'Look then to be well edified, when the fool delivers the madman': insider-trading regulation after Salman v. United States.

• Author: Walsh, James

"Today, the U.S. Supreme Court unanimously and 'easily' rejected the Second Circuit's novel reinterpretation of insider trading law in U.S. v. Newman. In its swiftly decided opinion, the Court stood up for common sense and affirmed what we have been arguing from the outset--that the law absolutely prohibits insiders from advantaging their friends and relatives at the expense of the trading public. Today's decision is a victory for fair markets and those who believe that the system should not be rigged. "

--Preet Bharara, U.S. Attorney for the Southern District of New York December 6. 2016 (2)

CONTENTS INTRODUCTION I. OVERVIEW OF THE "PERSONAL BENEFIT" REQUIREMENT II. MIRROR OPPOSITES: UNITED STATES V. NEWMAN & SALMAN V. UNITED STATES III. INSIDER-TRADING ENFORCEMENT AFTER SALMAN CONCLUSION INTRODUCTION

Perhaps the above quote tells the reader everything she needs to know about the case in question. After all, Justice Alito pointed to the writing on the wall when he declared that "this case involves 'precisely the gift of confidential information to a trading relative' that Dirks (3) envisioned." (4) Hence, what can we take away from an opinion that, in both result and diction, is unequivocally clear? As legal scholars, we know that judicial restraint leaves open enough questions to keep the well of Note and Comment topics from running dry. In that spirit, the following pages explore the interstices in Justice Alito's opinion, specifically the plausible ambiguities the Court mentions but, in the name of judicial restraint, purposefully declines to address. (5)

Along these lines, circuit splits often result in countless speculative works of legal scholarship." But in Salman v. United States, (7) the Supreme Court laid to rest the question of whether the government can convict a tippee who trades on inside information if the sole benefit to the tipper is their relationship with a "trading relative or friend." (8) Absent a tangible benefit to the tipper, this "gift-theory" of liability (9) permits the government to convict a trading tippee exclusively because of their relationship with the tipper. (10) Salman, therefore, refined the understanding of a "personal benefit" in insider-trading law. (11)

The Supreme Court granted certiorari on Salman's appeal from the Ninth Circuit because of a contemporaneous and diverging opinion by the Second Circuit, (12) which resulted in the aforementioned circuit split. (13) In United States v. Newman, (14) the Second Circuit overturned the tippees' convictions on the grounds that the tippers, who were corporate insiders that indirectly passed inside information to the tippees via the tippees' analysts, (15) did not receive a "personal benefit" from their tips. (16) This prompted the Supreme Court to grant certiorari in Salman, which culminated in a resounding win for the government. (17) Since "circuit splits [are purported to] ... provide a reliable and objective measure of judicial performance," (18) we are poised to review Justice Alito's opinion in Salman, which the Court joined unanimously, (19) and evaluate how it impacts the future of insider-trading jurisprudence, specifically in the realm of "personal benefit."

1. OVERVIEW OF THE "PERSONAL BENEFIT" REQUIREMENT

   Under [section] 10(b) of the Securities Exchange Act of 1934 (20) and Rule 10b-5, (21) which the Securities and Exchange Commission promulgated pursuant to its powers under [section] 10(b), a person is guilty of insider trading if the Government can prove: "(i) the existence of a relationship affording access to information intended to be available only for a corporate purpose, and (ii) unfairness of allowing a corporate insider to take advantage of that information by trading without [public] disclosure." (22) Wang and Steinberg describe the combination of [section] 10(b) and Rule 10b-5 as "one of the most potent weapons" in the federal arsenal for policing insider trading. (23) Defense counsel in Salman, however, correctly argued that "no statute defines the elements of [insider trading]." (24) The crime is a species of what some commentators call "federal common law." (25) Thus, for "personal benefit" purposes, our inquiry focuses on the second prong of this two-prong test, which the SEC announced in the seminal case In re Cady, Roberts & Co., (26) and the Supreme Court subsequently adopted in Chiarella (27)

   In Cady, Roberts, the SEC opined that "information intended to be available only for a corporate purpose" must also "not [be] for the personal benefit of anyone," (28) This applies to the tipper, the tippee, and even the elusive second- and third-level (and beyond) "remote tippees." (29) We will come to appreciate, however, that the chief concern for tippees is whether the tipper receives a personal benefit from their tip. (30) Nonetheless, "personal benefits" come in both obvious and not-so-obvious forms, (31) some of which we will survey to grasp the possible implications of the "personal benefit" test after Salman. (32)

   Following Cady, Roberts, courts have continued to distill the term "personal benefit," perhaps most notably in the landmark case Dirks v. SEC. (33) In Dirks, the Supreme Court held that "the initial inquiry is whether there has been a breach of duty by the insider," which "requires courts to focus on objective criteria, i.e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as pecuniary gain or a reputational benefit that will translate into future earnings." (34) Because Dirks was essentially a whistleblower to a massive fraud, however, the Court had difficulty applying this framework to him. (35) He was not a company insider and, in fact, some argue that his disclosure played a vital role in uncovering one of the most egregious accounting frauds in American history. (36) Thus, it was not immediately clear what the tipper's benefit was in revealing this information to Dirks. Yet, the Government still attempted to satisfy this requirement to justify an insider-trading conviction against him. Justice Powell clarified, however, "that there is no general duty to disclose before trading on material nonpublic information." (37) Further, Justice Powell explained that "not 'all breaches of fiduciary duty in connection with a securities transaction' ... come within the ambit of Rule 10b-5." (38) The requisite concern is whether the breach of fiduciary duty is the result of deliberate "manipulation or deception." (39)

   Still, the Government persisted in its argument that Dirks "breached a duty which he had assumed as a result of knowingly receiving confidential information from [Equity Funding] insiders," (40) and that "tippees such as Dirks who receive non-public, material information from insiders become 'subject to the same duties as [the] insiders.'" (41) But this argument did not sway the Dirks Court; it summarily rejected this reasoning and held that "the test is whether the insider personally will benefit, directly or indirectly, from his disclosure." (42) Because the insiders did not personally benefit from Dirks's disclosure, there was no breach of duty to the shareholders, and because the insiders did not breach their duty, "there [was] no derivative breach" by Dirks. (43)

   The Dirks Court based its decision on the fact that "the tippers received no monetary or personal benefit for revealing Equity Funding's secrets, nor was their purpose to make a gift of valuable information to Dirks." (44) Hence, the Court overturned Dirks's conviction because "the tippers were motivated by a desire to expose the fraud," (45) not to receive a personal or reputational benefit, or to make a gift to Dirks. Consequently, the Supreme Court's analysis in Salman centers on the Second and Ninth Circuits' uneven application of the principles enunciated in Dirks. (46)

2. MIRROR OPPOSITES: UNITED STATES V. NEWMAN & SALMAN V. UNITED STATES

   Because Salman and Newman both involved "tippee" liability, the key issue in both cases was that the tippers did not receive any tangible benefit for their tips. In both instances, the insiders tipped off family members or professional friends who then tipped off others. Eventually, "remote tippees" down the line traded on the material nonpublic information. (47) The "misappropriation doctrine" of insider trading, which is "when a [non-insider] trades on or tips material nonpublic information in breach of a duty to the information source," (48) encompasses situations like Salman and Newman.

   The "misappropriation theory" (49) is distinct from the "classical theory" of insider trading in which "a corporate insider ... trades 'in the corporation's securities on the basis of material, nonpublic information about the corporation,' for his or her own benefit." (50) In the "misappropriation doctrine," as Justice Alito explained, "the tippee acquires the tipper's duty to disclose or abstain from trading if the tippee knows the information was disclosed in breach of the tipper's duty." (51) Further, "the tippee may commit securities fraud by trading in disregard of that knowledge." (52) This is so because, as the Second Circuit noted, "the Supreme Court explicitly rejected the notion of 'a general duty between all participants in market transactions to forgo actions based on material, nonpublic information.'" (53) Thus, to be guilty of insider trading, the tippee must know that the insider breached a duty by giving the tip. Irrespective of the form of insider trading, the elements are the same for both the classical theory and the misappropriation doctrine. (54)

   In Newman, two defendants traded in Dell and NVIDIA stock after they heard news of the companies' "earnings numbers before they were publicly released." (55) This generated large windfalls for their respective hedge funds. (50) In the Dell trade, the insider shared inside information with a former Dell coworker who by that time was working on Wall Street. (57) The...