Pomerantz LLP

Second Circuit Reconsiders “Personal Benefit” Requirement

Attorney: Marc C. Gorrie
Pomerantz Monitor September/October 2017

As the Monitor has reported, in the past year there have been numerous developments concerning the requirements for criminal liability for insider trading. Most recently, in U.S. v. Martoma, the Second Circuit revisited its 2014 decision in U.S. v. Newman and decided that there was no requirement, after all, that the recipient of the leaked information (the “tippee”) be a close relative or friend of the insider who leaked the information (the “tipper”).

The seminal case in this area is the 1983 Supreme Court decision in Dirks v. Securities and Exchange Commission.

There, the Court held that culpability for insider trading can exist if the tipper received a personal benefit for leaking the information, such as when he “makes a gift of confidential information to a trading relative or friend.” The Court did not elaborate on how close the relationship had to be between the tipper and the “trading relative or friend.”

When the Second Circuit decided Newman in 2014, it effectively put the brakes on much of the government’s expansive insider trader enforcement efforts. The Newman court overturned the convictions of two “remote” tippees, who had received the information indirectly from the original tippee. The Newman court held that the government must prove that the tipper had a “meaningfully close personal relationship” with the tippee, and that he expected “at least a potential gain of a pecuniary or similarly valuable nature” to support a finding of criminal liability for insider trading. This heightened standard required a showing that the tipper received some “tangible” benefit other than the satisfaction of rewarding the friend or relative – an interpretation rejected by other circuits. Further, the Second Circuit required that the government must also demonstrate the tippee knew that the tipper breached a fiduciary duty. This can present a major problem if the defendant is a remote tippee, such as colleagues of the original tippee at a brokerage firm, who may have little information of how the information was obtained and under what circumstances.

In Salman v. United States, the Supreme Court affirmed the defendant’s conviction for insider trading, unanimously holding that a jury may infer a personal benefit when a tipper provides inside information to a relative or friend, and that this is sufficient for a finding of criminal liability for insider trading. The Supreme Court went on to address the Second Circuit’s Newman decision, finding that any requirement “that the tipper must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends” is inconsistent with Dirks.

On August 23, 2017, the Second Circuit affirmed the insider trading conviction of Mathew Martoma in a 2-1 opinion holding that the Supreme Court’s decision in Salman effectively overruled Newman’s requirement of a “meaningfully close personal relationship,” but did not disturb Newman’s other requirement that a tippee knew that the tipper breached a duty and received a benefit.

Martoma was a pharmaceutical and healthcare portfolio manager at S.A.C. Capital Advisors, LLC, (“S.A.C.”), a former group of hedge funds founded by Steven A. Cohen. During the course of his employment,  he acquired shares of Elan and Wyeth, two companies that were developing an experimental Alzheimer’s drug. Martoma executed these trades based on information he obtained from the chair of the safety monitoring committee for the drug’s clinical trial, Dr. Sidney Gilman. The two of them met in approximately 43 consultations where, for some, Martoma paid Gilman $1,000 per hour. Dr. Gilman disclosed trial results and other confidential information to Martoma during these consultations.

Martoma and Gilman met twice, just before a conference at which Gilman was to present the clinical trial results of the new drug. After these two meetings but before the conference, S.A.C. began to reduce its positions in Elan and Wyeth. Following Gilman’s July 29 presentation disclosing that the drug failed to improve cognitive function in a test of 234 Alzheimer’s patients after 18 months of treatment, the share prices of Elan and Wyeth plummeted. The trades that Martoma’s hedge fund had made in advance of the presentation resulted in approximately $80 million in gains and $195 million in averted losses.

Martoma was convicted of insider trading and during his appeal, the Supreme Court decided Salman, doing away with the personal benefit requirement. Martoma argued that the jury instructions improperly ignored that he did not have a close personal or family relationship with the tipper.

The Second Circuit held that the logic of Salman meant that “Newman’s meaningfully close personal relation- ship requirement can no longer be sustained.” The Court held that “the straightforward logic of the giftgiving analysis in Dirks, strongly reaffirmed in Salman, is that a corporate insider personally benefits whenever he discloses inside information as a gift with the expectation that the recipient would trade on the basis of such information or otherwise exploit it for his pecuniary gain” – whether the recipient has a close personal relationship with the tipper or not.

Acknowledging a vigorous dissent that argued that Salman did not overrule Newman’s “meaningfully close personal relationship” requirement where inferring a personal benefit from a gift, the majority concluded that though the government must still prove that the tipper received a personal benefit, a “meaningfully close personal relationship” need not exist between tipper and tippee.

Though the Second Circuit dispensed with Newman’s “meaningfully close personal relationship” requirement, the other controversial Newman requirement, that the tippee knew the tipper provided inside information in exchange for some benefit, apparently remains intact. Additionally, it appears that one fact-sensitive evidentiary foray was replaced with another, with the government now having to prove “the expectation that the recipient would trade” based on inside information. En banc review of Martoma may also be on the horizon, as the dissent contended the Martoma court could not overrule Newman without convening en banc.