Featured Expert Contributor, Corporate Governance/Securities Law
Stephen M. Bainbridge, William D. Warren Distinguished Professor of Law, UCLA School of Law.
Matthew Martoma was a portfolio manager at S.A.C. Capital Advisors, LLC, a hedge fund owned and managed by Steven A. Cohen, which had been the subject of numerous insider trading investigations. One of those investigations resulted in Martoma being charged with insider trading on the stocks of a pair of drug companies developing a new Alzheimer’s disease drug treatment. Martoma had received tips of material nonpublic information about the treatment from two drug company employees. Martoma was convicted and appealed.
In a 2-1 opinion by Chief Judge Katzmann, the Second Circuit affirmed Martoma’s conviction. Its decision in United States v. Martoma is the first major interpretation of the Supreme Court’s decision in Salman v. United States, and the first effort to determine the remaining scope, if any, of the Second Circuit’s 2014 decision in United States v. Newman.
In Dirks v. Securities and Exchange Commission, the Court had held that the liability of tippees like Martoma was derivative of that of the tippers. Accordingly, the government must prove—among other things—that the tipper received a personal benefit from making the tip.
In Newman, the Second Circuit held that the personal benefit requirement could not be satisfied simply by “the mere fact of a friendship, particularly of a casual or social nature.” Instead, there must be proof of “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.”
In Salman, the defendant argued that a “gift of confidential information to a trading relative or friend,” was insufficient to establish insider trading liability “unless the tipper’s goal in disclosing inside information [wa]s to obtain money, property, or something of tangible value,” citing Newman. The Supreme Court rejected that argument, holding that the requisite personal benefit includes “the benefit one would obtain from simply making a gift of confidential information to a trading relative.”
In doing so, the Supreme Court took a swipe at the Newman decision, opining that “[t]o the extent the Second Circuit held that the tipper must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends, … this requirement is inconsistent with Dirks.”
As Judge Pooler pointed out in his Martoma dissent, Salman spoke exclusively to the question of whether a gift of information—absent a quid pro quo—satisfied the personal benefit requirement. The Supreme Court did not overrule Newman’s requirement that there be proof that the parties to the gift had a meaningfully close personal relationship. Judge Pooler reasoned:
Beyond leaving Newman’s first holding untouched, the Supreme Court’s decision in Salman also declined to adopt the government’s theory of the personal benefit rule, which would have broadened the gift-giving doctrine substantially. In Salman, the government argued that “a gift of confidential information to anyone, not just a ‘trading relative or friend,’ is enough to prove securities fraud.” Such a holding would have substantially broadened the rule in Dirks, which stated that a personal benefit may be inferred when “an insider makes a gift of confidential information to a trading relative or friend.” The Supreme Court did not adopt the government’s view, deciding instead to “adhere to Dirks.”
Oddly, however, the Chief Judge’s majority decision held that Salman had in fact rejected the meaningful-personal-friendship requirement:
Thus, we 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,’ whether or not there was a ‘meaningfully close personal relationship’ between the tipper and tippee.
The majority’s holding guts the personal benefit requirement. In effect, any disclosure could now be characterized as a gift (assuming the tipper expects the tippee to trade on it). But that outcome flies in the face of the Supreme Court’s emphasis in both Dirks and Salman that the core of tipping liability is intended to deal with gifts among trading relatives and friends. It also flies in the face of the Supreme Court’s refusal to adopt the broad standard for which the government argued in Salman.
It’s conceivable that the Martoma saga may not be over. There are several reasons the Second Circuit could decide to rehear the case en banc. First, as Chief Judge Katzmann acknowledged, it is rare for a panel to overturn established Second Circuit precedent. Second, Judge Pooler’s strong dissent may raise doubts about the validity of the majority’s reasoning. Finally, given that the Second Circuit is the epicenter of insider trading litigation, the other circuit judges may feel it appropriate for the court as a whole to render an opinion on this crucial and controversial issue. And, of course, Martoma might seek Supreme Court review as well.
On the other hand, there is a strong argument that the personal benefit aspect of Martoma is pure dicta. Although there was no direct exchange of money between Martoma and the doctors in connection with the specific tip at issue in this case, there was evidence at trial that one of the doctors regularly gave Martoma confidential information in return for fees. As the majority observed, the two had an “ongoing ‘relationship of quid pro quo,’” which even Newman had acknowledged could constitute a pecuniary benefit sufficient to support an insider trading conviction.
As a result, even if the Martoma case is now at end, the last word on this issue may not have spoken.