Securities & Derivatives Enforcement and Regulatory Update
In a much-anticipated decision in Salman v. United States, No. 15-628 (U.S. Dec. 6, 2016), the Supreme Court yesterday upheld the Ninth Circuit's interpretation of the three-decade-old Dirks v. SEC "personal benefit" standard for insider trading under the federal securities laws. The Court applied it to tippees of confidential information, who are family members of the tippers, whether or not they kick back any of the profits to the tipper. In the unanimous decision, the Court found that "a personal benefit includes the benefit one would obtain from simply making a gift of confidential information to a trading relative." Slip op. at 12. While it remains unclear how courts will apply this decision to situations where the tipper and tippee are unrelated, the broad language used by the Court signals its unwillingness to depart from venerable principles of insider trading law and will likely embolden the government to pursue more such cases under the "gift" theory.
The Circuit Split
Dirks established that, when a corporate insider who could not trade on confidential information instead shares it with a "tippee" who trades on it, the tippee's trading can violate the federal securities laws so long as the tipper receives some "personal benefit" that makes the tippee's trading attributable to the tipper. Salman involved an investment banker who provided information about pending mergers and acquisitions to his brother, who (with the knowledge of the tipping brother) traded on the tips and (without the tipping brother's knowledge) tipped others, including the tippee's brother-in-law, Bassam Salman, who also traded. See id. at 2-4. The Ninth Circuit found that, because of the close family relationship between the brothers, the tippee provided the tipper with a sufficient personal benefit to establish the breach of duty (in this case, to the investment bank's clients). The Ninth Circuit relied on the Supreme Court's 1983 holding in Dirks v. SEC that the "elements of fiduciary duty and exploitation of nonpublic information . . . exist when an insider makes a gift of confidential information to a trading relative or friend." 463 U. S. 646, at 664 (1983). On appeal, Salman argued that a close family relationship is insufficient, citing the Second Circuit's decision in United States v. Newman, which required "an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature." 73 F. 3d 438, 452 (2d Cir. 2014), cert. denied, 577 U. S. ___ (2015).
The Supreme Court's Ruling
The Court found that Dirks "makes clear that a tipper breaches a fiduciary duty by making a gift of confidential information to 'a trading relative,'" and thus "easily resolves the narrow issue presented here." Slip op. at 8. In particular, the Court explained:
Dirks specifies that when a tipper gives inside information to "a trading relative or friend," the jury can infer that the tipper meant to provide the equivalent of a cash gift. In such situations, the tipper benefits personally because giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds. Here, by disclosing confidential information as a gift to his brother with the expectation that he would trade on it, [the tipper] breached his duty of trust and confidence to [the bank] and its clients—a duty Salman acquired, and breached himself, by trading on the information with full knowledge that it had been improperly disclosed.
Id. at 8-10 (citations omitted). The Court illustrated this point with the evidence at hand: "In one of their
tipper-tippee interactions, [the tippee] asked [the tipper] for a favor, declined [the tipper]'s offer of money, and instead requested and received lucrative trading information." Id. at 11. The parties did not dispute, and the Court assumed, without deciding, that the personal-benefit test applies both where the tipper is a classical insider or a misappropriator (i.e., an investment banker entrusted with company information). Id. at 6 n.2.
The Court specifically rejected the additional requirement in Newman that there be a concrete or tangible pecuniary or other financial benefit to the tipper, finding that such a requirement is inconsistent with Dirks. Id. at 10. The Court, however, did not offer any further clarification of how the Dirks standard would apply in non-family situations such as Newman where there was only a casual social/business relationship between tipper and tippee. Rather, the Court found "no need for us to address those difficult cases today, because this case involves precisely the gift of confidential information to a trading relative that Dirks envisioned." Id. at 11-12 (quotations and citation omitted). Likewise, this decision does nothing to disturb Newman's holding — with which the government seems to agree — that the government must prove that the tippee knew that the tipper disclosed the inside information for a personal benefit. See id at 8. To the extent that Salman encourages more enforcement and prosecutions of remote tippees where no one provided a tangible economic benefit in exchange for information, the knowledge requirement is likely to assume even greater importance.
What to Expect Following Salman
The 8-0 holding in Salman shows that government enforcement of prohibitions on securities
fraud — whether insider trading or otherwise — at its core remains a bipartisan issue. Regulators and criminal prosecutors have long been focused on investigating and bringing charges for insider trading, and we expect that this decision will only stoke that interest. Compliance programs are also under the microscope with regard to preventing insider trading. In particular, the Securities and Exchange Commission has a continued focus on enforcing Section 15(g) of the Securities Exchange Act of 1934 and Section 204A of the Investment Advisers Act of 1940, which require broker-dealers and investment advisers to adopt and enforce written policies and procedures reasonably designed to prevent the misuse, in violation of the Exchange Act and Advisers Act (e.g., insider trading), of material nonpublic information (MNPI).
Broker-dealers and investment advisers, including hedge fund managers and private equity firms, must ensure that their compliance regimes are appropriate, effective and well supported. Firms should consider reviewing and strengthening existing written policies and procedures related to insider trading, as well as other policies and procedures regarding the protection and use of MNPI. This assessment should include, for example:
- Identifying potential internal and external sources of MNPI, such as clients, consultants, "expert networks" and certain public company employees, and analyzing the adequacy of the firm's procedures concerning the use and sharing of such information;
- Examining the need for various types of restrictions on and surveillance of employee trading and communications; and
- Assessing how the firm ensures that all employees and principals understand and adhere to relevant firm policies and procedures.
If you have any questions regarding this Sidley Update, please contact the Sidley lawyer with whom you usually work, or
Barry W. Rashkover
+1 212 839 5850 Daniel A. McLaughlin
+1 212 839 5823 Joseph McLaughlin
+1 212 839 5312 Ashley C. Pfeiffer
+1 212 839 8629
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