Last week's dueling Second Circuit opinions in United States v. Martoma – Chief Judge Katzman’s 37-page majority opinion and Judge Pooler vigorous 44-page dissent – once again transformed insider trading law. In the aftermath of last December's U.S. Supreme Court decision in Salman, Martoma modified, if not overruled, the circuit's prior decision in United States v. Newman. 

Legal Background

In its seminal 1983 Dirks v. SEC decision, the Supreme Court held that the “tippee” who receives material, non-public information from an insider and then trades on that information can only be liable for violation of the securities law if the insider/“tipper” received some form of a personal benefit for providing the information. In such cases, the Supreme Court explained, the tipper's duty to the corporation transfers to the tippee, who is obligated not to trade on information received from an insider who disclosed the information in breach of a fiduciary duty to that corporation. Under Dirks, therefore, whether the tipper breached a fiduciary duty depends on whether the tipper received some form of a “personal benefit” for providing the information. The Supreme Court, however, did not specify what exactly constitutes a personal benefit. While the Court defined “personal benefit” as including pecuniary and reputational gain, it also held that a “personal benefit” may be inferred “when an insider makes a gift of confidential information to a trading relative or friend.” 

The Dirks personal benefit language figured prominently in the personal benefit instruction to the jury in the trial leading to Martoma’s 2014 conviction in the Southern District of New York. However, later that year, while Martoma’s appeal was pending, the Second Circuit dramatically impacted insider trading prosecutions in Newman when it took a narrow reading of the Dirks personal benefit requirement. In the context of an insider’s gift of secret information to a trading relative or friend, Newman held that a personal benefit may only be inferred when there is a showing of both (1) a “meaningfully close personal relationship” and (2) “a potential gain of a pecuniary or similarly valuable nature” to the tipper. Based on that ruling, Martoma argued for reversal of his conviction, challenging the Dirks-based jury charge as legally erroneous.

But in December 2016, before Martoma’s appeal was decided, the Supreme Court again addressed the personal benefit rule in Salman v. United States, holding that a corporate insider who gifts information to a relative need not have received a pecuniary benefit in order to impute liability to the trading outsider. The Court relied on Dirks' reasoning that a tipper providing inside information to a trading relative is the equivalent of the tipper trading on such inside information himself and then gifting the proceeds to that relative, and thus benefitting from the gift itself. Salman thus, at the very least, undermined the Newman holding, although to what extent was unclear. And so the Second Circuit, which was still considering Martoma’s appeal, scheduled further oral argument to address Salman, leading to last week’s decision. 

The Decision

Martoma, a former manager for SAC Capital Advisors LP, was convicted in September 2014 and sentenced to nine years in prison on multiple counts of securities fraud violations for receiving and trading on insider information provided by doctors who worked on the drug trials of an experimental drug. Trading executed by Martoma and SAC in advance of the public announcement of the tipped information resulted, after the stock drop from public disclosure, in some $80 million in gains, $195 million in averted losses and a $9 million bonus to Martoma.

In last week’s decision, the Second Circuit held that under the Supreme Court’s reasoning in Salman, Newman’s meaningful relationship requirement can no longer be sustained.

[W]e hold 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.”

The court noted that although Salman involved a tip by a corporate insider to his brother and this case involved a more nuanced relationship between Martoma and the doctors, Salman did not distinguish between gifts to relatives or friends and gifts to others less close to the tipper. Therefore, the court concluded that under Salman, the same rule applied whether or not there was a “meaningfully close personal relationship” between the tipper and tippee.

The Dissent

In her 44-page dissenting opinion, Judge Pooler argued that Salman did not overrule Newman’s “meaningfully close personal relationship” requirement, nor did it change the personal benefit rule, as the majority does here, by holding that a person who gives insider information as a gift to anyone, whether or not a relative or friend, always receives a personal benefit. Thus, Judge Pooler argued the majority’s holding eradicates limits previously placed by the personal benefit requirement. Because the majority’s holding requires subjective rather than objective proof, she concluded, it allows for the prosecution of individuals with innocent motives. 

Impact

Martoma arguably makes insider trading prosecution easier because it eliminates the government’s need to show a meaningful relationship between tippers and tippees. In contrast, however, the decision is likely to lead to increased disputes and new defense theories over the tipper’s subjective expectations and whether the disclosure resembles trading by the insider followed by a cash gift.

In any event, the vitality of the Second Circuit’s holding remains uncertain. Given Judge Pooler’s lengthy dissent and because the panel arguably reversed circuit precedent if Salman is read as not itself having done so, a rehearing en banc in Martoma may well ensue. Regardless of whether further clarity may come from the Second Circuit or the Supreme Court, however, each of the dueling Martoma opinions provides detailed analyses of the evolution and current state of insider trading law that will serve as guidance for prosecutors and defense counsel alike in future cases.