There’s family, and then there’s insider trading

The connection between the law of insider trading and the nature of the sibling relationship may not be immediately obvious — but the U.S. Supreme Court will consider it Wednesday in what may be one of the most interesting cases of a term that the justices have designed to be boring. Salman v. U.S. turns on whether one brother derives “personal benefit” from providing insider information to another brother who trades on it. Regardless of which answer it chooses, the court will essentially have to offer an analysis of brotherly love — and what it does for the siblings.
The facts are pretty simple. Maher Kara worked for Citigroup. He loved his brother Michael Kara very much, and repeatedly shared insider information with him, knowing that Michael would trade on it. Eventually, Michael began sharing the information with Maher’s brother-in-law, Bassam Salman, who also traded on it.
Salman was convicted of securities fraud for the insider trading. On appeal, he argued that he shouldn’t be held liable because Supreme Court precedent requires the person who made the trade in question to have known that the insider information was leaked by someone who was violating a fiduciary duty in exchange for a personal benefit.
The controlling Supreme Court precedent, Dirks v. SEC, goes back to 1983. That case involved a whistle-blower who had been rebuffed when he went to the Securities and Exchange Commission and therefore leaked his inside information to an equities analyst. The analyst went public, eventually revealing massive fraud. Before he did, he shared information with some of his clients, who got out of the stock in advance of the disclosures.
The Supreme Court held that the tips were not a violation of the securities laws. “The test,” wrote Justice Lewis Powell, “is whether the insider personally will benefit, directly or indirectly, from his disclosure.” The whistle-blower hadn’t benefited.
Powell went on to define personal benefit as “a pecuniary gain or a reputational benefit that will translate into future earnings.” But he also wrote that “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 U.S. Court of Appeals for the 9th Circuit held that because Maher Kara disclosed the information to his brother Michael, he was making a “gift of confidential information to a trading relative” that was covered by the Dirks precedent.
Quirkily, the 9th Circuit opinion was written by Judge Jed Rakoff, who sits on the federal district court in New York and is known as a scourge of wrongdoing bankers. Federal judges, including district judges, are allowed hear cases in other circuits, through a process known as sitting by designation. That can produce weird results.
This time it led to a particularly strange outcome. In 2014, the U.S. Court of Appeals for the 2nd Circuit — which oversees New York, and therefore Judge Rakoff — held in a much discussed case called U.S. v. Newman that mere friendship wasn’t enough to satisfy the personal benefit requirement. Instead, the court said, there must be “at least a potential gain of a pecuniary or similarly valuable nature.” Salman urged the 9th Circuit to follow the 2nd Circuit precedent.
Writing for the 9th Circuit panel, Rakoff said that if the 2nd Circuit case could be read to require a payoff, the 9th Circuit refused to follow its ruling. In other words, a lower court judge whose job is usually governed by 2nd Circuit precedent took advantage of his busman’s holiday on the West Coast to reject a 2nd Circuit precedent.
The result was a circuit split, which led the Supreme Court to take the case. Now it will have to decide whether brotherhood inherently involves mutual benefit.
The theory behind Justice Powell’s 1983 statement was presumably that close familial relationships are by their nature mutually beneficial: I do a favor for my brother, and in exchange, he does something for me. As a result, we each benefit.
But there’s an alternative view, according to which family members support each other out of love, not gain. If a tip made in the interests of whistle-blowing justice can’t give rise to an insider-trading conviction, why should a tip made from love be any different?
To resolve this dispute, the justices will almost certainly have to ask why siblings do things for each other — to opine, as it were, on the nature of the relationship that goes back to Cain and Abel.
Reading the tea leaves, there’s reason to think the court might refuse to treat brotherly love as a basis for securities fraud violation. The court declined to review the Newman case, but it agreed to hear the Salman decision. Yet it’s also true that there was no circuit split after Newman. If the court reads the Dirks decision literally, then Powell’s reference to a trading relative might decide the case. Regardless, the case is a hard one — but without obvious political or ideological implications. That’s especially welcome when the court has only eight members.
—Bloomberg
Noah Feldman is a Bloomberg View columnist