In December 2016, the United States Supreme Court decided an important issue affecting when individuals may be liable for securities fraud. The issue was whether an insider’s “gift” of confidential information to a relative is enough to establish fraud, even though the insider receives no pecuniary benefit in return. In Salman v. United States, 137 S.Ct. 420 (2016), the Court responded in the affirmative, effectively making it easier to establish insider trading liability.
THE LEGAL BACKDROP
Section 10(b) of the Securities Exchange Act prohibits undisclosed trading on inside corporate information by persons with duties of trust and confidence. Similarly, such insiders may not “tip” inside information to others for trading. A person receiving such information acquires a duty to refrain from trading on it if he/she knows that it was disclosed in breach of the tipper’s duty. A tippee’s violation of that duty may lead to liability for securities fraud.
In Dirks v. SEC, 463 U.S. 646 (1983), the Supreme Court held that a tippee’s liability hinges on whether the tipper breached his/ her fiduciary duty in disclosing inside information. The Court noted that a tipper breaches his/her duty in disclosing inside information for “personal benefit,” which can be inferred where the tipper (a) receives something of value in exchange for the tip, or (b) “makes a gift of confidential information to a trading relative or friend.” Id. at 664.
SALMAN’S CONVICTION AND APPEAL
Maher Kara, an investment banker at Citigroup, provided inside information to his brother, Mounir “Michael” Kara, to “help him” meet his needs, and with the expectation that Michael would trade on it. Michael, in turn, provided inside information to Bassam Salman. Salman made over $1.5 million in profits trading on the information.
Investigative authorities ultimately caught on to Salman’s trading activities. Maher and Michael both pleaded guilty to securities fraud and cooperated with the government. Salman, on the other hand, was indicted for securities fraud and convicted. Salman then appealed.
While the appeal was pending, the Second Circuit Court of Appeals issued an opinion in United States v. Newman, 773 F.3d 438 (2d Cir. 2014). In Newman, the Second Circuit concluded that an inference of personal benefit to a tipper is impermissible absent proof a meaningfully close relationship between the tipper and the tippee that generates, among other things, “at least a potential gain of a pecuniary or similarly valuable nature.” Id. at 452.
Citing Newman, Salman argued that his conviction should be reversed because there was no evidence that Maher received any pecuniary benefit in exchange for inside information. The Ninth Circuit Court of Appeals disagreed, reasoning that Maher’s disclosures to Michael were the kind of gift to a relative that Dirks envisioned. The Ninth Circuit declined to follow Newman to the extent that it required any additional gain by the tipper. The Supreme Court granted certiorari to resolve the apparent tension between the Second and Ninth Circuits.
A GIFT’S SUFFICIENCY
A unanimous, eight-member Supreme Court affirmed Salman’s conviction. Writing for the Court, Justice Alito noted that the Dirks precedent resolved the issue of whether an insider’s gift of confidential information to a trading relative or friend can be enough to establish securities fraud. It can.
Justice Alito’s opinion noted that Dirks provides that the elements of fiduciary duty and exploitation of nonpublic information are met where an insider makes a gift of inside information to a friend or relative who trades on that information. The Court concluded that was the case with Maher, even though he never received a pecuniary benefit from his brother in exchange for the tip. Maher’s tip constituted a gift of confidential information to a trading relative under Dirks. The Court noted that a jury could infer that Maher’s conduct meant to provide the equivalent of a cash gift to the tippee. In such situations, the Court reasoned, the tipper personally benefits because gifting the information is effectively the same as trading on inside information and gifting the proceeds.
The Court thus held that by disclosing confidential information to Michael, Maher breached his fiduciary duty. By trading on that information, Salman likewise breached the duty which he acquired as a result of his knowledge of Maher’s improper disclosure.
The Salman decision is an important one in that it clarifies the scope of potential liability for tippers and tippees of inside information. It is now clear, that securities fraud liability may attach regardless of whether the tipper received a pecuniary benefit in exchange for the inside information. A “gift” of inside information to a friend or relative could very well be enough. Steve Kerbaugh