This is from the Georgetown Supreme Court Institute. It is a preview of cases on the Supreme Court docket for the upcoming term. One of the cases fits into our study of a part of Rule 10b-5 known as insider trading,
Insider Trading Liability
Salman v. United States
Section 10(b) of Securities Exchange Act of 1934, and the SEC’s implementing Rule 10b-5, broadly prohibit deceptive or fraudulent acts in connection with trading securities. For over 35 years, the Court has recognized insider trading as a deceptive practice that violates Section 10(b) and Rule 10b-5. One type of insider trading occurs when a corporate insider violates his fiduciary duty to the corporation and its shareholders by trading on material, nonpublic information he has obtained because of his position for his own personal benefit. In Dirks v. SEC, the Court held that Section 10(b) also prohibits an insider from disclosing, for personal benefit, inside information to a corporate outsider (a “tippee”) to trade, and prohibits a tippee from trading if he knows the insider received a personal benefit from the disclosure.
At issue in Salman v. United States is what type of personal benefit to the insider for disclosing inside information to a trading tippee establishes securities fraud. Basim Salman was charged with securities fraud for trading on inside information he learned from his future brother-in-law, Michael Kara, who passed along (and traded on) stock tips he received from his brother, Maher Kara, a vice president in Citigroup’s healthcare investment banking group. Maher Kara received no money or other pecuniary benefit from giving inside information to his brother Michael. The jury was instructed that the “personal benefit” to Maher could include “the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend,” and convicted Salman.
The Court in Dirks gave a number of examples of personal benefits that would demonstrate an insider’s fiduciary breach: pecuniary gain, reciprocal information, reputational benefit expected to increase future earnings, or other things of value. Personal benefit could be inferred, the Court stated, from evidence of “a relationship between the insider and the recipient that suggests a quid pro quo from the latter or an intention to benefit the particular recipient.” The Court further advised that the “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.” The Court observed that in these circumstances, “[t]he tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.”
In the wake of Dirks, courts have struggled to decide what type of “relationship” suggests that the insider received a quid pro quo in exchange for the information, or intended to benefit the tippee. Disputes have arisen over who qualifies as a “friend” or “relative” sufficiently close to suggest the inside information was a “gift” from the insider, and whether the emotional gratification the insider derives from his generosity is a personal benefit. In their merits briefs, both sides in Salman wisely steer the Court away from the messy territory of evaluating personal relationships and measuring psychological satisfaction.
Petitioner urges the Court to hold that pecuniary gain is required to avoid the constitutional due process and separation of powers problems posed by the indeterminate “gift” scenario. Basing criminal liability on an insider’s emotional response, petitioner argues, invites arbitrary enforcement and is too vague and subjective to give adequate notice to market participants of whether a trade is lawful or illegal. Allowing federal prosecutors and courts to decide which personal favors or relationships permit an inference of an improper quid pro quo or intent to benefit the tippee, petitioner maintains, unconstitutionally usurps Congress’s role to define crimes and specify their elements.
Petitioner contends that liability for insider trading must be narrowly circumscribed because the offense is tantamount to an impermissible judge made “common law” crime. Neither Section 10(b) nor Rule 10b-5 explicitly prohibits it, and the elements of the offense are nowhere defined.
The government argues that whenever an insider discloses material nonpublic information to an outsider for trading and lacks any legitimate corporate purpose for the disclosure, a jury may infer that the insider has received the requisite personal benefit. The government reasons that if an insider has no legitimate corporate purpose for disclosing inside information to an outsider for trading, he is by definition acting for his personal benefit, since corporate purpose and personal benefit are “opposite sides of the same coin.” The government warns that requiring pecuniary gain, as petitioner suggests, would harm investors and damage public confidence in the fairness of securities markets, undermining a core purpose of the securities laws. The outcome in Salman will depend on whether a majority is willing to give the government broader latitude to prosecute insider trading, or would rather narrow the scope of liability, as petitioner urges, and leave it to Congress to enact a law that clearly defines the offense and its elements. Either option seems preferable to where the law stands now.