The U.S. Court of Appeals for the Second Circuit in August closed a window it had opened three years earlier in the law of insider trading that created greater leeway for trading on inside tips from people other than close friends and family members. In United States v. Martoma, the Second Circuit affirmed the 2014 conviction of hedge fund trader Michael Martoma, who, through well-timed short sales of two drug companies’ stock, generated millions of dollars in profits and avoided losses based on tips from a doctor involved in drug trials. Martoma’s appeal was based, in essence, on the proposition that he was not a close friend of the doctor/tipper, and that he (the tippee) had to have been one in order to be liable for insider trading. The Second Circuit rejected that argument, and thus overruled the key holding of United States v. Newman (773 F.3d 438 (2d Cir. 2014)). The court concluded that the law did not require a “meaningfully close personal relationship” between tipper and tippee, as Newman required, for a tippee like Martoma to be liable for trading on a tip provided as a gift.
This past August, the SEC reached an agreement with hedge fund advisory firm Deerfield Management for $4.6 million to settle charges that it did not have the necessary preventative measures in place to prevent insider trading. The case alleged that some Deerfield analysts traded on information from a political intelligence analyst working at the Centers for Medicare and Medicaid Services who also provided consulting services for the fund. The case underscores the need for investment fund advisory firms to adopt policies and procedures relating to the particular risks presented by their businesses.