On August 23, 2017, a divided U.S. federal appeals court affirmed the conviction of a former hedge fund portfolio manager for insider trading based on allegations that he traded on confidential information received from two doctors who worked on a clinical trial for an experimental Alzheimer's drug.
In United States v. Martoma, the United States Court of Appeals for the Second Circuit affirmed the conviction of Mathew Martoma, a former portfolio manager at SAC Capital Advisors. Mr. Martoma, originally convicted in 2014, argued on appeal that the jury instructions were inadequate in light of the Second Circuit's subsequent decision in U.S. v. Newman. In Newman, the Second Circuit held that the government must demonstrate that a tipper and tippee have 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" to infer a personal benefit from a personal relationship for the tipper. In his appeal, Mr. Martoma sought a retrial because he allegedly did not have a "meaningfully close personal relationship" with the doctors, and because the doctors had not received any "objective, consequential . . . gain of a pecuniary or similarly valuable nature."
Recently, the United States Supreme Court also weighed in on tipper/tippee liability in United States v. Salman (see previous coverage). In Salman, the Court partially overruled Newman and held that when a tipper "gifts" inside information to a "trading relative or friend," the jury "can infer that the tipper meant to provide the equivalent of a cash gift." In doing so, the Court abrogated Newman's requirement that a tipper receive something of a "pecuniary or similarly valuable nature" in exchange for a gift to family or friends.
In the case of Mr. Martoma, the Second Circuit held that Salman also rejected the "meaningfully close personal relationship" requirement instituted by Newman: "Following the logic of the Supreme Court's reasoning in Salman, interpreting [ Dirks v. SEC], we think that Newman's 'meaningfully close personal relationship' requirement can no longer be sustained." In light of Salman, the Second Circuit held that a tipper benefits personally when he "gifts" information to a tippee "with the expectation that the recipient would trade on the basis of such information or otherwise exploit it for his pecuniary gain." According to the Court, liability arises from these circumstances because the disclosure "resembles trading by the insider followed by a gift of the profits to the recipient."
In a lengthy dissenting opinion, Judge Rosemary S. Pooler argued that the ruling "radically alters insider-trading law for the worse." Judge Pooler expressed concern that the majority opinion "significantly diminishes the limiting power of the personal benefit rule" by expanding "gift"-based liability for insider trading beyond disclosures to friends and family, with an increased potential to ensnare persons with innocent intentions.
Commentary / Nathan Bull
In Martoma, the Second Circuit held that criminal insider trading liability may arise from a tipper's "gift" of material, non-public information to a tippee that the tipper "expects will trade on the information," whether or not there was a close personal relationship between the tipper and tippee. The far-reaching decision significantly expands the category of persons that, upon the disclosure of confidential information without pecuniary or tangible benefit, may constitute tippers or tippees subject to insider trading liability in the Second Circuit. Indeed, the Court made clear that liability for "gifted" information may now extend well beyond friends and family to far less substantial relationships, including tenants and doormen or even acquaintances. The decision expressly rejected the more stringent standard previously set forth by the Second Circuit in Newman (which required a "meaningfully close personal relationship") and clarifies the scope of potential liability set forth in the Supreme Court's recent landmark holding in Salman (which concerned trading relatives).
This comment was co-authored by Lex Urban.
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