INTRODUCTION II. NEWMAN'S AND SALMAN'S APPLICATION OF DIRKS A. The Stock Trading Tips in Newman B. The Classical Theory of Insider Trading C. Newman's Novel Reading of Dirks D. The Grant of Certiorari in Salman III. MISAPPROPRIATION THEORY--DOCTRINE AND POLICY A. The Misappropriation Theory of Insider Trading B. Tippers as Misappropriators C. Classical Insiders Viewed Under a Misappropriation Lens IV. LEGISLATIVE DEVELOPMENTS A. The Insider Trading Sanctions Act of 1984 (ITSA) B. Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA) C. The Stop Trading on Congressional Knowledge (STOCK) Act of 2012 V. REGULATION FD A. Regulation FD's Purpose and Scope B. The Interplay Between Regulation FD and Gratuitous Tipping VI. LACK OF GOOD FAITH AND THE DUTY OF LOYALTY A. The Duty of Loyalty under Delaware Law B. The Interplay between State Fiduciary Law and Rule 10b-5 VII. ALTERNATE PATHS FORWARD A. Joint Tipper-Tippee Liability Premised on Deceptive Breaches of Loyalty B. Insider Trading Based on a "Fraud on Contemporaneous Traders" VIII. CONCLUSION I. INTRODUCTION
In the iconic 1983 film The Big Chill, Harold (played by Kevin Kline) provided a stock trading tip to his long-time friend Nick, a Vietnam War veteran and former radio psychologist turned drug dealer (William Hurt). During a morning jog, Harold told Nick that a very large corporation was planning to buy his running shoe company, "Running Dog," and that the company's stockholders would see their money tripled. Harold shared this information in the hope that Nick would trade on it and then use the profits to get into some other line of work. Harold bluntly acknowledged that his stock tip could get him into big trouble because he was violating a host of federal securities laws. Later that evening, Harold's wife Sarah (Glenn Close) chastised him for risking so much on a futile desire to change people's lives. (1)
The three second circuit judges who overturned the defendants' insider trading convictions in United States v. Newman (2) would likely disagree with Harold's assessment of his wrongdoing. In the court's view, even if evidence establishes that a corporate insider and his "tippee" are friends, disclosing inside information does not constitute securities fraud absent proof that they had a "meaningfully close personal relationship" (3) and that the insider expected some type of tangible benefit in exchange for the information. (4) The film leaves little doubt that Harold and Nick shared a "meaningfully close personal relationship." (5) Harold, however, neither sought nor received a tangible benefit. Instead, he engaged in what can be termed "gratuitous tipping"--Harold gifted the confidential corporate information so that Nick could benefit from using it in a securities transaction.
The common sense notion that gratuitous tipping violates insider trading law aligns squarely with the Supreme Court's holding in Dirks v. SEC (6) (which, as it happens, shares the date of the movie--1983). Building on the "classical" theory developed three years before in Chiarella v. United States, (7) Dirks held that the disclosure of material nonpublic information constitutes fraudulent tipping under Section 10(b) of the Securities Exchange Act (8) and Rule 10b-59 thereunder when the tipper breaches a fiduciary duty of trust and confidence by personally benefitting (directly or indirectly) from the disclosure. Dirks held further that a tippee's liability under Rule 10b-5 derives from the tipper's liability, provided the tippee knew or should have known about the tipper's breach. (10) An insider's "personal benefit" from a tip would include a quid pro quo producing "pecuniary gain or a reputational benefit that will translate into future earnings." (11) But Dirks stated explicitly that "[t]he 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." (12) Surreptitious gifts of confidential information can likewise originate from an "outsider" to the corporation that issued the securities subject to a tip, as opposed to a classical insider such as Harold. An unethical lawyer or accountant, for instance, could breach a client's confidence to enable a friend or relative to profit mightily in the stock market. (13) Gratuitous trading tips can also come from rogue employees who are privy to market-sensitive developments that have yet to be announced publicly (14) or from persons who secretly relay business-related confidences that have been entrusted to them by a family member or friend. (15) Because such outsider scenarios involve a breach of the duty of trust and confidence owed to the source of the entrusted information rather than to a trading party, they are analyzed under the "complementary" misappropriation theory endorsed by the Court in United States v. O 'Hagan. (16)
The court in Newman evaded Dirks's reference to informational gifts because it refused to view as a personal benefit the "ephemeral benefit of the 'value of [a tippee's] friendship.'" (17) Specifically, Newman's two-fold requirement of a "meaningfully close personal relationship" (18) and "a personal benefit of ... some consequence" (19) prompted the court to reject the jury's finding that an investor relations official had personally benefitted when he disclosed, on multiple occasions, his company's confidential earnings information to a securities analyst, who had been his classmate in business school and a former colleague. (20) Newman likewise rejected the jury's finding regarding the personal benefit received by a second tipper, an insider at a different corporation who repeatedly shared that company's confidential earnings information with a family friend. (21)
Since the Second Circuit decided Newman, its heightened standard for proving a personal benefit has been impeding Department of Justice (DOJ) and Securities and Exchange Commission (SEC) efforts to prosecute tipping and trading in both classical-insider and misappropriation-outsider contexts. One highly publicized instance occurred a month after Newman, when a federal district court vacated the guilty pleas of several defendants who had traded on a tip, allegedly passed from one friend to another, about an imminent acquisition. (22) That court read Newman to demand evidence that the initial tipper expected a monetary or other quantifiable benefit from his friend--not merely the warm feelings of satisfaction that occur when one pal does a favor for another. (23) A host of other defendants, both within and outside the Second Circuit, have since sought to have their indictments or complaints dismissed, criminal convictions or civil liability determinations overturned, and guilty pleas or settlements vacated. (24) The growing list includes former Goldman Sachs director Rajat Gupta, who recently convinced the Second Circuit to reconsider his motion to vacate his conviction for fraudulent tipping. (25)
However, in jurisdictions that continue to adhere to Dirks's pronouncement that a personal benefit derives from gifting information to a friend or family member, the SEC and DOJ have garnered several post-Newman successes. The government's most salient victory occurred in the Ninth Circuit, with the decision in United States v. Salman (26) The tipper was an investment banker who shared confidential merger and acquisition (M&A) information with his brother, who traded securities on the basis of that information. (27) The brother also passed the tips on to the defendant, Bassam Salman (a close friend who later became a family in-law), who traded as well. (28) The Ninth Circuit affirmed the defendant's conviction based on Dirks's "gift" language (29) and held that "[p]roof that the insider disclosed material nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish the breach of fiduciary duty element of insider trading." (30) The First Circuit has likewise declined to follow Newman's heightened standard for personal benefit. (31)
Securities law scholars have mirrored the divergent views of the federal circuits. Scholars who have sided with Newman include Professors Stephen Bainbridge, Jonathan Macey, and Todd Henderson. They view Newman as "an important corrective to the government's drive to expand the limits of insider trading liability," (32) and they regard communications between corporate executives and securities analysts as "industry activity that the Supreme Court correctly understands to be normal, socially beneficial, and important to the integrity of capital markets, and that it explicitly seeks to protect." (33) Professor Adam Pritchard likewise references Dirks's policy objectives and observes that Justice Lewis Powell's majority opinion sought "to leave space for securities professionals to uncover nonpublic information, even if it came from corporate insiders." (34) He therefore concludes that "Newman's interpretation of personal benefit is consistent with, if not compelled by, Powell's purpose in Dirks." (35)
My own views coincide with those of scholars including Professors Michael Perino, (36) Jay Brown, (37) and James Cox, (38) who each regard Newman as a blatant misapplication of Dirks and a troubling impediment to effective insider trading enforcement. (39) For as long as Newman remains the controlling precedent in the "Mother Court" of securities law, unscrupulous tippers--whether corporate insiders or fiduciary outsiders--will be even more emboldened to leak confidential information, which would undermine investor confidence by fostering the perception that securities markets are "rigged" against honest traders. (40) Newman's consequences are particularly troubling because they resulted from catapulting the policy objectives that motivated Dirks above the Court's actual holding (as well as the complementary holding in O'Hagan). Although...
Beyond Dirks: gratuitous tipping and insider trading.
|Author:||Nagy, Donna M.|
|Position:||I. Introduction through IV. Legislative Developments A. The Insider Trading Sanctions Act of 1984 (ITSA - Author abstract|
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