On August 23, 2017, a divided three-judge panel of the United States Court of Appeals for the Second Circuit upheld the insider trading conviction of SAC Capital Advisors, LLC (“SAC”) portfolio manager Mathew Martoma. United States v. Martoma, No. 14-3599 (2d Cir. Aug. 23, 2017). The decision represented the Second Circuit’s first occasion to consider its landmark decision in United States v. Newman in light of the Supreme Court’s recent decision in Salman v. United States. Over a strong dissent, the majority found that the logic underpinning the Salman decision abrogated Newman’s requirement that a “meaningfully close personal relationship” exist between a tipper and tippee before allowing a jury to infer the personal benefit necessary to establish insider trading liability merely from a tip of inside information. The majority held “that an insider or tipper personally benefits from a disclosure of inside information whenever the information was disclosed with the expectation that the recipient would trade on it and the disclosure resembles trading by the insider followed by a gift of the profits to the recipient, whether or not there was a meaningfully close relationship between the tipper and tippee.” Martoma, slip op. at 27-28 (internal quotation marks and citations omitted). In so doing, it shifted the focus from the relationship between a tipper and tippee to the tipper’s subjective intent in making the tip, and seemingly did away with the limiting principle that Newman had established. However, while clearly a win for prosecutors, this new standard will still require a highly fact-intensive inquiry into the purpose of any tip, meaning that precisely how much of a shift in law it portends remains to be seen. Further, the requirement established in Newman that a tippee must know about the personal benefit received by the insider remains unchanged and will continue to limit prosecutions involving extended tipping chains.

Background

The procedural history of the Martoma decision, as well as the substance of the decision, was heavily influenced by recent developments in insider trading law, specifically the Second Circuit’s 2015 decision in United States v. Newman, 773 F.3d 438 (2d Cir. 2015), and the Supreme Court’s 2016 decision in Salman v. United States, 137 S. Ct. 420 (2016). Both decisions examined the contours of the requirement laid out by the Supreme Court in Dirks v. S.E.C., 463 U.S. 646 (1983), that a tipper must receive a “personal benefit” to be held liable for insider trading.

In United States v. Newman, the Second Circuit reversed the convictions of two hedge fund managers who allegedly received tips relating to two issuers from individuals who were themselves several steps removed from the original tipper. In reversing the convictions, the Second Circuit held—in the context of individuals who were professional acquaintances, not close friends—that in order to establish a personal benefit to the tipper, it is necessary that the personal benefit to the tipper is “objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” Newman, 773 F.3d at 452. In the absence of any “meaningfully close personal relationship” between the original tipper and tippee in Newman, the Second Circuit concluded that no jury could have inferred that the tipper had passed inside information on in exchange for a personal benefit. The Second Circuit also held that, regardless of the nature of the personal benefit to the tipper, a tippee does not engage in illegal insider trading unless he knows of the personal benefit to the insider. The impact of the Newman decision was thus to clarify, and arguably tighten, the personal benefit requirement laid out in the Supreme Court’s 1983 United States v. Dirks decision, where the Court held that a company insider violates his or her fiduciary duty to shareholders—giving rise to liability for insider trading—when he or she will benefit, directly or indirectly, from passing material nonpublic information to a tippee.

One year later in Salman, the Supreme Court held that the jury could infer that the tipper personally benefited from making a gift of confidential information to a relative who traded on it. The Salman decision rejected certain interpretations of the Newman decision, specifically noting that “to the extent the Second Circuit [in Newman] held that the tipper must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends, . . . this requirement is inconsistent with Dirks.” Salman, 137 S. Ct. at 428. In many ways, the Salman decision was noteworthy for what it did not say. The decision repeatedly emphasized the narrowness of the holding, which was limited to the situation in which information is disclosed among close relatives. Specifically, the Court stated that “there is no need” to address the scope of the gift theory beyond the gift of confidential information to a trading relative—expressly choosing not to speak to the Government’s argument that the personal benefit test for these types of relationships should be only whether the insider knew that the tippee would trade on the information. In Newman, for example, the tippee was a former work colleague of the tipper, not a relative or close friend. The Supreme Court did not address or resolve whether the standard for personal benefits articulated by the Second Circuit in Newman would still apply in that context, and the Supreme Court expressly stated that it was not addressing Newman’s holding that a tippee must know of the personal benefit obtained by the insider.

The Salman decision therefore left a fair amount of ambiguity in the Second Circuit regarding the holdings from Newman, which apparently remained intact; the Second Circuit appears to have eliminated the remaining ambiguity (at least for now) with its Martoma ruling.

The Martoma Decision

The Martoma decision centers on the February 2014 conviction of Mathew Martoma on various insider trading charges. The government alleged that Martoma learned in July 2008 that a clinical trial for an experimental drug being developed by Wyeth and Elan had gone poorly. The tip allegedly came from two doctors who worked on the trial—Sidney Gilman and Joel Ross—and allegedly allowed SAC, owned by billionaire Steve Cohen, to avoid losses of approximately $275 million by unwinding its considerable holdings in the company prior to a sharp drop in share value. Martoma was ultimately convicted of insider trading charges and sentenced to nine years in prison, one of the longest sentences doled out in an insider trading case.

Martoma initially argued on appeal that the jury instructions were improper and that there was insufficient evidence to convict in light of Newman, and in supplemental briefing he argued that Salman did not lessen the force of his claims.

In Martoma, the Second Circuit affirmed the judgment of the district court, and in doing so determined that the “meaningfully close personal relationship” requirement imposed by Newman was inconsistent with Salman. While recognizing that both Dirks and Salman largely confined their analysis to situations of gifts to relatives and close friends, the Martoma majority reasoned that the “straightforward logic of the gift-giving analysis in Dirks, strongly reaffirmed in Salman, is that a corporate insider personally benefits whenever ‘he disclos[es] inside information as a gift . . . with the expectation that [the recipient] would trade’ on the basis of such information or otherwise would exploit it for his pecuniary gain.” Martoma, slip op. at 25 (quoting Salman, 137 S. Ct. at 428). In the majority’s view, nothing in this logic suggests there should be any distinction between gifts to “people with whom a tipper shares a ‘meaningfully close personal relationship’” and people with whom the tipper lacks such a relationship. Martoma, slip op. at 25-26. However, the majority’s opinion did little to address the circumstances in which a jury will be permitted to infer that a given tip should be considered a “gift”—i.e., whether it “resembles trading by the insider followed by a gift of the profits to the recipient.” Id. at 26. Nor did the majority grapple with the expressly limited scope of the Salman decision, where the Supreme Court declined to adopt the broad standard proposed by the government in that case that all gifts of confidential inside information benefit the giver if he understood that the recipient would trade.

In a strongly worded dissent, Judge Rosemary Pooler argued that the majority disregarded well-established precedent in a manner that “radically alters insider-trading law for the worse.” Martoma, dissent at 3. Supreme Court precedent, wrote Judge Pooler, has consistently required a “personal benefit” to the tipper when that individual gives a gift of inside information. She explained that this requirement has served as an important limiting principle, and that “[i]n holding that someone who gives a gift always receives a personal benefit from doing so, the majority strips the long‐standing personal benefit rule of its limiting power.” In the absence of the close relationship requirement laid out in Newman, Judge Pooler warned, liability under insider trading laws will be expanded beyond that contemplated by well-established precedent.

Import and Implications of the Martoma Decision

The Martoma decision eliminates much of the potential ambiguity that remained in the Second Circuit following the Supreme Court’s narrow Salman decision. When combined with the Salman decision, Martoma also removes a number of the obstacles to insider trading prosecutions that were presented by Newman. Indeed, the only key holding that appears to remain from the Newman decision is the Second Circuit’s requirement that tippees must know that the tipper providing the information received a personal benefit in exchange for the inside information.

Nonetheless, the impact of Martoma will depend in part not only on how courts determine what evidence is sufficient to determine whether “the disclosure resembles trading by the insider followed by a gift of the profits to the recipient,” but also on whether the opinion withstands additional judicial scrutiny. Indeed, Judge Pooler’s dissent explicitly criticized the majority for overturning circuit precedent without convening the court en banc. Martoma will almost certainly now seek en banc review of the decision, and if such a petition is unsuccessful, it remains possible that the Supreme Court will hear the case.

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