March 18, 2020

Explaining Dirks

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The personal benefit element of the tipping violation established in Dirks v. SEC has been misunderstood. Courts, the Securities and Exchange Commission, and criminal prosecutors have broadly construed it to create liability for insiders who received remote, speculative, immaterial, or intangible returns after disclosing confidential company information. Several situations, such as an insider’s gift of confidential information to a relative or friend or an intention to benefit the recipient of the information, do not require the insider to receive anything at all. The drafting history of the majority opinion in Dirks in the papers of its author, Justice Lewis Powell, reveals that the current wide interpretations of personal benefit in tipping cases are not consistent with the test the Court intended. The principal test of personal benefit was to be the insider’s receipt of cash or something of value within a short time. The special fact situations mentioned in Dirks, including a disclosure as a gift or with an intention to benefit, were not independent and sufficient grounds for finding that an insider received a personal benefit. They were situations that often could create an inference of personal benefit. The drafting history and Powell’s previous opinions show that Powell carefully used the word “inference” in the final opinion. He wanted proof of a fact situation to allow but not require a fact finder to conclude a tipper received a personal benefit.  He did not intend proof of a fact situation to create a presumption or ultimate liability. Lessons from the drafting history show that the Supreme Court misapplied the gift situation in Salman. They also show that the Second Circuit’s recent Martoma decision misinterpreted the intention-to-benefit language in the fact situations.