United States: Second Circuit's Martoma Decision Enhances The Government's Ability To Prosecute Insider Trading Cases

On August 23, the United States Court of Appeals for the Second Circuit affirmed the high-profile insider trading conviction of SAC Capital Advisor LP manager Matthew Martoma. The appellate court's decision, which eliminates the need to prove a "close personal relationship" between tippers and tipees who exchange confidential information, will likely expand the number of criminal insider trading prosecutions by the federal government, and make it easier for prosecutors to pursue, and net convictions.

Background on the Personal Benefit Rule

Since the U.S. Supreme Court's seminal Dirks v. SEC decision in 1983, the government has had to prove unlawful insider trading by demonstrating that the tipper breached a duty in exchange for a "personal benefit."[1]

The Second Circuit later refined the personal benefit rule in 2014's United States v. Newman. In that case, the court held that it's permissible to infer that tippers receive such a benefit, only where there's "proof of a meaningfully close personal relationship [between the tipper and the tippee] that generated an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature."[2]

Newman redefined the insider trading landscape, but it took a little over two years for the Supreme Court to essentially overturn that language. In December 2016's Salman v. United States decision, the Court made clear that it's permissible to infer that a tipper receives a personal benefit when he or she makes a gift of confidential information to a relative or friend, even without proof that the benefit is of a "pecuniary or similarly valuable nature."[3] In those circumstances, the Court found that the gift of confidential information is the functional equivalent of the insider trading on the information and presenting the proceeds of the trade to the tippee.

Personal Benefit Rule Changes Again in Martoma

In the latest Martoma decision, the Second Circuit voted 2-1 to alter its standard for defining the "personal benefit" requirement. In this latest interpretation, the appellate court held that a tipper is not required to have a "meaningful close personal relationship" with a tippee in order to reap a personal benefit sufficient enough to give rise to criminal liability for insider trading.[4]

Martoma was responsible for managing $400 to $500 million of SAC's pharmaceutical and health care investments. He allegedly learned from doctors Sidney Gilman and Joel Ross that a clinical trial for an experimental Alzheimer's drug had gone poorly. Martoma used this tip to reduce SAC's holdings in the companies developing the experimental drug, a move which generated approximately $80 million in profits and helped avoid losses of approximately $275 million. Martoma was convicted in February 2014, and is currently serving a nine year prison sentence – one of the longest jail terms ever imposed in an insider trading case.

On appeal, Martoma contended that Sidney Gilman was a casual acquaintance who was not compensated for the consulting meetings during which the tip was disclosed. Thus, in light of Newman, they did not have a "meaningfully close personal relationship."[5] However the appellate court rejected Martoma's claim, with the majority holding that Martoma's "quid pro quo" relationship with the tipping doctor, whose consulting rate was $1,000 per hour, was sufficient to support a conviction.[6]

In doing so, the court explained that insiders personally benefit any time they disclose information with the expectation that the tippee will trade on the information, and where the disclosure was equivalent to a gift of the trading proceeds by the tipper.[7]

Ramifications of the Martoma Decision

In her lone dissent, Judge Rosemary S. Pooler lamented that the "majority opinion significantly diminishes the limiting power of the personal benefit rule, and radically alters insider-trading law for the worse."[8] By eliminating the "close personal relationship" requirement, the Second Circuit has left many more individuals potentially liable for insider trading, and has no doubt made it easier for prosecutors to pursue, and win cases. If this new "personal benefits" standard survives a potential en banc review it will be up to the Second Circuit lower courts to implement the new standard while not running afoul of the Supreme Court's imposition of the "personal benefits" requirement.


[1] 463 U.S. at 663.

[2] 773 F.3d at 452.

[3] Salman, 137 S. Ct. at 428.

[4] Martoma,14-3599, 2017 WL 3611518, at *10 (2d. Cir. Aug. 23, 2017).

[5] Id.

[6] Id. at *6.

[7] Id. at *8.

[8] Id. at. *11.

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