The U.S. Court of Appeals made a major change to insider trading law in its ruling this week in Martoma v. United States, involving Matthew Martoma, a former portfolio manager at S.A.C. Capital Advisors. The Second Circuit held that the inference of a personal benefit to a tipper no longer requires a showing of a “meaningfully close personal relationship,” as had been ruled in the 2014 case United States v. Newman.
The Newman and Salman Cases
In the Newman case, the Second Circuit held in 2014 that that a conviction for insider trading cannot be sustained unless it can be shown both that the tipper received a “personal benefit” in exchange for the information provided and that the tippee had knowledge that the tipper had received the personal benefit. The Second Circuit also held that the existence of a personal benefit cannot be inferred by a jury unless there is “proof of a meaningfully close personal relationship” between the tipper and tippee “that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” This decision sent shockwaves through Wall Street and appeared to open an enormous loophole in the then-existing body of insider trading law.
Then, in December of 2016, the U.S. Supreme Court handed down a decision in Salman v. United States in which the Court rejected at least some portion of Newman. The Court found that Salman could be resolved merely by reference to its prior precedent, United States. v. Dirks. Applying the plain language of Dirks to the Salman case, which involved tips of confidential information between family members, the Supreme Court reaffirmed its holding in Dirks that a personal benefit can be inferred when the tipper “makes a gift of confidential information to a trading relative or friend.” The Supreme Court then opined that “to the extent that 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 a trading relative, that rule is inconsistent with Dirks.”
Following Salman, however, some question remained as to whether the Supreme Court had abrogated the portion of Newman which held that “proof of a meaningfully close personal relationship” was required to infer the existence of a personal benefit flowing to a tipper.
The Martoma Case
Matthew Martoma was convicted in September 2014 of insider trading, based on a scheme in which Martoma had contacted expert networking firms and arranged paid consultations with two doctors, both of whom relayed to him confidential information on ongoing clinical drug trials. On appeal, Martoma argued that his conviction should be reversed because, notwithstanding the Supreme Court’s decision in Salman, the trial court had failed to instruct the jury on Newman’s holding that an inference of a personal benefit to the tippers was “impermissible in the absence of proof of a meaningfully close personal relationship.” The Second Circuit rejected this argument, finding 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.”
Looking closely at the logic of the Supreme Court’s holdings in Dirks and later Salman, the Second Circuit found that in cases where a tipper makes a gift of confidential information, “such a disclosure is the functional equivalent of trading on the information himself and giving a cash gift to the recipient.” The Court found that “nothing in Salman’s reaffirmation of this logic supports a distinction between gifts to people with whom a tipper shares a ‘meaningfully close personal relationship’ … and gifts to those with whom a tipper does not share such a relationship.” Quoting from Salman and Dirks, respectively, the Court then articulated the rule 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 that “the disclosure ‘resemble[s] trading by the insider followed by a gift of the profits to the recipient[.]'” This rule applies “whether or not there was a ‘meaningfully close personal relationship’ between the tipper and tippee.”
The Martoma case appears to relegate much of the holding of Newman to a detour in the history of insider trading jurisprudence, to be studied intently by law students, but no longer applicable. The portion of Newman requiring that a tippee know of the benefit flowing to the tipper appears, however, to still be good law. Thus, in insider trading cases involving remote tippees several times removed from the original tipper, Newman will likely still be a boon to defendants. It remains to be seen whether the Department of Justice and Securities and Exchange Commission, with Newman no longer as significant an impediment to sustaining insider trading claims, will repeat their past successes in the Second Circuit, many of which were undone by Newman.