Poetic Expansions of Insider Trading Liability.

• Author: Anderson, John P.

1. INTRODUCTION II. POETIC EXPANSIONS III. SOME CRITICISM IV. CONCLUSION I. INTRODUCTION

   The Second Circuit's 2014 decision in United States v. Newman represented a significant setback to the Securities and Exchange Commission's (SEC) slow push through rulemaking and enforcement actions toward an equal access insider trading enforcement regime in the United States. (1)

   The Newman court held that a factfinder is not permitted to infer a tipper personally benefitted by gifting confidential information to a trading relative or friend absent "proof of a meaningfully close personal relationship" between the tipper and tippee "that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature." (2) This test is far more difficult to satisfy than the government's preferred test, which would permit the inference of a personal benefit from any gift of confidential information from an insider for a non-corporate purpose. (3) When combined with the Newman Court's added insistence that the government also prove a tippee's knowledge that this personal benefit test was satisfied, the Second Circuit's decision made it exponentially more difficult for the SEC and prosecutors to establish remote tippee liability. And in light of the Supreme Court's recent holding in Salman v. United States, much--though certainly not all--of Newman's rigor appears to remain intact. (4)

   The Salman Court unanimously reaffirmed the personal benefit test for tipper-tippee insider trading liability and did not overturn the Newman court's requirement that the government prove the tippee's knowledge of the tipper's personal benefit. (5) Moreover, the Court was very careful to limit its decision to the facts of Salman, where the tipper was the brother of, and had a "very close relationship" with, the tippee. (6) The Court noted that these facts were within the "heartland" of the Dirks v. SEC (7) rule concerning gifts of material nonpublic information to relatives and friends, (8) and it left open the question of whether proof of a tangible benefit may be required where a gratuitous tip is made to a remote relative or to a mere acquaintance (as was the case in Newman) (9) The Salman Court did, however, limit Newman by making it clear that receipt of money, property, or something of a "pecuniary or similarly valuable nature" is not necessary for satisfying the Dirks personal benefit test for tipper-tippee liability in all cases. (10)

   The post-Salman status of Newman was very recently called into question by a split panel of the Second Circuit in United States v. Martoma. (11) Nevertheless, while circuits may continue to differ in their interpretations of the scope and extent of the personal benefit test, Salman's unanimous reaffirmation of Dirks suggests that the test itself will remain undisturbed for some time to come. With this in mind, many scholars have joined the SEC and prosecutors in expressing concern that any meaningful personal benefit test opens "a disturbing loophole" for insider trading resulting from gratuitous tipping, (12) and some have looked to identify novel theories of liability to capture such conduct from within the existing regulatory framework.

   For example, Professors Michael Guttentag and Donna Nagy have each offered arguments suggesting that the entire tipper-tippee framework first laid out by the Supreme Court in Dirks, including the personal benefit test, has been rendered obsolete by subsequent common law and regulatory developments that have fundamentally transformed the U.S. insider trading enforcement regime. (13) These developments include: (1) the Supreme Court's endorsement of the misappropriation theory in United States v. O'Hagan, (14) (2) recent state court decisions offering more expansive accounts of what conduct constitutes a breach of fiduciary duty of loyalty in the corporate context, and (3) the SEC's adoption of Regulation Fair Disclosure (Regulation FD) in 2000. (15)

   Both Guttentag's and Nagy's arguments are erudite and quite creative. Such creativity is a virtue in law professors, but not in prosecutors. Exercising poetic license to expand criminal liability risks violating the time-honored principle of legality and leaving citizens without adequate notice of the crimes for which they may be charged. (16) Insider trading law in the United States is already plagued by vagueness, (17) and concern over prosecutors' continued exploitation of this ambiguity to push the line of liability further and further out is part of what motivated the Second Circuit to push back in Newman. (18) I share the Newman court's concern. (19)

   In what follows, I summarize what I take to be the most crucial aspects of Guttentag's and Nagy's arguments. I then offer some criticism. Specifically, I explain why I regard these interpretations as poetic expansions (rather than straightforward readings) of the law, a conclusion that was only strengthened by the Supreme Court's recent decision in Salman.

2. POETIC EXPANSIONS

   First, both Guttentag and Nagy point out that when the Supreme Court endorsed the misappropriation theory in O'Hagan, it expanded the set of persons the deception of whom could trigger insider trading liability from including just counterparties to also including sources of material nonpublic information. (20) In doing so, the Court also opened the door to new types of deception that might trigger Section 10(b) insider trading liability. As Guttentag explains, the "types of deceptive conduct that a misappropriator might engage in when taking information from the source are far more numerous than the silence that constitutes the only type of deception that can take place on an impersonal securities market." (21) For example, a...