As you consider which gifts to give this Holiday season, the U.S. Supreme Court has just made it clear that you should not give the gift of insider stock tips. The Salman v. United States decision resolves a split between lower courts about whether the government must show that someone who breaks trust by giving insider information to a friend or relative automatically breaks rules against insider trading since the “tipper” expects the “tippee” will make money from the tipped information, or whether prosecutors must be prove the tipper expects to gain personally when the tippee trades.
Prohibitions Against Insider Trading Tips
Section 10(b) of the 1934 Act and Securities and Exchange Commission (SEC) Rule 10b-5 provide SEC’s primary tool for enforcement against individuals and entities for insider trading. The most obvious scenario is when someone qualifies as an “insider” and uses information from this position to trade for his or her own benefit. SEC and courts require this person to adhere to all three of the following criteria:
Has access to “material non-public information”
Owes a “duty of trust or confidence” to the issuer or its shareholders.
Engages in a purchase or sale of the securities based on the information.
But what if the insider tells someone else, who trades on the information? As caselaw has developed, the tippee may be treated as an “insider”; this depends on the tipper’s intent (deliberate or inadvertent), the nature of the tip, and whether the tippee has any relationship with the company (outsiders who acquire such information without the connivance of an insider usually are not insiders -- taxi drivers who trade on information they overhear from their passengers are a classic example).
The Salman decision focuses on another aspect of many situations: the relationship between the tipper and the tippee, and whether or not the tipper expected the tippee to trade, and expected to receive some personal benefit from the trade. In 1983 the Supreme Court ruled in Dirks v. SEC that a non-insider did not breach duties when he tipped others to insider information he’d learned (while investigating fraud at a public company) with no expectation of personal gain should not be liable. But the Ninth Circuit’s Salman decision – and a Second Circuit decision (United States v. Newman and Chiasson) that was “in tension with” Salman – addressed a situation where the tipper was an insider and may or may not have expected personal benefits from tippee trading.
What Question Did the Salman Case Pose for the Supreme Court?
Bassam Salman was indicted for federal securities-fraud crimes for trading on inside information he received from a friend and relative-by-marriage, Michael Kara, who, in turn, received the information from his brother, Maher Kara, a former investment banker at Citigroup. Maher testified at Salman’s trial that he shared inside information with his brother Michael to benefit him and expected him to trade on it, and Michael testified to sharing that information with Salman, who knew that it was from Maher. Salman was convicted.
On appeal to the Ninth Circuit, Salman argued that he could not be held liable as a tippee because the initial tipper (his brother-in-law Maher Kara) did not personally receive money or property in exchange for the tips and thus did not personally benefit from them. Salman’s appeal tried to use the aspect of the longstanding Dirks decision that emphasized that Dirks tipped without expecting benefit. He also argued that the Ninth Circuit should apply the logic used by the Second Circuit that intent to benefit had to be proven, in a case where the government failed to prove a tipper’s expectation of personal benefit or that the tippee of a tippee knew of any such expectation. The Ninth Circuit affirmed his conviction, finding that the jury had enough information to infer that Maher Kara had breached his duty not to disclose insider information knowing his brother would trade on it and that the link to Salman was strong enough to convey liability.
Salman appealed to the U.S. Supreme Court, repeating his arguments about the meaning of the Dirks decision as applied to his situation.
What Did the Supreme Court Decide?
Writing for a unanimous court, Justice Alito rejected Salman’s arguments and reaffirmed that Dirks applies. His analysis is summarized in the following text (from which I’ve deleted internal citations):
“… we held [in Dirks] that ‘[t]he elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. … In such cases, ‘[t]he tip and trade resemble trading by the insider followed by a gift of the profits to the recipient.’ We then applied this gift-giving principle to resolve Dirks itself, finding it dispositive that the tippers “received no monetary or personal benefit” from their tips to Dirks, “nor was their purpose to make a gift of valuable information to Dirks.’ …
“Our discussion of gift giving resolves this case. Maher, the tipper, provided inside information to a close relative, his brother Michael. Dirks makes clear that a tipper breaches a fiduciary duty by making a gift of confidential information to “a trading relative,” and that rule is sufficient to resolve the case at hand. As Salman’s counsel acknowledged at oral argument, Maher would have breached his duty had he personally traded on the information here himself then given the proceeds as a gift to his brother. … It is obvious that Maher would personally benefit in that situation. But Maher effectively achieved the same result by disclosing the information to Michael, and allowing him to trade on it.”
Put another way, Maher Kara breached his duty when disclosing inside information, using the company’s information for a personal purpose – whether or not that purpose included personal profit. His brother fulfilled that purpose by trading for his own profit, and helped Salman do the same.
Mister Justice Alito also expressly rejected the Newman decision’s holding that proof of a tipper’s expectation of pecuniary or similar benefit is necessary to prove insider trading liability.
The Salman decision restores the decades-old holding from Dirks, and allows prosecutors to focus on an initial tipper’s breach of duty not to disclose a company’s inside information. It thereby ends the confusion in compliance and enforcement circles created by Newman. This restores the duties of insiders and their associates – including friends and relatives – not to disclose or trade on insider information.
Have I obtained non-public information about a public company that could be “material” to its share price?
Am I an insider or did I learn this information from an insider – directly or indirectly through a series of “tips”?
Have I passed that information to anyone else?
Do I make stock trades in the affected company based on that information, or do I know or believe that anyone I have “tipped” does so?
Where Can I Go For More Information?
Specialty Technical Publishers (STP) provides a variety of single-law and multi-law services, intended to facilitate clients’ understanding of and compliance with requirements. These include:
About the Author
Jon Elliott is President of Touchstone Environmental and has been a major contributor to STP’s product range for over 25 years. He was involved in developing 13 existing products, including Environmental Compliance: A Simplified National Guide and The Complete Guide to Environmental Law.
Mr. Elliott has a diverse educational background. In addition to his Juris Doctor (University of California, Boalt Hall School of Law, 1981), he holds a Master of Public Policy (Goldman School of Public Policy [GSPP], UC Berkeley, 1980), and a Bachelor of Science in Mechanical Engineering (Princeton University, 1977).
Mr. Elliott is active in professional and community organizations. In addition, he is a past chairman of the Board of Directors of the GSPP Alumni Association, and past member of the Executive Committee of the State Bar of California's Environmental Law Section (including past chair of its Legislative Committee).
You may contact Mr. Elliott directly at: email@example.com