US v. Newman and the Rewriting of the Law of Insider Trading (Part 7)

The need for a breach of fiduciary duty, for all of its problems, did not accomplish the goal of the Supreme Court.  Secrist was still open to a claim that he violated those duties by tipping information to Dirks that harmed the company (albeit while helping the market).  The Court addressed the continuing uncertainty by defining breach in a narrow manner, unconnected to state law. 

Breach occurred when the fiduciary obtained a benefit.  Moreover, benefit had to be something pecuniary or objective.  See Dirks, at 663 (“This requires courts to focus on objective criteria, i. e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings.”).  Reputational benefit, for example, left open the possibility that the Secrists of the world could still be subject to uncertainty to the extent the government could claim that the tip was in return for something ephemeral such as improved reputation. 

The analysis had little connection to state law fiduciary duty principles.  For the most part, fiduciary duties looked to the interests of shareholders.  The Court, however, ignored the impact on shareholders and instead focused entirely on the benefits (or lack thereof) to the insider.  The approach was both under and over inclusive.  Insiders routinely benefit from the corporation without violating their fiduciary obligations (getting paid compensation for example).  Likewise the absence of benefit does not mean they were acting in the best interests of shareholders. 

The made up nature of the standard had some intended advantages.  Much of the uncertainty was gone.  The “slip of the tongue” cases where material nonpublic information was accidentally disclosed in a manner that did not benefit the corporation (and even caused harm) were no longer actionable.  Moreover, the practical reality was that insiders rarely gave away information in circumstances detrimental to the company unless they somehow benefited. 

The test, therefore, largely protected the flow of information from insiders to market participants.  The Court, however, understood that relationships between fiduciaries and family/friends raised different concerns.  In those circumstances, there was no presumptive benefit to the company and no need to protect the flow of information between insiders and friends/family. 

As a result, the Court recognized that in these circumstances, there was no need for an overinclusive rule that would protect the two way flow of communications.  As a result, a pecuniary benefit was not required. See Dirks, at 664 (“The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.”).  The analysis turned not on the nature of the benefit but on the nature of the relationship.    

With respect to Newman, the decision and the request for rehearing en banc is posted, along with the SEC’s amicus brief, at the DU Corporate Governance web site.  The amicus filed by a small group of law professors that supports the decision is here.