United States: Hello, Newman. A Second Circuit Panel Revives U.S. V. Newman's Personal Benefit Test, Maybe.

On June 25, 2018, the Second Circuit Court of Appeals issued a revised opinion in United States v. Martoma, No. 14-3599, Dkt No. 226. (2d Cir. Jun. 25, 2018) ("Martoma"). While the outcome for Matthew Martoma does not change—his conviction for insider trading still stands—other defendants facing insider trading charges may once again, at least for the present, avail themselves of the Second Circuit's more stringent personal benefit test under United States v. Newman, 773 F.3d 438 (2d Cir. 2014) ("Newman").

The Court's original opinion, issued in 2017, acknowledged that Salman v. United States, 137 S. Ct. 420 (2016) ("Salman") "fundamentally altered the analysis underlying Newman's 'meaningfully close personal relationship' requirement such that the 'meaningfully close personal relationship' requirement is no longer good law." United States v. Martoma, 869 F.3d 58, 69 (2d Cir. 2017) ("Martoma 2017"). In a surprise move, however, the revised opinion relies on Newman to find error in the district court's jury instructions, not because they omitted the term "meaningfully close personal relationship," but because they allowed the jury to find a personal benefit in the form of a "gift of confidential information to a trading relative or friend" without requiring the jury to find either that (1) the tipper and tippee shared a relationship suggesting a quid pro quo from the tippee or (2) the tipper gifted the confidential information with the intention to benefit the tippee.

Mathew Martoma was a portfolio manager at S.A.C. Capital Advisors, LLC ("SAC"). Martoma's portfolio included two pharmaceutical companies, Elan Corporation, plc ("Elan") and Wyeth Pharmaceuticals, Inc. ("Wyeth"), that were jointly developing an experimental drug to treat Alzheimer's disease. Martoma engaged two doctors working on the experiment for multiple consultations, paying $1000 for each consult. Before Elan and Wyeth publicly disclosed negative results of a clinical trial, one of the doctors revealed the results to Martoma. The next day, SAC began to reduce its positions in Elan and Wyeth and entered into short‐sale and options trades before the results were made public. After the results were publicly disclosed, Elan and Wyeth's share prices declined approximately 42% and 12%, respectively. SAC made approximately $80.3 million and averted losses of approximately $194.6 million.

The district court instructed the jurors that, in order to convict Martoma, they must decide whether the doctors received or anticipated receiving a "personal benefit" by disclosing the information. The jurors could infer a personal benefit if the doctors gave the information (1) with the intention of benefiting themselves in some manner, (2) with the intention of conferring a benefit on Martoma, or (3) as a gift with the goal of maintaining or developing a personal friendship or a useful networking contact. The jury returned a conviction on February 6, 2014.

Tippee liability, i.e., the liability of one receiving and trading on inside information provided by an insider "tipper," is based on several layers of tests. The original framework of tests is set forth in Dirks v. S.E.C., 463 U.S. 646 (1983) ("Dirks"). Under Dirks, tippee liability depends on whether the tipper "has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach." Dirks at 660. The test for whether the tipper breached his fiduciary duty "is whether the [tipper] personally will benefit, directly or indirectly, from his disclosure" to the tippee. Id. at 662. In other words, the preliminary test for tippee liability is whether the tipper personally benefits from giving the tippee the information.

The secondary layer tests whether the tipper personally benefitted from the disclosure of information. Dirks explained that a personal benefit to the tipper could be inferred if the tipper made "a gift of confidential information to a trading relative or friend," i.e., a tippee, where "[t]he tip and trade resemble trading by the [tipper] himself followed by a gift of the profits to the [tippee]." Dirks, at 664. Dirks also held that "a relationship between the [tipper] and the [tippee] that suggests a quid pro quo from the [tippee], or an intention to benefit the [tippee]" would justify the inference of a personal benefit to the tipper. Id. It is this test, whether the tipper personally benefitted, that is the focus of Newman and the Court's revised opinion in Martoma

In United States v. Newman, 773 F.3d 438 (2d Cir. 2014) ("Newman"), the Second Circuit held that a "personal benefit" could not be inferred under the "gift" theory—making a "gift" of inside information to "a trading relative or friend" where the tippee's trades "resemble trading by the [tipper] himself followed by a gift of the profits to the [tippee]" (Dirks at 664)—unless there was a "meaningfully close personal relationship [between the tipper and the tippee] that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature." Newman at 452. The Court explained that this standard "requires evidence of 'a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the [latter].'" Id. (quoting United States v. Jiau, 734 F.3d 147, 153 (2d Cir. 2013) (quoting Dirks, 463 U.S. at 664)). In other words, Newman rolled the three examples provided in Dirks into one, holding that, under the gift theory, the inference of a personal benefit could not be drawn from the gift of information alone, but only when the tipper made the gift in the context of a quid pro quo relationship or with the intent to benefit the tipper.

Two years after Newman, the U.S. Supreme Court decided Salman v. United States, 137 S. Ct. 420 (2016)("Salman"). In Salman, the Supreme Court rejected Newman's requirement that there must be a "meaningfully close personal relationship" in order to infer a personal benefit to a tipper who gifted information to a tippee. "To 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." Salman at 428. "When a tipper gives inside information to 'a trading relative or friend,' the jury can infer that the tipper meant to provide the equivalent of a cash gift. In such situations, the tipper benefits personally because giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds." Id . In other words, under Salman, a gift of confidential information to a "trading relative or friend"—and nothing more—is sufficient basis to infer a personal benefit to the tipper.

In Martoma 2017, the Second Circuit upheld Martoma's conviction. Martoma 2017 explicitly held that Salman had abrogated Newman's "meaningfully close personal relationship" requirement for the personal benefit test and that Martoma's jury instructions were not erroneous. The Court clarified, however, that even if the instructions had been erroneous, this would not have affected the outcome because there was overwhelming evidence that at least one doctor received a personal benefit—to the tune of $70,000—by disclosing the information to Martoma.

On June 28, 2018, the Second Circuit issued its revised opinion. In Martoma, the Court held that Martoma's jury instructions were erroneous under Newman, not because they omitted the term "meaningfully close personal relationship," but because they allowed the jury to find a personal benefit in the form of a "gift of confidential information to a trading relative or friend" without requiring the jury to find either "evidence of 'a relationship between the [tipper] and the [tippee] that suggests a quid pro quo from the [tippee], or an intention to benefit the [tippee].'" Martoma at 6. In other words, the Court made a semantic swap of "meaningfully close personal relationship" for its evidentiary equivalent of "a relationship between the [tipper] and the [tippee] that suggests a quid pro quo from the [tippee], or an intention to benefit the [tippee].'" Notwithstanding the error, the Court preserved Martoma's conviction because there was no error in the district court's instructions that the jury could also find a personal benefit based on either of those two factors alone, i.e., if it concluded that [the doctor] disclosed confidential information "with the intention of conferring a benefit on Mr. Martoma," or "with the intention of benefiting [himself] in some manner." Each of these personal benefits is unaffected by Newman's interpretation of the gift theory, and neither requires proof that [the doctor] and Martoma share any type of "personal relationship.

Martoma at 32.

After Martoma, the test for tippee liability in the Second Circuit is confusing at best and contravenes Salman at worst. It remains to be seen if the Court will issue an opinion en banc to clarify the Circuit's personal benefit test, or whether the Supreme Court will again weigh in to address, and possibly re-abrogate, Newman. In the meantime, defendants facing insider trading charges in the Circuit should make the most of Newman's more stringent personal benefit theory, but only while it lasts.

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