Explaining Dirks
Published date | 01 July 2021 |
Date | 01 July 2021 |
FEATURED ARTICLE
EXPLAINING DIRKS
Andrew N. Vollmer*
ABSTRACT
The personal benefit element of the tipping violation established in Dirks v.
SEC has been misunderstood. Courts, the SEC, and criminal prosecutors have
broadly construed it to create liability for insiders who received remote, specula-
tive, immaterial, or intangible returns after disclosing confidential company in-
formation. Several situations, such as an insider’s gift of confidential information
to a relative or friend or an intention to benefit the recipient of the information,
do not require the insider to receive anything at all.
The drafting history of the majority opinion in Dirks in the papers of its author
Justice Lewis Powell reveals that the current wide interpretations of personal
benefit in tipping cases are not consistent with the test the Court intended. The
principal test of personal benefit was meant to be the insider’s receipt of cash or
something of value within a short time.
The special fact situations mentioned in Dirks, including a disclosure as a gift
or with an intention to benefit, were not independent and sufficient grounds for
finding that an insider received a personal benefit. Rather they were situations
that often could create an inference of personal benefit. The drafting history and
Justice Powell’s previous opinions show that Powell carefully used the word in-
ference in the final opinion. He wanted proof of a fact situation to allow but not
require a fact finder to conclude a tipper received a personal benefit. He did not
intend proof of a fact situation to create a presumption or ultimate liability.
Lessons from the drafting history show that the Supreme Court misapplied the
gift situation in Salman. They also show that the Second Circuit’s Martoma deci-
sion misinterpreted the intention to benefit language in the fact situations.
INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 524
I. THE FOUNDATIONS OF THE PROHIBITIONS ON INSIDER TRADING AND TIPPING 529
A. Chiarella v. United States . . . . . . . . . . . . . . . . . . . . . . . . . . . 529
B. Dirks v. SEC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 530
* Senior Affiliated Scholar, Mercatus Center at George Mason University. Former Professor of Law, General
Faculty, University of Virginia School of Law; former Deputy General Counsel of the Securities and Exchange
Commission; and former partner in the securities enforcement practice of Wilmer Cutler Pickering Hale and
Dorr LLP. I benefitted from comments from Joseph Grundfest, Andrew Hayashi, Brian Knight, Adam Pritchard,
Alexandra Shapiro, Walter Valdivia, and two anonymous peer reviewers. © 2021, Andrew N. Vollmer.
523
II. APPLICATIONS OF THE PERSONAL BENEFIT TEST . . . . . . . . . . . . . . . . . . 533
III. THE DRAFTING HISTORY OF DIRKS . . . . . . . . . . . . . . . . . . . . . . . . . . . 537
A. The Chazen Article . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 537
B. Early Chambers Drafts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 539
C. Justice O’Connor’s Suggestion . . . . . . . . . . . . . . . . . . . . . . . 543
D. Final Drafts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 544
IV. LESSONS FROM THE DRAFTING HISTORY . . . . . . . . . . . . . . . . . . . . . . . 545
A. Cash and Things of Value as Personal Benefit . . . . . . . . . . . . 546
B. Personal Benefit as an Inference from the Fact Situations . . . . 549
C. The Martoma Dispute About an Intention To Benefit . . . . . . . . 557
V. THE RELEVANCE OF DRAFTING HISTORY . . . . . . . . . . . . . . . . . . . . . . . 559
CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 562
INTRODUCTION
Dirks v. Securities and Exchange Commission
1
is a consequential Supreme
Court decision. It gave the Supreme Court’s stamp of approval to a fraud claim for
tipping as part of the insider trading prohibition in the federal securities laws.
2
The
decision also determined the elements for a tipping claim and catalyzed a new area
for law enforcement and legal practice. The Securities and Exchange Commision
(“SEC”) and criminal prosecutors bring a large number of tipping cases every
year.
3
Many of the most famous insider trading decisions involved tipping allega-
tions, such as Salman,
4
Martoma,
5
Newman,
6
and Chestman.
7
The government
charged Ivan Boesky,
8
Martha Stewart,
9
and Raj Rajaratnam
10
as tippees. As a
legal or practical matter, hedge funds, broker-dealers, and financial analysts must
have policies and procedures in writing to avoid the possibility that their receipt of
information will be viewed as a tip.
11
1. 463 U.S. 646 (1983).
2. The prohibition against fraud in the purchase or sale of a security in Rule 10b-5, 17 C.F.R. § 240.10b-5,
issued under authority of section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b), forbids insider
trading.
3. See SEC, DIVISION OF ENFORCEMENT ANNUAL REPORT 7, 15, 20–21, 24–25, 27 (2019), https://www.sec.
gov/files/enforcement-annual-report-2019.pdf.
4. Salman v. United States, 137 S. Ct. 420, 423 (2016).
5. United States v. Martoma, 894 F.3d 64, 67 (2d Cir. 2018).
6. United States v. Newman, 773 F.3d 438, 443 (2d Cir. 2014), abrogated in part by Salman v. United States,
137 S. Ct. 420 (2016).
7. United States v. Chestman, 947 F.2d 551, 564 (2d Cir. 1991) (en banc).
8. Government’s Memorandum with Regard to the Sentencing of Ivan F. Boesky at 2–3, United States v.
Boesky, 1989 WL 46628 (S.D.N.Y. 1989) (No. 86 Cr. 378 (MEL)), http://3197d6d14b5f19f2f440-5e13d29
c4c016cf96cbbfd197c579b45.r81.cf1.rackcdn.com/collection/papers/1980/1987_1214_BoeskySentencing
GovernmentT.pdf.
9. Press Release, SEC, SEC Charges Martha Stewart, Broker Peter Bacanovic with Illegal Insider Trading
(June 4, 2003), https://www.sec.gov/news/press/2003-69.htm.
10. SEC v. Rajaratnam, 918 F.3d 36, 39 (2d Cir. 2019).
11. 15 U.S.C. §§ 78o(g), 80b-4a (requiring broker-dealers and investment advisers to have written policies
and procedures to prevent insider trading); see also Andrew N. Vollmer, How Hedge Fund Advisers Can Reduce
524 AMERICAN CRIMINAL LAW REVIEW [Vol. 58:523
For all that, Dirks has been misunderstood. It meant to authorize a tipping claim
in a narrow, specific set of circumstances when the insider’s wrongdoing was not
in doubt, but law enforcement agencies, courts, and legal writers have construed it
broadly. They have skipped over a critical feature of the opinion and constantly
stretched liability for tipping.
The misunderstanding centers on the meaning of the personal benefit element of
a tipping violation. In a majority opinion written by Justice Lewis Powell, the
Dirks Court reasoned that, to be liable, an insider must have disclosed confidential
information to an outsider in breach of the insider’s fiduciary duty of trust and con-
fidence. How do investigators and courts evaluate whether an insider tipped in
breach of a duty? Dirks said: “[T]he test is whether the insider personally will ben-
efit, directly or indirectly, from his disclosure. Absent some personal gain, there
has been no breach of duty to stockholders.”
12
This is the personal benefit element
or test.
A paragraph in Dirks explained the personal benefit test. An insider needs to
receive “cash, reciprocal information, or other things of value.”
13
The opinion then
listed certain fact patterns that often create an inference that the insider expected to
receive a personal benefit: the insider’s gift of information to a trading relative or
friend or a relationship between the tipper and the tippee suggesting a quid pro quo
or the insider’s intention to benefit the tippee (the “fact situations”).
14
Since the
opinion was issued, it and the personal benefit element have been the subject of
considerable commentary.
15
As the SEC, criminal prosecutors, and courts applied the personal benefit ele-
ment in enforcement cases after Dirks, the test expanded and became easier to
meet. Dirks referred to the insider’s gain and receipt of cash or things of value, but,
over time, less tangible and more remote, speculative, and immaterial returns to
the insider satisfied the test.
16
Maintaining a good relationship with a friend and
Insider Trading Risk, 3 J. SEC. L., REG. & COMPLIANCE 106 (2010) (describing internal policies and procedures
to avoid tipping issues).
12. Dirks v. SEC, 463 U.S. 646, 662 (1983).
13. See infra note 149.
14. Dirks, 463 U.S. at 663–64.
15. JOHN P. ANDERSON, INSIDER TRADING: LAW, ETHICS, AND REFORM 71–75 (2018); STEPHEN M.
BAINBRIDGE, INSIDER TRADING LAW AND POLICY 59–64 (2014); 4 THOMAS LEE HAZEN, TREATISE ON THE LAW
OF SECURITIES REGULATION § 12:167 (7th ed. 2020); DONALD C. LANGEVOORT, INSIDER TRADING: REGULATION,
ENFORCEMENT & PREVENTION § 4 (2015); LOUIS LOSS, JOEL SELIGMAN & TROY PAREDES, FUNDAMENTALS OF
SECURITIES REGULATION (7th ed. 2018); Karen E. Woody, The New Insider Trading, 52 ARIZ. ST. L.J. 594
(2020); Michael D. Guttentag, Selective Disclosure and Insider Trading, 69 FLA. L. REV. 519 (2017); Jonathan
R. Macey, Beyond the Personal Benefit Test: The Economics of Tipping by Insiders, 2 U. PA. J.L. & PUB. AFFS.
25 (2017); Ronald J. Colombo, Tipping the Scales Against Insider Trading: Adopting a Presumption of Personal
Benefit To Clarify Dirks, 45 HOFSTRA L. REV. 117 (2016); Donna Nagy, Beyond Dirks: Gratuitous Tipping and
Insider Trading, 42 J. CORP. L. 1 (2016); A.C. Pritchard, Dirks and the Genesis of Personal Benefit, 68 SMU L.
REV. 857 (2015); Sarah S. Gold & Richard L. Spinogatti, Consequences of Justice Powell’s Slippery Slope in
“Dirks,” 254 N.Y. L.J. 3 (2015).
16. See discussion infra Part II; Pritchard, supra note 15, at 869–70 (SEC “persuaded lower courts to adopt
broad interpretations of Dirks’ personal benefit requirement”).
2021] EXPLAINING DIRKS 525
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