Why it matters: On Aug. 23, 2017, the Second Circuit decided U.S. v. Martoma, in which the court affirmed a tippee’s conviction in an insider trading case based on the Supreme Court’s 2016 decision in Salman v. U.S. The Martoma opinion further eroded the Second Circuit’s own landmark 2014 decision in U.S. v. Newman—which was still standing after Salman although the Supreme Court had rejected certain aspects of Newman’s holding—by rejecting as “no longer good law” the requirement imposed in Newman that there be a finding of a “meaningfully close personal relationship” between the tipper and the tippee to satisfy the “personal benefit” element of insider trading liability.
Detailed discussion: On Aug. 23, 2017, the Second Circuit, with one dissent, handed down its opinion in U.S. v. Martoma, which affirmed an insider trading tippee’s conviction based on the Supreme Court’s 2016 decision in Salman v. U.S. The Martoma opinion further eroded (the dissent would say entirely overruled) the Second Circuit’s own landmark 2014 decision in U.S. v. Newman—which was still standing after Salman although the Supreme Court had rejected certain aspects of Newman’s holding—by rejecting as “no longer good law” the requirement imposed in Newman that there be a finding of a “meaningfully close personal relationship” between the tipper and the tippee to satisfy the “personal benefit” element of insider trading liability.
Defendant-appellant Mathew Martoma was convicted, following a four-week jury trial, of securities fraud (and conspiracy to commit said securities fraud) in connection with an insider trading scheme involving the securities of two pharmaceutical companies, Elan Corp., plc, and Wyeth, that were jointly developing the experimental drug bapineuzumab (Drug) to treat Alzheimer’s disease.
The court detailed the underlying facts of the case at the outset of its opinion. Briefly, Martoma worked as a portfolio manager at the hedge fund S.A.C. Capital Advisors, LLC (SAC), which was owned and managed by Steven A. Cohen. At SAC, Martoma managed an investment portfolio that was focused on pharmaceutical and healthcare companies and also recommended investments to Cohen, who managed SAC’s largest portfolio. Martoma began to acquire shares in Elan and Wyeth in his portfolio and recommended that Cohen acquire shares in the pharmaceutical companies as well.
From 2006 through 2008, Martoma received nonpublic confidential information involving clinical trials of the Drug during numerous information-gathering sessions with the chair of the Drug’s safety monitoring committee (Dr. Gilman) and other, less frequent sessions with another principal investigator on the clinical trials (Dr. Ross). Martoma paid $1,000/hour for sessions with Dr. Gilman and $1,500/hour for sessions with Dr. Ross.
In mid-July 2008, SAC began to reduce its portfolios’ holdings in Elan and Wyeth securities after Martoma learned, and informed Cohen, about concerns involving the Drug’s efficacy that had been conveyed to him by Drs. Gilman and Ross but which had not yet been made public. Shortly thereafter, once such concerns were publicly announced, Elan’s and Wyeth’s stock prices declined by 42% and 12%, respectively, and the trades that Martoma and Cohen made in advance of the announcement resulted in approximately $80.3 million in gains and $194.6 million in averted losses for SAC. In addition, Martoma received a $9 million bonus based in large part on his trading activity in Elan and Wyeth.
At Martoma’s jury trial leading to his insider trading conviction, the jury was given instructions with respect to finding a “personal benefit” to the tipper—one of the elements of insider trading liability—including the following:
If you find that Dr. Gilman or Dr. Ross disclosed material, non-public information to Mr. Martoma, you must then determine whether the government proved beyond a reasonable doubt that Dr. Gilman and Dr. Ross received or anticipated receiving some personal benefit, direct or indirect, from disclosing the material, non-public information at issue. The benefit may, but need not, be financial or tangible in nature; it could include obtaining some future advantage, developing or maintaining a business contact or a friendship, or enhancing the tipper’s reputation (emphasis added).
The court began its discussion of the procedural history of the case by noting that it “is inextricably intertwined with recent developments in insider trading law.”
Before delving into the procedural history, the court gave a brief overview of the statutory scheme and case law precedent pertaining to the development of current insider trading jurisprudence. The court focused on the precedential 1983 Supreme Court decision in Dirks v. SEC—on which the recent insider trading cases relevant to Martoma have centered—which held, among other things, that (1) in order to establish a “personal benefit” to the insider tipper—one of the elements of insider trading liability—“the test is whether the insider personally will benefit, directly or indirectly, from his disclosure … for in that case the insider is breaching his fiduciary duty to the company’s shareholders not to exploit company information for his personal benefit”; (2) the recipient of inside information (tippee) is equally liable if “‘the tippee knows or should know that there has been [such] a breach’ … i.e., knows of the personal benefit”; and (3) that such a personal benefit can be inferred from a list of illustrative examples in the opinion, such as “when an insider makes a gift of confidential information to a trading relative or friend.”
After Martoma was convicted and while his appeal was pending, the Second Circuit decided Newman in 2015, which increased the burden on the government to prove “personal benefit” in insider trading cases by holding that “[t]o the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee,… we hold that such an inference is impermissible in the absence of proof of a (1) meaningfully close personal relationship (2) that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature (numbering and emphasis added).”
Based on this holding in Newman and its new two-part modification to the Dirks “personal benefit” requirement, Martoma sought to have his conviction overturned by the Second Circuit, challenging both the jury instructions and the sufficiency of evidence presented at trial by the government.
Shortly after oral argument was held in the Martoma case before a Second Circuit panel, however, the Supreme Court decided Salman in December 2016 on certiorari from the Ninth Circuit. The Supreme Court re-established Dirks to be controlling precedent in this instance and held, among other things, that the required “personal benefit” to the insider can properly be inferred merely from evidence showing that the insider gave “a gift of confidential information to a trading relative or friend” (which was the Dirks example relevant to the fact pattern in Salman) and that no evidence of an additional tangible or pecuniary personal benefit to the insider need be provided by the government. The Supreme Court then specifically set aside the Second Circuit’s opinion in Newman to the extent that it was “inconsistent” with Dirks, effectively doing away with the second “pecuniary” element added by Newman in the highlighted language above. See our December 2016 Newsletter under “Insider Trading: Supreme Court Affirms Salman” for a discussion of the Salman decision.
In light of Salman, the Second Circuit requested additional briefing and held a second round of oral argument “to address how Salman affects this case.” Martoma argued that even though the Supreme Court overturned Newman with respect to the “pecuniary” benefit element, the requirement of a “meaningfully close personal relationship” still remained for a “personal benefit” to the tipper to be found, which was not proven by the government in his case, nor was it part of the jury instructions. Thus, he argued, his conviction should be overturned.
This leads us to the Second Circuit’s opinion in Martoma.
The Court’s Holding
The Second Circuit affirmed Martoma’s conviction. The Court made short shrift of Martoma’s challenge to the sufficiency of evidence presented by the government at trial, finding, among other things, that the evidence of significant hourly fees paid by Martoma to Dr. Gilman over some 43 sessions was by itself more than sufficient to prove to the jury that at the very least one of the insider doctors received a quid pro quo “personal benefit” from Martoma.
With respect to the sufficiency of the jury instructions, and Martoma’s argument that the “meaningfully close personal benefit” requirement in Newman still survived, the court said that “[f]ollowing the logic of the Supreme Court’s reasoning in Salman, interpreting Dirks, we think that Newman’s ‘meaningfully close personal relationship’ requirement can no longer be sustained.”
The court reviewed the Dirks holding and came to the conclusion that it had erred in Newman by treating the given list of examples from which a “personal benefit” can be inferred as “limiting” rather than merely illustrative, concluding 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.”
Thus, the court held (quoting Salman and Dirks) 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 ‘resemble[s] trading by the insider followed by a gift of the profits to the recipient,’… whether or not there was a ‘meaningfully close personal relationship’ between the tipper and tippee.”
Given this holding, the court concluded that the district court’s jury instructions were not “obviously erroneous” and that, further, “any instructional error would not have affected Martoma’s substantial rights because the government presented overwhelming evidence that at least one tipper received a financial benefit from providing confidential information to Martoma.”
Judge Rosemary S. Pooler “respectfully” dissented “[b]ecause the majority rejects limitations the Supreme Court set forth in Dirks v. S.E.C. … and Salman v. United States … and overrules our holding in United States v. Newman … without convening this Court en banc … [a]nd, because those precedents show that Martoma’s jury instructions were erroneous in a way that affected his rights at trial.” Therefore, she argued that the majority “significantly diminishes the limiting power of the personal benefit rule, and radically alters insider-trading law for the worse.”
On Oct. 6, 2017, Martoma asked for a rehearing en banc, and the Second Circuit may hear the case again if the rehearing is granted.