Last week, a three-judge panel of the federal appeals court in New York upheld the September 2014 conviction of Mathew Martoma, a former portfolio manager for S.A.C. Capital Advisors, LLC – then a hedge fund – for insider trading.
The court held by a 2-1 vote that, contrary to guidance in a 2014 decision it also issued, a corporate insider who has a fiduciary duty not to disclose any material, nonpublic information of his company (“tipper”) and a non-insider who receives material, nonpublic information (“tippee”) are not required to have a “meaningfully close personal relationship” to infer the tipper’s receipt of a personal benefit for a gift of proprietary information to the tippee.
Mr. Martoma was found guilty of insider trading and later sentenced to nine years imprisonment in 2014 as a result of his role in the trading of the securities of two pharmaceutical companies by SAC Capital following his receipt of alleged insider information from at least one paid consultant regarding the efficacy of an experimental drug the companies were developing to treat Alzheimer's.
According to a 1983 decision by the US Supreme Court, the receipt of a personal benefit is a requisite to finding that a tipper breached his/her fiduciary duty to his/her company. Only if a tippee knew or should have known that the tipper was breaching his/her fiduciary relationship to his/her company, can a tippee potentially be convicted for insider trading. (Click here to access the Supreme Court’s decision in Dirks v. SEC.) Previously, the Supreme Court ruled that, absent a breach of a fiduciary duty, there is generally no prohibition for market participants from trading on material, non-public information. (Click here to access the Supreme Court’s decision in Chiarella v. United States.)
In some cases, said the Supreme Court in its 1983 decision, the relationship between a tipper and tippee suggests a “quid pro quo” or an intention to benefit the tippee. In other circumstances, however, where an insider provides a gift of confidential information to a relative or friend who then trades on it, “[t]he tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.”
In this case involving Mr. Martoma, the federal appeals court held that “a corporate insider personally benefits whenever he ‘discloses information as a gift …with the expectation that [the recipient] would trade’ on the basis of such information …because such a disclosure is the functional equivalent of trading on the information himself and giving a cash gift to the recipient.” (Emphasis added.) There does not need to be a “meaningfully close relationship” between a tipper and tippee for prohibited insider trading to occur, explained the court.
The federal appeals court hearing Mr. Martoma’s appeal had ruled differently in a 2014 decision reversing the insider-trader conviction of Todd Newman and Anthony Chiasson – former portfolio managers – for insider trading. There the court held that, in its prosecution of the defendants, the US government failed to demonstrate that the initial insiders from whom defendants’ liability ultimately derived received sufficient personal benefit to establish their (let alone defendants’) securities law liability. In part, this was because there was no meaningfully close relationship between the tipper and tippee. (Click here for background on this decision in the article “Appeals Court Sets Aside Insider Trading Convictions Saying Traders Distance From Corporate Insiders Too Far” in the December 14, 2014 edition of Bridging the Week.)
Subsequent to the Newman decision, however, the US Supreme Court reiterated its earlier 1983 pronouncement that, “the giving of a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds” to a tippee whenever a corporate insider gives confidential information with the expectation that the recipient will trade based on it. This was done in a decision upholding the insider-trading conviction of Bassam Salman, an individual trader. (Click here for background on this decision in the article “Supreme Court Rules Sharing of Nonpublic Information With Relative Is Sufficient to Find Illegal Insider Trading in Tipper/Tippee Context” in the December 11, 2016 edition of Bridging the Week.) The federal appeals court acknowledged in upholding Mr. Martoma’s conviction that it was revising its views expressed in Newman relying on the “logic” of the Supreme Court’s decision in Salman.
Although the federal appeals court in Martoma determined to follow Salman, it noted that it did not have to in order to uphold Mr. Martoma’s conviction. This was because, in this case, the tipper that provided Mr. Martoma with confidential insight regarding the experimental Alzheimer's drug received “substantial financial benefit” for providing nonpublic information – concretely evidencing his breach of fiduciary duty. Specifically, the court observed that for 18 months, the alleged tipper – the paid consultant – billed Mr. Martoma US $1,000/hour for 43 hours of consultation sessions.
One judge – the Hon. Rosemary Pooler – dissented from the court’s majority opinion, claiming that if someone who gives a gift of inside information is deemed always to have received a personal benefit there may be no limitation on who may ultimately be prosecuted as a potential tippee. “[T]here is great wisdom in the Supreme Court’s limitations on broad rules, particularly when those rules might otherwise allow punishment of the absentminded in addition to persons with corrupt intentions,” wrote Ms. Pooler.
Legal Weeds: The provisions of applicable law and SEC rule that serve as the basis for a civil action or criminal prosecution for insider trading of securities are the inspiration for similar provisions of law and a rule of the Commodity Futures Trading Commission that prohibit employment of a manipulative or deceptive device or contrivance in connection with futures and swaps trading. (Click here to access the relevant securities law, 15 USC § 78j(b) and here to access SEC Regulation 10b-5, 17 CFR §240.10b-5. Click here to access 7 US Code § 9(1), and here to access CFTC Rule 180.1.) The CFTC has brought two actions that sound in the securities law concept of insider trading for an employee impermissibly trading based on futures positions of his employer. (Click here for background on both cases in the article “Ex-Airline Employee Sued by CFTC for Insider Trading of Futures Based on Misappropriated Information” in the October 2, 2016 edition of Bridging the Week.) The CFTC has not brought the equivalent of an insider trading enforcement action against anyone other than a person who, as an employee, directly was alleged to have misappropriated the nonpublic, confidential information of his employer.