Dirks Test - Explained
What is the Dirks Test?
Written by J. Mance Gordon
Updated at April 20th, 2024
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What is the Dirks Test?
The Dirks Test is a standard measure that establishes whether a wrongful insider trading has occurred in a company or whether a tippee is guilty of insider trading. It is a standard test that formulates the basic criteria for insider trading. The Dirks Test is used by the Securities and Exchange Commission (SEC) to determine whether a breach has occurred in a company as a result of someone having access to insider information.
A Tippee refers to an individual who receives insider information and acts on it and such a person uses the insider information for personal gains, he is guilty of insider trading and this can be detected through the Dirks Test. A tippee can also be guilty of insider trading if they are aware that the tipper (person who gave the information) has breached his fiduciary duty to the company.
How does the Dirks Test Work?
The Dirks Test takes two dimensions, first is to determine whether an individual has broken a company rule by leaking information about the company that is not for public consumption or disclosure of confidential materials.
The second dimension of the dirks test is to determine whether an individual who is guilty of insider trading did it willingly or knowingly. The Court case between Dirks vs SEC in 1984 gave rise to the Dirks Test. Certain conditions were established to determine wrongful insider trading, according to this test, an individual does not have to engage in an actual trade before he can be guilty of insider trading. For instance, this test allows tippees to be held liable for insider trading.
Testing the Dirks Test
According to the Dirk test, an individual can be guilty of unlawful insider trading just by disclosing confidential about a company. There are many premises of the test but one crucial element remained controversial, hence, there was the need to test the Dirks test itself.
The controversial part of the test whether an insider breached a fiduciary duty or whether they received a personal benefit. This element was quite unclear given the judgment of the Supreme Court which states that that "absent some personal gain [to the insider] there has been no breach of duty to stockholders. And absent a breach by the insider there is no derivative breach [by the tippee]."