Tips as Gifts: Insider Trading Liability for Family & Friends After Salman
On December 6, 2016, the US Supreme Court issued a unanimous opinion upholding a Ninth Circuit Court of Appeals ruling that the conviction of a grocer for insider trading based on a tip by a member of his extended family was proper.
As we wrote in the “Update” section of a recent post, the Court ruled in Salman v. US that even though an investment banker who tipped inside information did not gain a pecuniary benefit by doing so, the tippee-grocer’s relationship with the banker was sufficiently close to make proving the existence of such a benefit unnecessary.
Bassam Salman was not a high-flyer on Wall Street. In fact, he worked as a grocery wholesaler in Chicago. Salman’s brother-in-law, Maher Kara, however, was an investment banker at Citigroup who provided tips of inside information — but not to Salman. Maher Kara tipped his older brother Michael Kara, who in turn tipped his friend (and Maher’s brother-in-law) Salman. Salman traded on the tips, which yielded hundreds of thousands of dollars for him.
The US Department of Justice (DOJ) charged the three men with insider trading. Maher and Michael pleaded guilty and testified against Salman at the latter’s criminal trial. A jury convicted Salman. Facing three years of imprisonment and over $730,000 in restitution, Salman appealed the verdict to the Ninth Circuit Court of Appeals.
While Salman’s appeal was pending, US v. Newman was decided in the Second Circuit Court of Appeals. That case held that proving tippee liability requires “a meaningfully close personal relationship [between the tipper and tippee] that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”
Salman argued in his case before the Ninth Circuit Court that in light of Newman, his conviction should be overturned because Maher did not receive a financial or similar benefit in exchange for the tip. The Ninth Circuit Court disagreed, and upheld Salman’s conviction. Salman petitioned the US Supreme Court for certiorari, which the Court granted.
The Court heard oral argument for Salman on October 5, 2016. (The prosecutors in Newman had also petitioned for certiorari, which the Court denied a year to the day prior to the day it heard oral argument in Salman). Two months later, the Supreme Court issued its opinion in Salman.
What the Court Said
The Supreme Court wrote that its precedential 1983 decision, Dirks v. SEC, “easily resolves the narrow issue presented here” — whether an insider’s (Maher) “gift of confidential information to a trading relative or friend” (Michael, Salman) is enough to establish tippee liability for insider trading.
First, the Court noted that Dirks v. SEC establishes that tippee liability comes from participation in the tipper’s breach of a fiduciary duty. The Court next noted that a breach of duty occurs when a fiduciary uses confidential information to gain a personal benefit. A personal benefit can include more than pecuniary gain, according to the Court. It can also include reputational benefits, a quid pro quo exchange, or an intent to benefit the recipient of the inside information.
This last type of personal benefit can include a gift of inside information to a “trading relative” — that is, a close family member or friend who trades on the information. “As Salman’s counsel acknowledged at oral argument,” explained the Court, “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.”
Applying the ruling to Salman, the Court held that since Salman knew Maher had breached his fiduciary duty by tipping Salman, the latter inherited Maher’s duty — and breached it — by trading based on the information. “Maher made a gift of confidential information to a trading relative [Michael] . . . and, [Michael testified that] Salman knew that Maher had made such a gift,” wrote the Court.
Addressing Newman’s narrow interpretation of the term “personal benefit” (which Salman had adopted in his defense), the Court ruled that “To 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.”
It’s worth noting here that, while it appears that our previous article on this subject incorrectly inferred that the Supreme Court’s denial of the Newman petition for certiorari “suggests that the Supreme Court did not find fault with the Second Circuit Court’s reasoning” (it turns out a significant part of the opinion was disapproved), this fact reinforces the overall message of that article: leadership needs to maintain effective compliance programs even in the face of legal uncertainty. Compliance efforts that solely or narrowly focused on discouraging tipping based on pecuniary gain, for example, would now be obsolete and ineffective.
What the Court Left Unsaid
Lifting the burden of proving that an insider gained financially by tipping friends and family grants federal prosecutors significant leeway in litigating cases in which the tipper provided the tippee with a “gift” of confidential information (but otherwise gained nothing).
But this case is also significant for what it left unsaid. Specifically, because the Court decided the “narrow issue” presented based on the fact that the tipper and tippee had a close relationship, the opinion did not state whether a gift to someone who was not so close — or was even a complete stranger — would also confer liability on the recipient.
According to SCOTUSBlog’s analysis of the Salman oral argument, the Court seemed to be hinting that liability would be limited in this manner. However, in the opinion, the Court simply recounts without adopting or refuting the DOJ’s argument that “a gift to a friend, a family member, or anyone else would support the inference that the tipper . . . personally benefited from the disclosure.” [Emphasis added]. Coupled with the Court’s express reluctance to address how the ruling would apply to hypothetical situations, the reach of the decision leaves room for ambiguity.
In sum, it remains to be seen whether the federal authorities will take this ambiguity as a license to vigorously prosecute gifts of inside information beyond close relationships . But not knowing the future is no reason to ignore the very real compliance and ethical risks posed by employees and others in-the-know improperly using and disclosing confidential information.
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