Insider Trading Before the Supreme Court: Dirks and Salman, Part IV

Oral argument in Salman highlighted the themes threaded through the briefs of the parties and the Court’s 1983 opinion in Dirks, centering on the question of gifts of inside information. Petitioner Salman hewed to the notion that the personal benefit and any gift must result in a pecuniary benefit to the insider. Petitioner cautioned that the Court should tread carefully in crafting elements of an insider trading cause of action in a criminal case as it has in construing other federal criminal statutes such as in the honest services fraud area. Respondent, in contrast, argued that transmitting inside information to one who intends to trade is impermissible. Both parties claimed the mantel of Dirks while the Court time and again returned to its earlier opinion, gently chiding the advocates they their positions were out of step with that decision.

Petitioner, represented by Alexandra Schapiro, began by citing McNally and Skilling, two honest services fraud cases, and McDonald, the Court’s reversal of former Virginia governor Bob McDonald’s corruption conviction last term, for the proposition that Congress, not the courts should define vague statues like Exchange Act Section 10(b) which fails to mention insider trading. The Court was not receptive. Justice Ginsburg immediately went to the core of the case: “Suppose in this case the person with the . . . inside information, the brother with the inside information, had himself traded in the securities, and then gave the proceeds to his . . . older brother? Would that have violated 10(b)?” Petitioner responded to the hypothetical, drawn nearly verbatim from Dirks, that it would. Justice Kennedy immediately picked up the theme noting that “[t]his is standard accomplice stuff.”

Petitioner tried to return to the key theme of her argument: “if the insider – as occurred in this case, and it’s undisputed in this case – did not act for any financial gain, did not make any money at all, that’s what’s not covered” by Section 10(b) and Dirks. Justice Sotomayor then turned to the question of what constitutes a gift: “Isn’t that always the quid pro quo of a gift, that you believe that if you give someone a gift, it’s going to cost you one way or another?” While that may be true Petitioner noted, that under that test “virtually anything would – any disclosure would then amount to a gift, and this Court has been crystal clear that – that not any disclosure leads to a violation.” Justice Sotomayor agreed that every communication of inside information is not a violation of the law. Rather, there has to be “a personal benefit, or a personal purpose, that there has to be a reason you’re doing it, not accidentally, not – unknowingly, but something you’re doing because you want to receive some benefit from it.” Justice Breyer picked up this theme, tying the notion of receiving a benefit from a gift to family members, noting that “the statute books [are] filled with instances where the public wants to know . . . how your family might benefit.”

Justice Kagan then returned the argument to what became a central theme: “So there’s a lot of language in Dirks which is very specific about, it’s not only when there’s a quid pro quo from the tippee to the tipper, but when the tipper makes a gift to the tippee, and in particular a relative or friend.” While Petitioner agreed with this point, Ms. Schapiro, tried to turn back to her central theme – there has to be a pecuniary benefit. Justice Kennedy was unconvinced, noting that “Dirks says there’s a benefit in making a gift . . .” Justice Kagan agreed noting that here “I’m stealing corporate information. It’s essentially a kind of embezzlement or conversion. I’m stealing information to give a gift to somebody I know. It might be, as in this case, a family member. It might be a friend. And I benefit from that because . . . I personally benefit. It’s the exact opposite of using corporate information for corporate purposes. I’m using it for my own personal benefit.”

Petitioner continued to press for a “clear line,” a central theme of Dirks. Justice Breyer brushed aside the issue of vague statutes such as honest services fraud, citing the antitrust laws as a “very vague statute.” The real question here, according to Justice Kennedy, is not whether there is a breach – that is a given – but how “far out does liability extend?” Petitioner’s line was financial – the gift must be financial. When pressed further by Justice Stomayor who asked for an alternative, Petitioner admitted there was none. If “Dirks is the test” noted Justice Ginsburg, “then this case falls within it because it’s a gift, right?” Petitioner disagreed.

Justice Kagan seemed to sum up the Court’s view, stating: “Ms. Schapiro, here [it] is not a question of expanding it [Dirks] further. You’re asking us to cut back significantly from something that we said several decades ago, something that Congress has shown no indication that it’s unhappy with . . . And you’re asking us essentially to change the rules in a way that threatens that integrity . . .” of the markets.

Picking up on comments from the Justices, the Government, represented by Deputy Solicitor General Michael Dreeben, began by claiming that a “pecuniary gain” limitation to the personal benefit test would be harmful to the integrity of the securities markets, permitting an insider to “parcel it [inside information] out to favored friends, family members and acquaintances [who] could all use it in trading . . .”

Exploring the limits of the gift theory, Chief Justice Roberts then noted that “not everything is a gift . . . social acquaintances, you know, that people say we’re all going away for the weekend, why don’t you join us? I can’t, I’m working on this Google things, or something like that, and it means something to the other people. You wouldn’t call that a gift. You’d call it a social interchange . . And it seems to me that, however you read Dirks . . . does certainly doesn’t go beyond gifts.” The Government did not disagree. The difference is that there has to be a breach where the information was made available to the insider for a corporate purpose and the insider is providing it to someone for a personal purpose.

Justice Breyer proceeded to examine the limits of the Government’s view by asking “If you give it [inside information] to anyone in the world, and – whom you happen to know, and you believe that that person will trade on it, that is for a personal advantage” to which the Government responded “Yes.” The breath of this comment lead Justice Alito to state that “It doesn’t seem to me that your argument is much more consistent with Dirks than Ms. Shapiro’s.” Mr. Dreeben responded, arguing that disclosing information that was entrusted for a corporate purpose to any person for trading violates the insider trading laws. The limit to this position, the Government told the Court, is if “there’s no knowledge that the individual to whom you’re going to give the information is trading, there’s no breach of the Cady, Roberts [seminal SEC administrative decision in the area] duty. This is because Dirks is bottomed, according to the Government, on the traditional corporate duty of loyalty – a point the Government reiterated but which was not picked up by any of the Justices.

When assessing the knowledge of the insider regarding the prospect that the outsider would trade, the Government contended that the duty is breached if the “insider anticipated that the person to whom he gave the information would trade.” Anticipated is the same as knowledge, the Government told Justice Kagan in response to a question. Later the Government augmented this point, noting that the doctrine of conscious avoidance could also be used to establish knowledge.

The limits of the Government’s theory – and the difference between DOJ criminal cases and SEC civil enforcement actions – was explored in an exchange between Justice Sotomayor and the Government:

Justice Sotomayor: “ I think you’re taking this way out of existing law. Are you going to suggest that tippees aren’t routinely prosecuted when tippers don’t know that they are going to trade? I think they are, and most often it’s because you claim that they should have known it was confidential information.”

The Government: “In a criminal case, we’re not claiming that. The SEC in a civil case –“

Justice Sotomayor: “There’s plenty – there’s a legion of cases I read for this – preparing for this argument where the government has said –

The Government: I don’t think that there are, Justice Sotomayor, because I don’t think that that’s what we’re – we’re certainly not making that submission in this case. And I think that the cases that we are trying and the jury instructions that we are obtaining contemplate that the disclosures to a trading relative or friend. And that is the heart of the gift theory. So I don’t think that I’m departing from the way that the –

Justice Sotomayor: “So you’re going to let go of the guy that Justice Alito – the guy on the street who looks dejected is not my friend or a close relative, but I give you a tip and say, go trade on this. It will make you a lot of money. That person – that tipper would not be liable.”

The Government: “He would, Justice Sotomayor, for the very reason you yourself articulated. In that situation, there’s a gift of information to someone which the intent that the person trade.”

As the argument drew to a close Justice Kagan asked the Government if they could limit the gift issue for now to relatives and friends, leaving the broader question for later. The Government agreed.

Analysis

While each party claimed to have advanced a position which closely followed Dirks, the arguments highlighted the fact that neither the position of the Petitioner nor that of the Government faithfully applied the Court’s seminal decision. To the contrary, as questioning from the Justices made clear, Petitioner is requesting that the limits of Dirks be contracted. The Government is asking that Dirks be expanded and its effort at a clear, bright line be obliterated.

Despite the positions of the parties, during the argument the Justices repeatedly indicated that Dirks and its holding regarding gifting inside information to relatives or close friends will stand. While neither the Justices nor the advocates discussed the kind of evidence necessary to establish this point, or the Dirks demand for objective criteria, those requirements seem likely to stand as well as the core holding of the decision requiring a personal benefit and limiting gifts to relatives and close friends. Despite the insistence of the Government that the court eliminate its restricted gift requirement in favor of a standard which prohibits any transmission of inside information where there is reason to believe that the recipient may trade, discussion during the argument seemed to make clear that the Justices do not favor that rule. At best there could be some reservation suggesting that the question of gifts to non-family members and friends is reserved for later consideration.

Finally, discussion during the argument seemed to suggest that the facts of Mr. Salman’s case fall squarely within the rule of Dirks. While the Court could remand the decision for consideration by the lower court in view of the opinion, it may simply affirm the verdict but not the rationale of the circuit court. Neither the approach of the ninth circuit nor that of the second circuit in Newman was discussed during the argument. In view of that, as well as the overall argument, it seems apparent that the Court intends to reaffirm Dirks and perhaps clarify its basic holding without regard to the opinions in either circuit court case.

A decision is expected by early Spring, 2017.

Next: The decision of the Court.