The Supreme Court’s decision to deny cert in US v. Newman was hardly surprising. In the first place, the procedural posture of the case made it a poor candidate for addressing the personal benefit issue.
The Second Circuit decision “not only overturned Newman’s and Chiasson’s convictions, but [also] dismissed their indictments….” It did so not just because the trial judge used the wrong jury instructions, but “also—and this was the fatal part—[because the government had] failed to come forward with evidence that could have convicted the two men even had the proper instructions been given.”[1]
The government’s cert petition failed to take issue with the latter holding. Accordingly, “even if the Supreme Court were to take the case and agree with [the government] that the Second Circuit’s definition of personal benefit was wrong, it seems that Newman and Chiasson would still walk, for lack of evidence that they knew that their tippees at Dell and Nvidia received any personal benefit.”[2]
To be sure, the government told the Supreme Court that it could send the case back for further fact finding, but the reality is that, in effect, the government was asking the court to issue an advisory opinion on the personal benefit test. The court wisely dodged that bullet.
Of course, I think the court also was correct on the substance. Along with my friends Professor Todd Henderson of Chicago and Jon Macey of Yale, I filed a brief opposing the government’s request for rehearing at the Second Circuit level. We argued that Newman was a correct application of Dirks’ personal benefit test and, moreover, that the government’s interpretation of Dirks would chill valuable analyst-insider communications that Dirks intended to protect.
As Adam Pritchard has demonstrated by reviewing Justice Powell’s papers, Dirks’s approach to tipping was driven in considerable measure by Powell's concern that insider trading laws could seriously infringe on the ability of market analysts to communicate with corporate managers.[3]
In addition, both Chiarella and Dirks reflected a policy concern to protect the market from the threat of prosecutorial over-reaching. In both, the government advocated a far broader liability rule than Justice Powell was willing to countenance. In both, Powell rallied a majority to smack down government overreaching.
With respect to the problem at hand, Powell fashioned the personal benefit test to provide a necessary “limiting principle” for fraud liability and a meaningful “guiding principle” for analysts, insiders and investors. As he recognized, such definite and objective limits on the scope of insider trading liability are necessary to protect the socially beneficial activities of market participants operating under the eye of the SEC. Without those “legal limitations, market participants are forced to rely on the reasonableness of the SEC’s litigation strategy” as their only assurance that their activities will not be subject to prosecution. And that, as he observed, “can be hazardous.”
Newman is a straightforward and correct application of Dirks. In particular, Newman correctly rejected the government’s contention that the “mere fact of a friendship” between the insider and the recipient of information is legally sufficient evidence that the insider sought a personal benefit. The function of the personal benefit test is to gauge whether a disclosure was made for an improper purpose. Unlike the personal benefit test, the fact that an analyst can be characterized as a social “friend” of the insider who discloses information, does nothing to illuminate the purpose for which the disclosure was actually made.
If mere evidence of “friendship” is presumptive evidence of personal benefit, then virtually all disclosures are potentially subject to prosecution, because insiders are far more likely to be involved in discussion of their companies with people they know than with strangers. As such, analysts and insiders who are engaged in industry activity that the Supreme Court correctly understands to be normal, socially beneficial, and important to the integrity of capital markets, and that it explicitly seeks to protect, would operate at peril of prosecution for securities fraud simply because they talk regularly, have common friends with whom they socialize, or have some other point of social interaction that could lead to their characterization as “friends.”
Newman thus protects the integrity of the market by placing a meaningful and objective limit on the scope of insider trading liability, allowing investors analysts and insiders to function with reasonable certainty and security about whether their conduct violates the law. In contrast, the government’s version of the personal benefit test fails to supply a standard to which market participants can reasonably conform their conduct. A recipient of information who tries to determine whether he or she is presently under a duty not to trade will find that there is no clear answer, because even the most nebulous of social relationships with the source of the information might be construed as a sufficient basis for liability.
The Supreme Court’s denial of cert leaves Newman intact. So as with the Second Circuit’s refusal to rehear the case en banc, that’s a good outcome. Not as good as a Supreme Court affirmation of Newman, of course, but frankly I prefer to keep securities law cases away from the Supreme Court. As Mitu Gulati and I argued a while back, you simply can’t trust the post-Powell court to get securities cases right.[4]
Which leads me to US v. Salman. Unlike Newman, Salman presents the personal benefit issue without procedural complications. “The Salman defendants’ petition for rehearing was denied on Aug. 13, so they have until about Nov. 13 to file their petition for writ of certiorari with the Supreme Court. While they most likely would have petitioned anyway, the denial of the Newman petition makes a petition all the more certain.”[5]
But this puts the government in a difficult position. “Under ordinary circumstances, it would oppose the Salman defendants’ petition for certiorari to protect its conviction and support the broader view of insider trading.” “But here, if Newman has the destabilizing impact that the government claims, even the government may want the Supreme Court to address insider trading sooner rather than later. Salman would provide the next vehicle to do so. Otherwise, the government might have to live with Newman for years until a circuit split deepened.”
The government therefore might file a fairly unconventional response to the Salman petition. It potentially could argue that Salman was right, but the court should nonetheless hear the case. Doing so obviously has risk, particularly since about two-thirds of cases accepted by the court are reversed. But arguing against certiorari in Salman means that the government must: (1) disavow its recent argument that a circuit split existed; and (2) live with Newman for the foreseeable future.”[6]
So my guess is that Salman stands a good chance of getting before the Supreme Court,which worries me because they'll probably screw it up. My sole hope is that Ninth Circuit’s reversal rate will help make sure that the Supreme Court upholds Newman’s approach to the personal benefit test.
[2] Id.
[3] A.C. Pritchard, Justice Lewis F. Powell, Jr., and the Counterrevolution in the Federal Securities Laws, 52 Duke L.J. 841 (2003).
[4] Stephen M. Bainbridge & G. Mitu Gulati, How Do Judges Maximize? (The Same Way Everybody Else Does--Boundedly): Rules of Thumb in Securities Fraud Opinions, 51 Emory L.J. 83 (2002)..
[5] http://www.natlawreview.com/article/rest-peace-newman-so-will-government-lay-down-salman
[6] Id.
