US Supreme Court Clarifies Tippee Liability in Insider Trading

The law on insider trading has received considerable
attention in the United States (US) in recent years. At the same time, the law
in the US is quite narrow compared to most other jurisdictions because liability
for insider trading arises only if the person trading owes a fiduciary duty to
the company and its shareholders, which has subsequently been extended to a
duty owed to the source of the information. This becomes especially important
in the case of persons who receive information, known as “tippees”, who then
trade while in possession of that information. A tippee who receives such
information with the knowledge that its disclosure breached the tipper’s duty
acquires that duty and may be liable for securities fraud for any undisclosed
trading on that information.
Tippee liability was enunciated by the US Supreme Court in 1983
in Dirks v. SEC, 463 US 646, wherein
the Court held that “
there
may be a relationship between the insider and the recipient that suggests a quid
pro quo
from the latter, or an intention to benefit the particular
recipient. The 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. The tip and trade resemble trading by the
insider himself followed by a gift of the profits to the recipient.”
In
the present case, Salman was indicted for trading on inside information he
received from a friend and relative-by-marriage, Michael Kara, who in turn
received information from his brother Maher Kara, who was a former investment
banker with Citigroup. Salman was convicted, and the Ninth Circuit held that Dirks allowed the jury to infer that the
tipper breached a duty because he made “a gift of confidential information to a
trading relative.” On the other hand, the Second Circuit held in United States v. Newman, 773 F. 3d 438,
that a mere gift of confidential information to friend or relative is
insufficient and that there must be “proof of a meaningfully close personal
relationship” between the tipper and the tippee “that generates an exchange
that is objective, consequential, and represents at least a potential gain of a
pecuniary or similarly valuable nature”. It was these different approaches
adopted by the Second and Ninth Circuits that the Supreme Court was called upon
to resolve.
In
a unanimous judgment delivered yesterday by Justice Alito in Salman v.
United States
, the US Supreme Court affirmed the Ninth Circuit’s
decision that was on appeal before it, and rejected the position adopted by the
Second Circuit in Newman. In doing
so, it simply adhered very closely to its earlier decision in Dirks, “which easily resolves the narrow
issue presented here”. The decision noted: “Dirks
makes clear that a tipper breaches a fiduciary duty by making a gift of
confidential information to “a trading relative,” and that rule is sufficient
to resolve the case at hand”. Accordingly, when a tipper provides information
to a relative or friend, there is a consequential inference that the tipper
meant to provide the equivalent of a cash gift. To the extent that the Second
Circuit in Newman required something
of a “pecuniary or similarly valuable nature” in exchange, the Supreme Court
disagreed with that requirement.
In
sum, this decision keeps alive a comparatively expanded scope of liability for
trading by tippees. The Newman
decision had caused some controversy by arguably limiting the scope of
liability, but the situation appears to have been corrected by the Supreme
Court by staying true to the spirit of its earlier decision in Dirks. To that extent, it emboldens
prosecutorial efforts in insider trading cases.
At
the same time, it may be noted that the jurisprudence developed in the US,
while quite often cited by the Indian regulator and appellate authorities, must
be adopted with caution because the regulatory approach towards insider trading
in the US (based on fiduciary duties) is vastly different from the rule-based
approach in India (based on parity of information).

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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