The complex crime of insider trading — and the government’s ability to prosecute those who would profit from confidential information — has relatively simple statutory roots: the Securities Exchange Act of 1934’s section 10(b), which bans the “use . . . in connection with the purchase or sale of any security . . . [of] any manipulative or deceptive device.”1 From these humble origins has sprung an intricate doctrine that must protect everyday shareholders while still encouraging the collection and dissemination of market information by analysts and others. This elaboration of section 10(b) has occurred in the face of congressional silence; thus the doctrine has been shaped by agency rulemaking2 and enforcement,3 as well as by judicial interpretation. The Supreme Court has played a particularly prominent role in defining the crime of insider trading.4 Last Term, in Salman v. United States,5 the Supreme Court reaffirmed its longstanding “personal benefit” test for “tippee” liability — tippees being traders acting on disclosures of material nonpublic information made by insiders.6 Though the decision was unsurprising given its alignment with clear precedent,7 the narrow resolution of the case represents a missed opportunity to clarify a murky doctrine.
Bassam Salman’s case began with his brother-in-law, Maher Kara, who worked at Citigroup as an investment banker focused on the healthcare industry.8 As a result of his position at the bank, Maher had access to confidential information regarding mergers and acquisitions in the industry and disclosed much of this information to his brother Michael, who was a friend of Salman.9 Though the information sharing was initially relatively innocuous — Maher sought guidance on the basis of Michael’s chemistry expertise, and the two discussed firms researching cancer treatments after their father came down with the disease — Michael eventually began trading on the information disclosed by his brother.10 Though Maher was at first oblivious to his brother’s transactions, he soon learned of the trading and “began to assist” his brother through intentional disclosures of confidential information.11 What Maher did not know was that his brother had been passing along the information to other friends, including Salman.12 Trading on this information himself, Salman made over $1.5 million in profit before investigators uncovered the scheme.13
Salman was indicted and charged in the Northern District of California with four counts of securities fraud and one count of conspiracy to commit securities fraud.14 A jury convicted Salman on all counts, and he was sentenced to thirty-six months in prison and ordered to pay over seven hundred thousand dollars in restitution.15 After unsuccessfully moving for a new trial, Salman appealed.16
While his appeal was pending, the Second Circuit decided United States v. Newman.17 That decision narrowed the scope of liability for tippees in insider trading cases — liability that the Supreme Court had established over three decades earlier in Dirks v. SEC.18 Whereas under Dirks, the government had needed to prove only that the tipper “personally benefit[ted]” from disclosing nonpublic information,19 the Second Circuit held in Newman that insider trading liability required more.20 Specifically, the government needed to show “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.”21 Salman argued that the Ninth Circuit should follow Newman, which on his reading required more than merely evidence of a family connection.22 According to Salman, the government had needed — and had failed — to produce evidence showing the type of monetary gain, potential or otherwise, contemplated by Newman.23
The Ninth Circuit, however, rejected Newman and affirmed Salman’s conviction.24 Writing for the panel, Judge Rakoff25 began by finding that Salman had not waived his sufficiency-of-the-evidence argument.26 Turning, then, to the merits of the sufficiency claim, Judge Rakoff noted that the personal benefit requirement in Dirks is met not only when the tipper receives monetary gain, but also “where an ‘insider makes a gift of confidential information to a trading relative or friend.’”27 To the court, this “holding of Dirks govern[ed]” Salman.28 Maher had testified that he intended to “benefit” Michael by disclosing the confidential information, making his actions “precisely” the type of conduct Dirks intended to proscribe.29 And Salman knew that Maher was the original source of the information and could infer that Maher’s disclosures were meant to benefit Michael, as he and Maher were quite close.30 Accordingly, it was clear the jury had sufficient evidence to convict Salman.31
Judge Rakoff then addressed Newman directly. Given the “clear holding of Dirks” that a range of personal benefits satisfied its test, Judge Rakoff found Newman to be an impermissible departure from precedent.32 And if Newman were to govern, insider trading could go unpunished so long as the tipper did not ask for any material benefit in exchange for the tip.33 Rejecting such an outcome, Judge Rakoff reasserted the Dirks standard.34
After Salman appealed,35 the Supreme Court affirmed.36 Writing for a unanimous Court,37 Justice Alito found that the Ninth Circuit had correctly applied the Dirks test.38 Salman had raised three challenges to the Ninth Circuit’s personal benefit formulation: First, he argued that the Dirks personal benefit test requires evidence that the tipper sought “to obtain money, property, or something of tangible value.”39 Second, he raised a more general concern that if the personal benefit test is satisfied by a broadly defined “gift,” the crime of insider trading becomes unconstitutionally vague.40 Finally, Salman contended that the constitutional implications of gift-based prosecutions are “especially troubling . . . for remote tippees” who are less likely to know the relationship between the original tipper and tippee and therefore less likely to know the reason for the original disclosure.41
Nonetheless, Justice Alito found that Dirks “easily resolve[d]” the case.42 Justice Alito pointed to the Dirks Court’s framing of the personal benefit test, noting that while the Court emphasized the role of objective facts in determining the existence of a personal benefit, it also specified that a tipper breaches a fiduciary duty by making a gift to a friend or relative.43 To Justice Alito, the Dirks holding encapsulated precisely the conduct before the Court, and thus Dirks’s “rule [was] sufficient to resolve the case at hand.”44 The Court pointed out the incongruity that would arise if Salman’s rule were to be upheld: while the law clearly prohibits an insider from trading on nonpublic information and then passing along the profits to a relative, an insider could avoid such liability by passing the information along to the relative and letting him conduct the trades.45 For insider trading enforcement to function, then, Dirks must be read to include the latter scenario and, accordingly, the conduct at issue in Salman.46 Justice Alito also briefly addressed the circuit split: the Court “agree[d] with the Ninth Circuit” that any reading of Newman that required proof of a monetary benefit must be “inconsistent with Dirks.”47
Finally, Justice Alito rejected Salman’s vagueness argument, finding that Salman had failed to show “that either § 10(b) itself or the Dirks gift-giving standard ‘leav[es] grave uncertainty about how to estimate the risk posed by a crime.’”48 Though he acknowledged that “even clear rules ‘produce close cases,’”49 Justice Alito held that Dirks’s “simple and clear” test for tippee liability fell short of unconstitutional vagueness in Salman’s case.50 Indeed, Salman’s case was “in the heartland” of the conduct contemplated by Dirks: the Court did not need to tackle the “difficult” cases in deciding Salman’s.51 The Court thus affirmed the Ninth Circuit’s judgment.52
The Court’s holding was unsurprising, as Salman’s trades do seem to fall squarely within Dirks’s “heartland”;53 the narrowness of the Court’s unanimous opinion, however, means the case must be viewed as a missed opportunity. Insider trading doctrine has developed inconsistently: from its limited statutory roots, the doctrine has evolved through SEC enforcement and Supreme Court intervention. The result — especially in the tipper-tippee context — is a liability standard that fits awkwardly within traditional conceptions of fiduciary duty and leaves sufficient ambiguity to frustrate the SEC and market participants alike. In Salman, the Court had a variety of paths through which it might have helped to resolve at least some of this uncertainty. Yet the Court took none of these paths, affirming the status quo and leaving the doctrine to muddle on.
The complex modern doctrine of insider trading can be traced to In re Cady, Roberts & Co.,54 an SEC enforcement action against a brokerage partner who had disclosed nonpublic information to other members of his firm. The SEC’s ruling in that case established a wide-ranging crime, the elements of which were “conspicuously absent” from both the statute and Rule 10b-5.55 The SEC’s vision was based on what is known as the “parity of information” theory of insider trading, by which anyone in possession of material nonpublic information must disclose that information to the public or refrain from trading.56
The Supreme Court’s centrality in shaping the doctrine began shortly thereafter in Chiarella v. United States,57 when it rejected this parity approach in favor of one focused on the breach of a duty.58 The Court’s mission since has been to define the exact contours of the duty breached when insider trading occurs. In Chiarella, the Court took its first crack at defining the doctrine by announcing what has come to be known as the “classical” theory59: the relevant breach was one of fiduciary duty, wherein the insider had failed to disclose material information and thus had breached a duty of “trust and confidence” owed to the shareholders on the other side of a trade.60 Dirks, decided three years later, further narrowed the category of defendants subject to the relevant fiduciary duty. In Dirks, the defendant had received a tip from a whistleblower exposing a large-scale fraud, prompting him to inform both the media and other investors of the tip.61 After the tipped-off investors sold their shares of the fraudulent company and the share price collapsed, an SEC investigation of Dirks led to a guilty verdict.62 The D.C. Circuit affirmed that Dirks had breached his duty to disclose by not revealing the fraud to the public or refraining from trading.63 The Supreme Court, however, disagreed: insiders could breach their fiduciary duties only if they received personal benefits from their disclosure.64 A disclosure of material nonpublic information without receipt of such a benefit did not trigger the requisite breach of fiduciary duty.65
The classical theory as expounded in Chiarella and applied to the tippee context in Dirks stood alone for nearly fifteen years, until the Supreme Court endorsed a companion vision of the relevant fiduciary duty — known as the “misappropriation” theory — in United States v. O’Hagan.66 There, the Court held insider trading liability accrued where the defendant had “misappropriate[d] confidential information for securities trading purposes, in breach of a duty owed to the source of the information.”67 Thus the breach of this duty, too — not just that owed to shareholders by insiders — could serve as the basis for insider trading liability.68
The Court’s trilogy of insider trading cases has left a muddled doctrine in its wake, with Dirks fitting particularly awkwardly into the fiduciary framework. Even accepting the fiduciary duty–based liability standard for tippees — itself a stretch — the personal benefit test is both poorly defined and a non sequitur within the doctrine.69 The misappropriation theory of O’Hagan, meanwhile, would seem to obviate the need for such an awkward accommodation; the competing theories and their uncertain applications, moreover, leave a great deal of uncertainty over how and when liability attaches for market participants and regulators.
The cause of this doctrinal confusion could well be timing: the misappropriation theory was developed only in the aftermath of Dirks, where the Court — and Justice Powell, the author of the Dirks majority opinion — were bound to the strict confines of Chiarella’s conception of insider trading as fundamentally a breach of the fiduciary duty of “trust and confidence” owed to shareholders.70 The Dirks Court, as Professor Donald Langevoort notes, had to “fiduciarize” tippees in some way, as a tippee owed no obvious fiduciary duty to other shareholders.71 And from that exercise emerged the personal benefit test, a means to establish that “the actions of tipper and tippee are knit together closely enough to charge the tippee with breach of the tipper’s fiduciary duty.”72 Under Dirks, the fiduciary duty does not originate with the tippee, but instead is imparted on the tippee by a tipper who benefits from the sharing of nonpublic information. Yet there is no sound reason to assume that the accretion of a personal benefit to the tipper must impose a duty on the tippee, much less the relevant fiduciary duty necessary for insider trading liability to attach.73 The personal benefit test was a creative form of line drawing, meant to separate whistleblowers from fraudsters. Indeed, Dirks may actually be illustrative of the mantra that “hard cases make bad law”: the Court’s effort to carve a liability exception for corporate-fraud whistleblowers out of its fiduciary duty–based insider trading offense was a difficult piece of judicial improvisation.74 And that maneuver has resulted in the muddled personal benefit test, an unclear standard that understandably culminated in the divergent applications seen in Newman and Salman.
Practitioners, too, have found the personal benefit test unworkable. Enforcement agencies, on one side, “have chafed” under the “unnecessarily restrictive” Dirks standard.75 The SEC’s frustration with Dirks contributed to its development of the misappropriation theory eventually adopted by the Court in O’Hagan, which provided a means of evading the evidentiary challenges of Dirks.76 And on the other side, the government’s enforcement of the test has given rise to concerns that it is criminalizing conduct not contemplated by the statute77 and gradually pushing the definition of a personal benefit beyond recognition.78 Moreover, the increasingly common prosecution of remote tippees, as in Newman, raises concerns regarding notice and the requisite scienter for traders far downstream from the original insider.79
With these concerns in the background, the Court had reason to clarify insider trading doctrine in Salman. And several options were available to provide greater clarity than did the Court’s narrow opinion. Some have argued, for example, that Newman and Salman were “easily reconcilable”: the familial and close-knit nature of Salman meant its tipper-tippee connection was fundamentally different from the professional and relatively convoluted informational chains prosecuted in Newman.80 Accordingly, the Court might have approved Newman while still finding the Salman relationship sufficiently close to accrue liability under Dirks. Preserving Newman could have provided needed security for investment analysts and others who facilitate the flow of market information, as under that approach, a tip from a mere acquaintance, without the required pecuniary gain on the part of the tipper and awareness on the part of the tippee, could not lead to prosecution.81
Outside of endorsing Newman, a more transformative path was available to the Court. Rather than continuing to wedge tippee liability into the awkward fiduciary construct of Chiarella and Dirks, the Court had the chance to acknowledge the impact of O’Hagan and the misappropriation theory on insider trading doctrine. Specifically, the Court could have recognized that the line drawing meant to be accomplished by the Dirks test has been largely obviated by the misappropriation theory’s application to those who have breached a duty beyond merely that owed to shareholders.82 The relevant duty no longer needs to be passed from tipper to tippee. Instead, liability could turn on the tippee’s own set of duties contemplated in O’Hagan. An embrace of the misappropriation theory in the tippee context — and the concurrent diminution of the personal benefit test — would provide doctrinal clarity, give the SEC an achievable prosecutorial target, and protect those tippees so removed from the tipper as to prevent a finding of fraud under the misappropriation theory.
Lastly, even an opinion that held exactly what the Court’s did, but also provided an updated justification for the personal benefit test, would have solved some of these problems. Neither our knowledge of the role of analysts in market efficiency nor the Court’s own understanding of insider trading has been static in the decades since Dirks. A reaffirmation of Dirks could have meaningfully fleshed out the instances in which the judiciary believes the passing of information furthers a “legitimate corporate purpose” and thus should escape liability.83 Such an elaboration of the type of conduct the personal benefit test shields would have at least provided clarity to the SEC and market analysts, even if it would not have resolved the doctrine’s theoretical incongruities.
By reaffirming Dirks and repudiating the Second Circuit’s attempt to raise the prosecutorial bar for proving tippee liability, the Court ignored these problems in both insider trading theory and practice. Justice Alito’s opinion accomplished this task in a hyperefficient manner, pointing, like Judge Rakoff’s opinion below, only to the language in Dirks prohibiting disclosure to a “trading relative or friend” to resolve the case.84 Justice Alito expended no ink discussing the rationale, legal or otherwise, for the Dirks rule or why the Second Circuit had stretched the rule too far. And while such a narrow holding carries some appeal,85 the lingering shortcomings of insider trading doctrine — as well as the Court’s particularly central role in shaping that doctrine — mean Salman must be viewed as a missed opportunity.
Insider trading doctrine, then, remains murky. The personal benefit test will continue to sit awkwardly within the Court’s dual fiduciary duties framework, while both market participants and the SEC will continue to operate under an uncertain liability standard. The Court’s reluctance to tackle these doctrinal issues directly may, however, produce an unintended benefit: If the incoherence of the doctrine leads to increasingly untenable prosecutions — or, as the SEC would surely suggest, increasingly untenable nonprosecutions — pressure may well mount on Congress to intervene and finally provide a proper definition for the offense of insider trading.