Despite a decision by the Second Circuit in 2014 that stripped away some of the government’s leverage in prosecuting insider trading cases, the pendulum has swung fully back in favor of the government.
As explained by the SEC, illegal insider trading generally refers to buying or selling a security in breach of a fiduciary duty or relationship of trust and confidence, while in possession or aware of material, non-public information about the security. Additionally, illegal insider trading includes, among other conduct, tipping material non-public information to others whereby the tipper receives a personal benefit from such disclosure. On its face, determining whether an individual’s trading is illegal based upon these tests may appear relatively straightforward. However, the judiciary has struggled over the years to reach a consensus on how best to evaluate various aspects of insider trading elements. Most recently, the judiciary has attempted to tackle what is sufficient to establish a personal benefit in exchange for a tipper’s divulgence of material, non-public information.
Just three years ago, the case of United States v. Newman endeavored to alter the landscape by taking a new approach to “personal benefit”. 773 F. 3d 438 (2d Cir. 2014). In Newman, two hedge fund managers were charged with insider trading in the stock of Dell and NVIDIA. The Government alleged that “a cohort of analysts at various hedge funds and investment firms obtained material, nonpublic information from employees of publicly traded technology companies, shared it amongst each other, and subsequently passed this information to the portfolio managers at their respective companies.” It was proven that each of the defendants obtained insider information and traded on it through a tipping chain; however, the Second Circuit did not agree with the prosecution that a social relationship between the tipper and tippees was sufficient to create a personal benefit, even though they attended church together and exchanged career advice. The Second Circuit held that to the extent a personal benefit may be inferred from a relationship, “such an inference is impermissible in the absence of proof of 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.” Many felt that the decision would “dramatically limit the Government’s ability to prosecute some of the most common, culpable, and market-threatening forms of insider trading.” Quoting the Petition for United States Rehearing and Rehearing En Banc in United States v. Newman at 3 (Jan. 23, 2015).
Shortly thereafter, the Supreme Court took its first insider trading case in nearly two decades and reshaped the Newman holding. In United States v. Salman, a tipper worked for an investment bank and provided confidential information regarding future mergers and acquisitions to his brother, who ultimately tipped his soon to be brother-in-law. 137 S.Ct. 420 (2016). The defense urged the Court to adopt the Newman rule, but the Court opted to regard a close personal relationship as a sufficient personal benefit and held the defendant guilty. The Court reasoned that liability exists where the “insider makes a gift of conditional information to a trading relative or friend.” This decision severely undercut the holding in Newman and suggested that prosecutors need only prove that the information was provided as a gift to a close friend or relative.
On August 23, 2017, guided by the Supreme Court’s ruling in Salman, the Second Circuit affirmed in the case of United States v. Martoma, 869 F. 3d 58 (2d Cir. 2017), that the logic of Salman abrogated Newman’s “meaningfully close personal relationship” requirement. In 2014, Martoma was convicted of masterminding what was once called the most lucrative insider trading scheme of all time, which profited his firm $275 million based on inside information received from a doctor working on clinical trials of an Alzheimer’s treatment. In light of the Supreme Court’s ruling in Salman, Martoma appealed his case. However, the Second Circuit followed the Supreme Court and concluded that “Salman fundamentally altered the analysis underlying Newman’s ‘meaningfully close personal relationship’ requirement such that the ‘meaningfully close personal relationship’ requirement is no longer good law.”
“Because insider trading undermines investor confidence in the fairness and integrity of the markets, the SEC has treated the detection and prosecution of insider trading violations as one of its enforcement priorities.” However, according to Forbes, Preet Bharara, the former United States Attorney for the Southern District of New York, chose to drop numerous insider trading charges in 2015 after Newman imposed its evidentiary hurdle on prosecutors. With that hurdle effectively removed by Salman and Martoma, it seems likely that we will begin to see an increase in insider trading charges brought as the SEC attempts to re-solidify insider trading prosecutions as one of its priorities.