Beyond the Personal Benefit Test: The Economics of Tipping by Insiders

Recent insider trading cases reveal a stark conceptual divided between the federal courts and the Securities and Exchange Commission (SEC) regarding liability for securities fraud in cases in which an insider (a "tipper") gives material non-public information to a market professional or close friend or other potential trader (a "tippee"). Following a landmark Supreme Court case called Dirks v. SEC, the federal courts do not impose liability on tippers or tippees unless there the tipper receives a consequential personal benefit or is a close friend or relative of the tippee. The SEC abjures this "personal benefit" requirement, and would define the concept of personal benefit so broadly as to remove it as an impediment to insider trading prosecutions. This Article explains the economic function of the personal benefit test as establishing the criterion upon which legitimate trading on the basis of material nonpublic information can be distinguished from venal or corrupt trading. The Article shows that the personal benefit test, while a valuable innovation to insider trading jurisprudence, is severely limited because it does not capture all of the various motivations that cause insiders to convey material nonpublic information to traders. This Article fills that gap by providing a complete taxonomy of tipping and trading, and explaining what the legal consequences of all of the various forms of insider trading.