Academic journal article Boston College Law Review

The Overlooked Daisy Chain Problem in Salman

Academic journal article Boston College Law Review

The Overlooked Daisy Chain Problem in Salman

Article excerpt

INTRODUCTION

The Supreme Court recently heard oral arguments in Salman v. United States.1 The Court granted certiorari to resolve the clash between Salman and the U.S. Court of Appeals for the Second Circuit's 2014 decision in United States v. Newman as to when corporate insiders receive sufficient personal benefit from making gifts of inside information to make the tip and consequent trade illegal.2 Interestingly, both Salman and Newman ignored another aspect of the personal benefit issue raised by the facts of both cases. This aspect, which I refer to as the "daisy chain problem," involves how the personal benefit element for illegal tipping applies to the subsequent tips that occur when the recipient of information from the corporate insider, in turn, passes the information on to others. Because the daisy chain problem will become pressing after Salman unless the Court addresses it in its opinion, this problem is worth exploring.

I. UNDERSTANDING THE PROBLEM

For the most part, the prohibition on insider trading in the United States comes from opinions of the Supreme Court interpreting Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated by the Securities and Exchange Commission.3 These opinions create a fairly elaborate set of rules governing when insider trading constitutes fraud in connection with the purchase or sale of a security, thereby violating Section 10(b) and Rule 10b-5. Essentially, corporate insiders cannot legally trade on material non-public information about the company for which they work, and persons cannot legally trade on information they misappropriate through the pretense that they could be trusted with such information.4 Critically for present purposes, in the 1983 case Dirks v. Securities and Exchange Commission, the Supreme Court held that insiders violate the law when they provide others with information upon which the insiders cannot legally trade (thereby becoming a "tipper") and receive some personal benefit from providing the tip for the recipient's trading.5 If the recipient of the information (the "tippee") knows or should have known he or she received the information illegally, then the tippee also cannot legally trade.

Benefits the tipper might receive from tipping include money from selling the information, other inside information from swapping the information, or perhaps some reputational gain. Language in Dirks suggesting that the tipper can obtain a benefit from making a giftof information-based upon the rationale that this is equivalent to the tipper trading on the information and making a giftof the proceeds-created the issue in the case now before the Court in Salman and also in the Second Circuit's decision in Newman. Yet, with all the focus in Salman and Newman on the benefit of making gifts, little attention has been given to the question of how Dirks's "benefit of the tip" test applies to chains of tipping, as occurred in both Salman and Newman.

The facts in Salman illustrate the problem. Maher, the insider, tipped his brother, Michael, who, in turn, tipped his friend (and Maher's brother-in-law), Salman.6 In order for Salman's trades to be illegal, must Maher, in addition to benefiting from his original tips to Michael, also have benefited from Michael's tips to Salman? Alternatively, is it sufficient that Michael benefited from his own tips to Salman, as long as Maher benefited from his tips to Michael? Or, given a benefit to Maher from his tips to Michael, is a benefit to either Maher or Michael from Michael's tipping Salman even necessary?

In some instances, it will not matter who, if anyone, must benefit from the subsequent tips and trades in a daisy chain of tipping in order for the subsequent tips and trades to be illegal. For example, suppose a corporate insider, Steve, sells inside corporate information to a stock analyst, Dirk. Steve understands that Dirk will not trade himself, but will instead provide the information to Dirk's clients for them to trade (in exchange for which Dirk will gain the continued patronage of his clients). …

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