Steve describes a psychiatrist who trades after learning about a merger from one of his patients, raising the question, “Does Treadwell’s conduct constitute an illegal tip under SEC Rule 10b-5?” We can ask the same question of the psychologist. Steve’s hypothetical is meant to generate discussion, and the possibility for extended discussion is meant to demonstrate just how much Salmon v. US left unanswered.
Unanswered questions are not unusual in insider trading law, and securities litigation generally, but Steve’s question rings out because of how close we got to clarity.
- The government argued that the Dirks personal benefit test is met “whenever the tipper discloses confidential trading information for a noncorporate purpose.” Under this permutation, the defendants would have faced long odds. The disclosure was not, say, to obtain strategic or legal advice vital to the merger; rather, the CEO sought only psychic relief. Perhaps a company benefits from a de-stressed CEO, but if that counts passes muster as a corporate purpose, a great many practices would have to be reevaluated.
- Salman and several amici asked for clarity, too, but with the opposite polarity. In United States v. Newman, Salman’s counterpart in circuit-splitting, the Second Circuit Court of Appeals held that recipients of information can lawfully trade unless the tip was shared as part of an “exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” This requirement would clearly have helped our defendants. Among the few things I remember from 1L tort class is the notion that ordinary occupational stress is rarely a compensable harm, suggesting that its relief would not amount to “objective . . . pecuniary” benefit to the CEO-source.
However, the Court’s decision this month largely overruled Newman, restoring the status quo ante as to quid pro quo. Likewise, the Court declined the government’s invitation consolidate a tougher standard. By refusing both invitations to clarity, the Court again leaves us imagine increasingly puzzling variations on the tipping theme.
Still, a practical attorney might question the value of such puzzles. After all, there is no mystery as to whether these characters are liable for breaking the law (at least assuming the other elements are met):
- The psychologist almost certainly ran afoul the misappropriation theory, by betraying her confidential relationship with the CEO.
- If we decide that the CEO’s disclosure didn’t violate a duty to his company, then there is a risk that this disclosure violated Reg FD, which prohibits senior officials of an issuer from sharing information with one shareholder before others.. Trading on the information would then expose the psychiatrist to civil liability.
- If this merger was going to involve a tender offer, both defendants may have violated Rule 14e-3, which sets up especially pro-prosecutor rules in that special context.
So the only mystery is whether the government can nail them on the classical theory too. Is that a mystery worth solving? Well, it is a mystery with real consequences because of the way that various elements of insider trading law hang together.
For example, our resolution of the personal benefit question bears directly on the applicable standard in “Possession vs. Use” Debate. Must a trader use proscribed information to plan her trades, or is it enough that she traded (for whatever reason), after having come into possession of such information? Professor Donna Nagy has persuasively argued that the pro-government “use” standard is far more appropriate to the classical theory than the misappropriation theory.
Thus, if the psychologist avoids the classical theory pursuant to Salman, he can argue – successfully or unsuccessfully, as the case may be – that he had long planned to trade and that this information did not influence his conduct. That argument is off the table if we find a personal benefit to the CEO.