(Article from Securities Law Alert, September 2017)
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On August 23, 2017, the Second Circuit held that the “meaningfully close personal relationship” test established in U.S. v. Newman, 773 F.3d 438 (2d Cir. 2014) for the personal benefit requirement for tipping liability “is no longer good law” in view of the Supreme Court’s decision in Salman v. U.S., 137 S. Ct. 420 (2016).[1] U.S. v. Martoma, 2017 WL 3611518 (2d Cir. 2017) (Katzmann, J.).
Neither Dirks Nor Salman Limited the Personal Benefit Requirement to Instances in Which the Tipper Had a “Meaningfully Close Personal Relationship” with the Tippee
In Dirks v. S.E.C., 463 U.S. 646 (1983), the Supreme Court held that a “test” for tipping liability is “whether the insider personally will benefit, directly or indirectly, from his disclosure.” The Second Circuit explained that the Dirks Court “gave several examples of situations in which an insider would personally benefit from disclosing inside information: disclosing inside information in a quid pro quo relationship, disclosing inside information with ‘an intention to benefit the particular recipient,’ and disclosing inside information as ‘a gift . . . to a trading relative or friend.’” Martoma, 2017 WL 3611518 (quoting Dirks, 463 U.S. 646). The Martoma court found that Dirks “did not purport to limit to these examples the situations in which a personal benefit can be inferred.” Rather, the court determined that “the broader inquiry underlying the examples” in Dirks focused on “‘whether the insider personally will benefit, directly or indirectly, from his disclosure.’” Id. (quoting Dirks, 463 U.S. 646).
The Martoma court explained that in Newman, however, the Second Circuit “did view [the] examples [set forth in Dirks] as limiting the situations in which a personal benefit could be inferred.” The Newman court “held that the jury was never permitted to infer that a tipper had personally benefited from disclosing inside information as a gift unless that gift was made to someone with whom the tipper had a ‘meaningfully close relationship.’” Martoma, 2017 WL 3611518 (quoting Newman, 773 F.3d 438).
The Martoma court found “the examples in Dirks” did not “support a categorical rule that an insider can never benefit personally from gifting inside information to people other than ‘meaningfully close’ friends or family members.” While the Martoma court acknowledged that it would “ordinarily be neither appropriate nor possible for a panel to reverse existing Circuit precedent,” the court found the Supreme Court’s decision in Salman “alter[ed] the relevant analysis fundamentally enough to require overruling” Newman’s “meaningfully close personal relationship” test.[2]
In Salman, the Supreme Court held that tipper liability attached where the defendant “disclose[d] confidential information as a gift to his brother with the expectation that he would trade on it.” 137 S. Ct. 420. The Salman Court stated 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.” Id. (quoting Dirks, 463 U.S. 646).
The Martoma court found that Salman “strongly reaffirmed” “the straightforward logic of the gift-giving analysis in Dirks.” 2017 WL 3611518. The Martoma court reasoned that “[n]othing in” the Salman opinion “supports a distinction between gifts to people with whom a tipper shares a ‘meaningfully close personal relationship’ . . . and gifts to those with whom a tipper does not share such a relationship.”
The Personal Benefit Requirement Is Met Whenever the Tipper Expects the Tippee to Trade on the Information, and the Disclosure Resembles Insider Trading Followed by a Gift of the Proceeds
“[I]n light of Salman,” the Martoma court “reject[ed] . . . [Newman’s] categorical rule that an insider can never personally benefit from disclosing inside information as a gift without a ‘meaningfully close personal relationship.’” The court held that “an insider or tipper personally benefits from a disclosure of inside information whenever the information was disclosed with the expectation that the recipient would trade on it, and the disclosure resembles trading by the insider followed by a gift of the profits to the recipient, whether or not there was a ‘meaningfully close personal relationship’ between the tipper and the tippee.” Id.
The Martoma court offered the example of “a corporate insider [who], instead of giving a cash end-of-year gift to his doorman, gives a tip of inside information with instructions to trade on the information and consider the proceeds of the trade to be his end-of-year gift.” The court explained that in this situation, “there may not be a ‘meaningfully close personal relationship’ between the tipper and tippee, yet this clearly is an illustration of prohibited insider trading, as the insider has given a tip of valuable inside information in lieu of a cash gift and has thus personally benefited from the disclosure.”
The Martoma court emphasized that its holding “reaches only the insider who discloses inside information to someone he expects will trade on the information.” The court acknowledged that “‘[d]etermining whether an insider personally benefits from a particular disclosure, a question of fact, will not always be easy for courts.’” Id. (quoting Salman, 137 S. Ct. 420). Given the facts of the case before it, however, the court determined that it “need not consider the outer boundaries of when a jury is entitled to infer, relying on circumstantial evidence, that a particular disclosure was made with the expectation that the recipient would trade on it, and resembled trading by the insider followed by a gift of the profits to the recipient.” Id.
In a Lengthy Dissent, Judge Pooler Opined That the Majority’s Decision “Strips the Long-Standing Personal Benefit Rule of Its Limiting Power”
Judge Pooler, dissenting, expressed her view that “the majority opinion significantly diminishes the limiting power of the personal benefit rule” by holding that “an insider receives a personal benefit when the insider gives inside information as a ‘gift’ to any person.” She also observed that under the majority’s ruling, “[w]hat counts as a ‘gift’ is vague and subjective.” She predicted that “[t]he result will be liability in many cases where it could not previously lie.”
Judge Pooler strongly disagreed with the majority’s interpretation of Salman. She emphasized that Salman “left untouched” Newman’s “holding that, in order to allow inference of a personal benefit, gifts must be exchanged within a ‘meaningfully close personal relationship.’” She explained that “[a]n opinion considering a relationship between brothers does not need to rule on, or even address, how close two persons’ friendship must be for them really to be ‘friends.’”
In Judge Pooler’s view, “Salman [did] not overrule the limitation described in both Dirks and Salman itself—that an inference of personal benefit may be based on an insider’s gift to relatives or friends, but not a gift to someone else.”
[1] Please click here to read our prior discussion of the Supreme Court’s decision in Salman.
[2] In Salman, the Supreme Court rejected Newman’s holding that the tipper “must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends” to satisfy the personal benefit requirement. 137 S. Ct. 420 (quoting Newman, 773 F.3d 438). The Martoma court found “the Supreme Court did not have occasion to expressly overrule Newman’s requirement that the tipper have a ‘meaningfully close personal relationship’ with a tippee to justify the inference that a tipper received a personal benefit from his gift of inside information—because that aspect of Newman was not at issue in Salman.” 2017 WL 3611518.