US Supreme Court Looks at Insider Trading Law, Leaves it Where it Found it

The US Supreme Court recently issued its opinion in US v Salman, a case introduced on this blog in October when the parties presented their arguments to the Court.

The October post set out the background of US insider trading law and the facts of the case, so a brief recap should suffice: an investment banker provided tips about upcoming takeovers to his brother, who passed the information on to his friend (and the banker’s brother-in-law), Mr. Salman. Salman traded and made handsome profits, but the authorities uncovered the scheme. He was convicted of insider trading and sentenced to three years in prison. The Ninth Circuit affirmed.

However, recognising that the Second Circuit in US v Newman had interpreted the law in a potentially more permissive fashion than the Ninth Circuit, Salman appealed to the Supreme Court. The Court granted certiorari to resolve the circuits’ potential differences in relation to the definition of the ‘personal benefit’ necessary to find an insider liable for tipping (and, in turn, the tippee for trading): is it sufficient that an insider ‘disclosed material non-public information with the intent to benefit a trading relative or friend’ (as held in Salman), or must there be ‘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’ (as the Newman court wrote)?

Justice Alito, writing for a unanimous Court, ruled that the Ninth Circuit had interpreted the law correctly: the tipper breached a duty to his employer and its clients by disclosing the information, and Salman acquired and himself breached that duty by trading. Regarding the personal benefit requirement, the Court declared that ‘[t]o the extent the Second Circuit held that the tipper must also receive something of a “pecuniary or similarly valuable nature” in exchange for a gift to family or friends, we agree with the Ninth Circuit that this requirement is inconsistent with Dirks’. Salman’s conviction was thus affirmed.

The Salman holding is congruous with the general understanding of the Court’s 1983 decision in Dirks v SEC and unlikely to surprise legal commentators. Some may have hoped that the Court would have taken this opportunity to establish broader principles to guide future tipping cases, but the opinion is notably confined to the particular facts of the case.

So where does Salman leave us? We now know that an insider tipping to family or friends automatically satisfies the ‘personal benefit’ test in Dirks. But this was not, in my view, the interesting question. Indeed, it is not clear that the Second Circuit would have disagreed with the Supreme Court’s holding in Salman, since the interpretation of Newman that Salman offered for his defence was a bit stretched. An important difference between Newman and Salman was that the tipping in Salman was to a family member (thus immediately clearing the Dirks hurdle of being a ‘gift of confidential information to a trading relative or friend’), whereas the Second Circuit in Newman were dealing with the question of whether the relationships between the tippers and tippees could be taken to mean that they were such friends that Dirks sought to cover.

Newman also raised (in my view) more delicate and interesting issues than Salman, in that the former involved the deliberate tipping by corporate insiders for the ostensible benefit of the firm to tippees they had prior, but vague, personal relationships with. It was against that background that the Second Circuit attempted to state general principles for when the relationship between tipper and tippee may be a friendship covered by Dirks. (I analyse tipping for the benefit of the firm, and suggest that the SEC reconsiders its Regulation FD, in this recent paper).

Following Salman, the question of who qualifies as a ‘friend’ under Dirks will in all likelihood be a contested one that will surface in further litigation where the personal benefit to tipping insiders is unclear. We can expect the SEC to present further theoretical constructs aimed at prohibiting all (or certainly most) forms of tipping, and the Second Circuit to continue with a more restrictive interpretation of Dirks, much like in Newman. It will be interesting to see what happens when they meet again.

Martin Bengtzen is a DPhil Candidate at the Faculty of Law and the Oxford-Man Institute of Quantitative Finance, both at the University of Oxford.