Judge Rakoff Strikes Back: US v. Salman (Part 2)
We are discussing Judge Rakoff's opinion in US v. Salman, a case where, sitting in the 9th Circuit by designation, he was able to directly disagree with a decision in the Second Circuit, the circuit that otherwise oversees his decisions as a district court judge.
In Newman, the Second Circuit interpreted Dirks, a seminal insider trading case, to require more than mere friendship to establish the requisite breach of duty. Instead, there had to be "a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” In short, friendship wasn't enough; there had to be some kind of tangible benefit to the friend or family member.
The SEC and the US Attorneys Office objected to the reasoning and sought en banc rehearing. The en banc court, however, declined to take the case. As a result, it represents the law of the Second Circuit and is binding on all of the trial judges, including Judge Rakoff.
In US v. Salman, however, the 9th Circuit panel (which included Judge Rakoff, sitting by designation), had to consider the issue of benefit in the context of friendship. Salman involved an alleged tip by one brother to another. For insider trading liability to apply to a tippee, there had to be a breach of fiduciary duty by the tipper/insider. The panel found that it was enough to show that the tipper and tippee were brothers and had a close relationship. No tangible benefit as a result of the tip was required.
Defendant nonetheless raised the anlysis in Newman and argued that "evidence of a friendship or familial relationship between tipper and tippee, standing alone, is insufficient to demonstrate that the tipper received a benefit" and instead required some evidence of tangible benefit.
In analyzing Newman, Judge Rakoff started by praising the Second Circuit's expertise in insider trading cases.
- Of course, Newman is not binding on us, and our own reading of Dirks is guided by the clearly applicable language italicized above. But we would not lightly ignore the most recent ruling of our sister circuit in an area of law that it has frequently encountered.
Despite this expertise, however, the 9th Circuit knew better.
- To the extent Newman can be read to go so far, we decline to follow it. Doing so would require us to depart from the clear holding of Dirks that the element of breach of fiduciary duty is met where an “insider makes a gift of confidential information to a trading relative or friend.”
The alternative interpretation in Newman threatened to create a massive gap in the application of the prohibition on insider trading.
- If [Defendant's] theory were accepted and this evidence found to be insufficient, then a corporate insider or other person in possession of confidential and proprietary information would be free to disclose that information to her relatives, and they would be free to trade on it, provided only that she asked for no tangible compensation in return. Proof that the insider disclosed material nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish the breach of fiduciary duty element of insider trading.
The 9th Circuit (ala Judge Rakoff) have now directly contradicted the reasoning in Newman. As a result, the Commission has greater latitude to decline to follow Newman in other circuits. The decision also potentially creates a framework for overturning Newman.
With a split in the circuits, the likelihood of a successful cert petition to the US Supreme Court has increased. To the extent that other circuits agree with Salman, and the 2nd Circuit becomes isolated in its reasoning, the Court may be willing to take the issue en banc and reverse Newman (it is after all inconsistent with Dirks). In any event, the 2nd Circuit's recognized expertise in insider trading cases has at least temporarily been tarnished. Judge Rakoff, therefore, set in motion a possible reversal of Newman and a challenge to the Second Circuit's reputation, something that would have been largely impossible as a district court judge in the Second Circuit.