prospective shareholder), there is no reason to think it is the only relevant fiduciary duty under the misappropriation theory (where the beneficiary is the source of the information).

Nagy points out that some recent Delaware cases have expanded traditional common-law limits on fiduciary duties as they pertain to corporate officers and employees, extending them beyond the classical understanding of a duty of loyalty (involving self-dealing) to a far more general duty of good faith.[9] This fiduciary duty of good faith requires more than refraining from self-dealing and avoiding conflicts of interest. It requires that fiduciaries always act in the “best interest of the corporation.”[10] Consequently, “where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act,” she breaches her fiduciary duty to the firm.[11]

If courts and regulators were to adopt this expanded understanding of fiduciary duty in applying the misappropriation theory, any tipping of material nonpublic information that violates a firm’s internal policies or external laws (regardless of personal benefit) would be sufficient to establish a fiduciary breach and therefore to predicate insider trading liability.[12]

Third, the SEC’s adoption of Regulation FD in 2000 introduced yet another significant change to the post-Dirks regulatory landscape.[13] Regulation FD requires that whenever an issuer (or certain defined persons acting on its behalf) discloses material nonpublic information concerning the issuer or its shares to market professionals or those who are likely to trade the firm’s shares, they must simultaneously disclose that information to the general investing public.[14]

Guttentag and Nagy both argue that Regulation FD closed the space for gratuitous selective disclosure once protected by Dirks.[15] Most of these disclosures are now illegal. Moreover, since the adoption of Regulation FD, virtually every firm has adopted internal rules that selective disclosures would violate.[16] Consequently, any such selective disclosure would deceive the source of the information (the issuing firm) by feigning fidelity while violating its disclosure rules, and by violating the law.

By combining the expanded reach of O’Hagan with expanded articulations of fiduciary duty under the common law, and then considering them against the backdrop of the adoption of Regulation FD, Guttentag and Nagy each argues that one can sidestep the personal benefit test altogether when applying the misappropriation theory.

And since most scholars agree that any insider trading cases brought under the classical theory could also be brought under the misappropriation theory, the result is that the Dirks personal benefit test is rendered obsolete.[17] But more than that, if we recognize Section 10(b) insider trading liability to have expanded as far as Guttentag and Nagy suggest, it is hard to conceive of a selective disclosure of material nonpublic information that (if traded upon) would not expose the tipper and tippee to liability.

So understood, this expanded interpretation would paradoxically render the U.S. insider trading regime functionally equivalent to the equal-access model that has been consistently rejected by the Supreme Court since Chiarella v. United States.[18] This is no subtle change.

II. Some Criticism

Each of the above-referenced premises for the conclusion that the Dirks personal benefit test has been rendered obsolete by subsequent legal developments is controversial.

First, it is true that by recognizing the fraud-on-the-source theory in O’Hagan, the Supreme Court created logical space for new forms of deception that might predicate insider trading liability. And the Court certainly could have exploited this opening to embrace a broader theory of insider trading liability that would recognize any form of deceptive or wrongful conduct towards the source as a form of affirmative misrepresentation, thereby dispensing with the need to establish a fiduciary duty to disclose or abstain. The O’Hagan court did not, however, do this.

Justice Ginsburg’s opinion explained that “[d]eception through nondisclosure is central to liability under the misappropriation theory.”[19] And the Court explicitly cabined the type of deceptive nondisclosure that triggers such liability as the “breach of a fiduciary duty owed to the source of the information.”[20] One could hardly ask for a clearer statement that Section 10(b) insider trading liability under the misappropriation theory, in symmetry with the classical theory, is a form of fraud by silence that requires the breach of a fiduciary or similar duty of trust and confidence.

Since the Court clearly intended to establish this symmetry between the “complementary” classical and misappropriation theories, it would be a poetic stretch to suggest that it nevertheless contemplated that the personal benefit test would apply under the former but not the latter.[21] Indeed, this narrow reading of the scope of misappropriation liability was undisputed in Salman,[22] where the Court unequivocally held that “disclosure of confidential information without personal benefit is not enough” to incur tipper liability.[23]

Second, while it is true the Delaware Supreme Court has expanded its understanding of fiduciary disloyalty in corporate contexts to include any conduct reflecting bad faith, application of this precedent to expand the scope of Section 10(b) insider trading liability is dubious on a number of levels.

To begin, Nagy cites no Delaware precedent suggesting that violating a fiduciary duty of good faith without self-dealing would suffice as proof of criminal fraud in that state.

The Delaware cases cited by Nagy recognize a spectrum of corporate culpability in the context of shareholder derivative suits, ranging from mere negligence (least culpable), to bad faith that does not involve self-dealing (more culpable), to bad faith involving self-dealing (most culpable).[24] Absent some precedent to the contrary, it should be assumed that Delaware still requires bad faith at the highest culpability level (i.e., involving self-dealing) as a predicate for criminal fraud.

But even assuming that criminal fraud in the corporate context does not require self-dealing in Delaware, does this somehow overturn more than three decades of federal court precedent interpreting Section 10(b) insider trading liability? Any regulator or court following Nagy’s lead on this would have been making a poetic stretch even before Salman. But after the Salman Court’s reaffirmation of Dirks and its personal benefit test, Nagy’s poetic stretch seems more like a leap.

Third, there are a number of reasons why it would be problematic for the SEC or the courts to regard Regulation FD as creating duties the violation of which would serve to predicate Section 10(b) insider trading liability.

To begin, Rule 101(c) of Regulation FD expressly excludes tipping “in breach of a duty of trust or confidence to the issuer” from the regulation’s coverage.[25] Since both O’Hagan and SEC Rule 10b5-2 require the violation of some duty of trust and confidence as an element of misappropriation liability,[26] Section 101(c) seems designed to make it logically impossible for a violation of Regulation FD to provide the basis of insider trading liability under the misappropriation theory.

Section 102 of Regulation FD offers proof that the SEC intended this logical separation, providing that no “failure to make a public disclosure required solely by [Regulation FD] shall be deemed to be a violation of Rule 10b-5.”[27]

Finally, even assuming arguendo that violations of Regulation FD could form the basis of insider trading liability, its impact would be limited to a relatively limited number of insiders defined by Section 101(c). It would not apply to outsiders, most constructive insiders, or even mid-to-low-level employees of the issuer.[28]


To say that Guttentag’s and Nagy’s interpretations of recent trends in insider trading law are controversial and require poetic leaps is not to say that the SEC and prosecutors will not embrace them in the wake Salman’s reaffirmation of the personal benefit test. Keep in mind that the misappropriation theory was itself a poetic, metaphorical response to a setback before the Supreme Court in Chiarella.

But while building metaphor on top of metaphor may be a sound method for expanding our aesthetic understandings of the arts, I am convinced it is an unjust method for expanding the scope of criminal liability.

Citizens expect and deserve advance notice of precisely what conduct will violate the criminal law so they can guide their actions to reliably avoid the associated reputational and penal sanctions. Justice therefore demands that the criminal law be expanded by legislative action, not poetic license.


[1] 463 U.S. 646 (1983).

[2] 773 F.3d 438 (2d Cir. 2014).

[3] Indeed, a split panel of the Second Circuit recently overruled its own interpretation of the scope of the personal benefit test in Newman (though not the knowledge requirement). See United States v. Martoma, 869 F.ed 58 (2d Cir. 2017). Martoma is currently pending possible en banc or perhaps even Supreme Court review.

[4] 137 S. Ct. 420 (2016).

[5] See Donna M. Nagy, Beyond Dirks: Gratuitous Tipping and Insider Trading, 42 J. Corp. L. 1, 22 (2016). Michael D. Guttentag, Selective Disclosure and Insider Trading, 69 Florida L. Rev. 519 (2017).

[6] 521 U.S. 642 (1992).

[7] See Guttentag at 545-550; Nagy at 17-26.

[8] Guttentag at 545.

[9] See, e.g., Stone v. Ritter, 911 A.2d 362 (Del. 2006); The Walt Disney Company Derivative Litigation, 906 A.2d 27 (Del. 2006).

[10] Disney, 906 A.2d at 67.

[11] Id.

[12] See Nagy at 43-45.

[13] 17 C.F.R. § 243.100 (2011).

[14] Id.

[15] See Guttentag at 541-46; Nagy at 40-41.

[16] See Nagy at 40; Guttentag at 544.

[17] See, e.g., Donald C. Langevoort, Insider Trading Regulation, Enforcement & Prevention § 6-1 (West vol. 18, 2015).

[18] 445 U.S. 222, 231-232 (1980).

[19] Id.

[20] 521 U.S. 642, 654 (1997).

[21] Id.

[22] Salman, 137 S.Ct. at 425, n.2.

[23] Id., 137 S.Ct. at 427.

[24] See Nagy at 43-45.

[25] 17 C.F.R. § 243.101(c).

[26] 17 C.F.R. § 240.10b5-2.

[27] 17 C.F.R. § 243.102.

[28] 17 C.F.R. 243.101(c).

This post comes to us from Professor John P. Anderson at the Mississippi College School of Law. It is based on his recent article, “Poetic Expansions of Insider Trading Liability,” available here.