Insider-trading is undoubtedly one of the murkiest areas of white-collar law, frustrating prosecutors, investors, and jurists alike. Specifically, the standard of what satisfies the “personal benefit” element of tipper-tippee insider-trading liability has been the source of much debate. The theory of tipper-tippee insider trading liability holds that a tipper can be guilty of insider trading if he or she discloses material, non-public information to a person (“tippee”) who trades based upon that information. The tipper must have disclosed the information for a “personal benefit” rather than for a legitimate purpose. The tippee can also be guilty of insider trading if he or she is aware of the improper motive for the information disclosure. However, the legal standard for what constitutes an impermissible “personal benefit” is not clearly established. Recently, the Second Circuit’s 2014 decision in United States v. Newman ended the Southern District of New York’s streak of more than eighty insider-trading convictions when it held that the prosecutors had not presented sufficient evidence that the original tippers of inside information received a consequential personal benefit from the disclosures. In January 2016, the Supreme Court agreed to hear the case of United States v. Salman in its upcoming fall term to decide the question of what evidence satisfies the requirement that a tipper receive a personal benefit from his or her disclosures in order to be guilty of insider trading.
The Supreme Court has the opportunity in Salman to clarify insider-trading jurisprudence and potentially endorse one of the three competing theories of the personal benefit standard that are currently supported by circuit precedent. Evidence that the tipper disclosed material non-public information for a pecuniary gain or to benefit a “quid pro quo” relationship is clearly sufficient to demonstrate that the tipper’s disclosure was motivated by personal gain. The controversy is over how the Government can establish that the tipper received a “personal benefit” from the disclosure in the absence of evidence of either a pecuniary gain or quid pro quo exchange. The three theories are: (A) the information disclosure must potentially lead to a pecuniary benefit for the tipper; (B) a personal benefit is presumed unless rebutted by evidence of a legitimate reason for the disclosure; or (C) evidence that the tipper intended to give a “gift” to or benefit the tippee is sufficient. In my paper, Resuscitating Dirks, I argue that a Supreme Court endorsement of the “gift theory” of the personal benefit standard would positively improve insider-trading jurisprudence and enforcement.
First, the “gift theory” of tipper-tippee insider trading liability reins in recent insider-trading jurisprudence that had strayed from both recent Supreme Court precedent and the original intent of Congress. Insider trading liability, as a violation of Rule 10b-5, requires conscious wrongdoing. Application of the “gift theory” standard will ensure that prosecutors only pursue cases where the tippee consciously trades on information that he or she knows was improperly disclosed. The Government will no longer be able to rely upon presumptions that the defendants should have known of improper motives for the disclosure of the information based solely on the defendants’ sophistication or the nature of the information. Given the enormous consequences that an insider-trading conviction can bring, a defendant’s mens rea should not be presumed.
Second, the “gift theory” will likely not threaten the overall efficacy of insider trading enforcement. Unlike the theory of personal benefit that requires potential pecuniary gain by the tipper, tippers under the “gift theory” will not be immune from prosecution for giving information to friends or family. If the relationship between the tipper and tippee indicates that the information was intended to be a gift, then the personal benefit standard will be satisfied. The “gift theory” will improve prosecutorial discretion by incentivizing prosecution of initial tippers and tippees rather than remote recipients of information. Prosecutions focused on the beginning of a tipping chain will have a greater deterrent effect on improper disclosures.
Third, this enhanced discretion will lead to enforcement that more effectively deters illegal disclosures but avoids chilling the free flow of information that is essential to efficient capital markets. Market analysts investigating and researching companies had been the target of frequent successful insider-trading prosecutions in recent years, in part due to the liberal personal benefit standard applied by many jurists pre-Newman. The SEC has admitted that bringing insider-trading prosecutions against persons for disclosures without requiring evidence of personal benefit would hurt market efficiency and capital formation. Ideally, the “gift theory” standard will maintain a free flow of information among securities analysts by focusing prosecutors’ attentions on initial tippers and tippees. A Supreme Court endorsement of the “gift theory” would give securities analysts a sense of security in pursuing their market research by focusing prosecutors’ attentions on illegal gifts of information that breach fiduciary duties, rather than on the exchanges between networks of researchers that improve market efficiency.
Katherine Drummonds is a recent graduate of the Georgetown University Law Center.