Target CEO Tony Treadwell has become highly stressed as a result of the high pressure merger negotiations and begins seeing a psychologist for therapy. In the course of their sessions, Treadwell discloses confidential information about the merger to his psychologist. Unbeknownst to Treadwell, the psychologist buys Target stock on the basis of that information. Does Treadwell’s conduct constitute an illegal tip under SEC Rule 10b-5?
In Salman v. US, the Supreme Court recently held that:
Section 10(b) of the Securities Exchange Act of 1934 and the Securities and Exchange Commission’s Rule 10b–5 prohibit undisclosed trading on inside corporate infor- mation by individuals who are under a duty of trust and confidence that prohibits them from secretly using such information for their personal advantage. ...
These persons also may not tip inside information to others for trading. The tippee acquires the tipper’s duty to disclose or abstain from trading if the tippee knows the information was disclosed in breach of the tipper’s duty, and the tippee may commit securities fraud by trading in disregard of that knowledge. In Dirks v. SEC, 463 U. S. 646 (1983), this Court explained that a tippee’s liability for trading on inside information hinges on whether the tip- per breached a fiduciary duty by disclosing the information. A tipper breaches such a fiduciary duty, we held, when the tipper discloses the inside information for a personal benefit. And, we went on to say, a jury can infer a personal benefit—and thus a breach of the tipper’s duty—where the tipper receives something of value in exchange for the tip or “makes a gift of confidential information to a trading relative or friend.” ...
Making a gift of inside information to a relative like Michael is little different from trading on the information, obtaining the profits, and doling them out to the trading relative. The tipper benefits either way.
One issue is whether disclosing information to a mental health care provider in order to receive appropriate treatment should be deemed the requisite sort of personal benefit required for a disclosure to be deemed an illegal tip. Your instinct may to say no, because Tony disclosed the information not with the intent of conducting an exchange or of making a gift. But this confuses the personal benefit test with the requirement of scienter.
Scienter is (probably) required in order for a tipper to be held liable. Scienter requires something more than mere negligence on Tony's part, but all lower courts agree that recklessness--i.e., "conduct that reasonable persons know is unsafe or illegal"--suffices. So if Tony was reckless in making the disclosure, the scienter requirement would be satisfied.
Where an insider discloses information for a corporate purpose, there is no personal benefit (which is why the SEC had to adopt Regulation FD). But here Tony has disclosed the information at least in part for the personal purpose of being restored to good mental health.
In Salman, the Supreme Court blew off these sort of hypotheticals:
It remains the case that “[d]etermining whether an insider personally benefits from a particular disclosure, a question of fact, will not always be easy for courts.” 463 U. S., at 664. But there is no need for us to address those difficult cases today, because this case involves “precisely the ‘gift of confidential information to a trading relative’ that Dirks envisioned.” 792 F. 3d, at 1092 (quoting 463 U. S., at 664).
To which one can only reply, thanks a bunch. That's a big [expletive deleted] help.
So the question remains: Because personal benefit is not limited to a monetary or similar quid pro quo, what is the outer limit of the personal benefit requirement?
Note, by the way, that U.S. v. Willis, 737 F.Supp. 269 (S.D.N.Y.1990) held that a psychologist could be held liable under the misappropriation theory on basically these facts. But I'm concerned with Treadwell's liability as a tipper under the classical theory.
Bill Klein suggests some further complications:
- Suppose TT knows that the psychologist is an active trader who has in the past traded on information TT has revealed in therapy sessions and has become especially accommodating to TT’s scheduling problems.
- On the other hand, suppose TT has warned the shrink not to trade on anything revealed in sessions and has tried to avoid revealing anything more than what is necessary therapeutically—but the shrink figures out what the deal is that is causing TT’s anxiety and trades anyhow.
- Suppose you were TT's lawyer. He tells you he is going to the psychologist. What do you tell him about disclosing information to the therapist?
- Do you think the lawyer (assume he's Target's general counsel) has a duty to go to the board and report that the CEO is so stressed out?