In the Courts

Second Circuit Upholds Conviction for Insider Trading; Overrules Part of Newman

A three-judge panel of the U.S. Court of Appeals for the Second Circuit upheld the conviction of Mathew Martoma for insider trading and, in doing so, overruled part of United States v. Newman, 773 F.3d 438 (2d Cir. 2014), thereby removing one obstacle for prosecutions of insider trading. The 2-1 decision overruled the portion of the Newman decision that held that there must be a “meaningfully close personal relationship” to infer that the provider of insider information has received a benefit by providing that information to another to trade on, a requirement for a conviction on insider trading. Now, no such relationship must be proven in order for a jury to make an inference that a provider of nonpublic information received a benefit by tipping off another, making allegations for insider trading that much easier for the government to prove.

Martoma had been convicted of insider trading while he was a portfolio manager at SAC Capital Advisors LP (SAC), the firm founded by billionaire Steven A. Cohen, and was sentenced to nine years in prison. SAC, which once managed $14 billion, shut down in 2013 after it pled guilty to insider trading, and paid a $1.8 billion fine. Cohen is currently barred from trading client's money until 2018 by the SEC.

Martoma relied on tips from two doctors about an unsuccessful drug trial in order to divest SAC's holdings in the pharmaceutical companies responsible for the failed trial, saving SAC $275 million as a result. Prior to the sale of the stocks, and after Martoma's meeting with the two doctors who provided the tip, Martoma spoke to Cohen on the phone for 20 minutes. Cohen himself was ultimately not charged.

The Supreme Court has held that in order for an individual to be liable for insider trading, the “tipper” must have received a direct or indirect personal benefit from providing nonpublic information to the “tippee.” Dirks v. S.E.C., 463 U.S. 646 (1983).

The court said in Dirks that such a benefit can be inferred if the insider information is given to a relative or friend. However, under Newman, 773 F.3d at 452, the Second Circuit stated that this inference requires 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.” This ruling significantly restricted the type of behavior that would satisfy the personal-benefit requirement under Dirks, making convictions for insider trading more difficult for the government to prove.

Following the Newman decision, the Supreme Court then ruled in Salman v. United States, 137 S. Ct. 420 (2016), that there was no requirement that the benefit be of a tangible, pecuniary nature if the information was exchanged among relatives, thus overruling that portion of the Newman decision. However, after that case, the question was still left open about what type of benefit was required if the exchange of information was among friends.

On appeal, Martoma argued that the jury instructions were incorrect and that there wasn't enough evidence to convict him under the Newman standard. Martoma argued that the decision only applied to family members and close friends, and that there was no “close relationship” between himself and one of the doctors accused of providing him with the tip about the pharmaceutical trial. Therefore, he argued, a benefit could not be inferred without more evidence.

The Second Circuit, in a 2-1 decision, found that the Supreme Court's decision in Salman eliminated the requirement that there be a “meaningfully close personal relationship” to infer the existence of a benefit. Therefore, a benefit could be inferred when information was exchanged even in the absence of a close personal relationship or a clear tangible benefit.

The dissenting judge, Judge Rosemary S. Pooler, stated that she believed the majority's decision went too far in loosening the personal-benefit requirement set out in Dirks. Based on the divided panel, en banc review by the Second Circuit of the decision could be likely, especially considering the major implications for insider trading prosecutions that come from this decision. This decision could also be appealed up to the Supreme Court to provide more guidance for the lower courts on what is required for a conviction on insider trading.

— Kate Monks, Mayer Brown, Washington, DC.