United States: Insider Trading Law Alert: Better The Devil You Know? Tipping Liability, Martoma And The Rise Of 18 U.S.C. § 1348

Last Updated: June 6 2019
Article by Mark D. Cahn, Elizabeth Mitchell and Brett Atanasio

Insider trading has frequently been splashed across headlines in recent months, with a congressman, an NFL player, a comedy writer, and a Silicon Valley executive all facing charges.1 In the background of these headlines are two legal developments that give the government greater flexibility to successfully litigate future insider trading cases, particularly those involving tipping.2

First, the US Court of Appeals for the Second Circuit's revised decision in United States v. Martoma3 embraced a broad theory of liability under Section 10(b) of the Securities Exchange Act and Rule 10b-5 (hereinafter, collectively, "Section 10(b)") that prohibits a party from tipping with an "intent to benefit" the recipient. Second, when prosecutors have pursued tipping cases under 18 U.S.C. § 1348, a criminal securities fraud provision adopted as part of the Sarbanes-Oxley Act of 2002, courts have interpreted this newer securities fraud statute to have less stringent requirements than Section 10(b). 

These two developments could lead the government to take a more aggressive stance on tipping charges in the future, and both finance professionals and lawyers need to be aware that the ground may be shifting under them.4

United States v. Martoma

In United States v. Martoma, the Second Circuit grappled with the question of whether liability under Section 10(b) attaches when a tipper passes along material nonpublic information to another person, even a casual acquaintance, who later trades on that information, and the tipper receives no apparent financial reward in return. Reflecting the uncertainty in this area, the Second Circuit issued an initial opinion in 2017 and then a revised panel opinion nine months later. This revised opinion changed the landscape of tipping jurisprudence, at least in the Second Circuit.

By way of background, the US Supreme Court first addressed liability associated with the tipping of material nonpublic information in Dirks v. SEC.5 The Dirks Court held that not all tippers and recipients of material, nonpublic information face liability for subsequent trading.6 Instead, a tippee assumes the tipper's fiduciary duty, and thus is prohibited from trading, only where the tipper "has breached his fiduciary duty . . . by disclosing the information to the tippee. . . ."7  Further, the tipper's tip is a breach of fiduciary duty only where the tipper receives a "personal benefit" from the disclosure.8 The Dirks Court explained: "the test is whether the insider personally will benefit, directly or indirectly, from the disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach" by the tippee.9   

When the tipper receives money, other financial remuneration or some other thing of value (like lobsters or an iPhone10) in exchange for sharing material nonpublic information, courts and juries have had little trouble finding a sufficient "personal benefit" to establish liability. The issue of liability in the absence of any apparent financial or other tangible benefit to the tipper is more difficult and has bounced back and forth to and from the Supreme Court:  

  • In 1983, in Dirks, the Supreme Court wrote that a gift of confidential information to a trading relative or friend—where the tip and the trade resemble trading by the tipper, followed by a gift of the profits to the recipient—is sufficient to establish tipping liability.11
  • Thirty years later, in United States v. Newman, the Second Circuit attempted to cabin the reach of Dirks, holding that, under the gift theory, there must be both evidence of a "meaningfully close personal relationship" between the tipper and the tippee, and evidence that the personal benefit reflects "an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature."12
  • In 2016, in Salman v. United States,13 the Supreme Court rejected Newman's requirement of proof of potential pecuniary gain in the context of gifts of information to trading relatives or friends, holding that "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."14 

Enter United States v. Martoma. A doctor who chaired the safety monitoring committee for the clinical trial of an Elan and Wyeth experimental drug to treat Alzheimer's disease provided Martoma with information demonstrating the drug was not effective; Martoma then sold Elan and Wyeth securities and engaged in other transactions related to the companies.15 Martoma was convicted of insider trading in 2016.16  

On appeal, Martoma challenged the jury instructions and the sufficiency of the evidence. In its August 2017 opinion (Martoma I), the Second Circuit panel took a broad view of the Supreme Court's decision in Salman and found not only that the Court rejected Newman's "pecuniary gain" requirement, but also that the "meaningfully close personal relationship" standard in Newman was no longer good law.17 The Martoma I panel held that "an insider or tipper personally benefits from a disclosure of confidential information whenever the information was disclosed with the expectation that the recipient would trade on it . . . and the disclosure resembles trading by the insider followed by a gift of profits to the recipient."18 (emphasis added). The panel then held that there was no clear error in the jury instruction and there was sufficient evidence to convict Martoma.19

In its revised opinion, Martoma II, the panel changed its analysis. The panel revived the "meaningfully close personal relationship" standard, reasoning that it was simply an articulation of already established theories for showing an inferred benefit to the tipper.20 More important, however, the panel embraced a separate and distinct theory of tipping liability predicated not on the parties' relationship, but on whether the tipper intended to benefit the tippee, which (the panel remarked) could be inferred from circumstantial evidence.21

The panel based its embrace of the "intent to benefit" theory on a close grammatical analysis of the following sentence in Dirks: "For example, there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intent to benefit the particular recipient."22  (emphasis added). The panel acknowledged that the comma and the word "or" in the sentence were ambiguous.23 However, the panel chose to interpret the separate clauses to articulate two separate and distinct ways of proving a personal benefit: 1) a personal relationship suggesting a quid pro quo, or 2) an intent by the tipper to benefit the tippee.24

The possible breadth of this holding, though downplayed by the panel, is clear from the hypothetical the panel embraced:

For example, suppose a tipper discloses inside information to a perfect stranger and says, in effect, you can make a lot of money by trading on this. Under the dissent's approach, this . . . would be insufficient to show a breach of the tipper's fiduciary duty to the firm due to the lack of a personal relationship. Dirks and Warde do not demand such a result. Rather, the statement "you can make a lot of money by trading on this," following the disclosure of material non-public information, suggests an intention to benefit the tippee in breach of the insider's fiduciary duty.25

Under the panel's hypothetical, both the tipper and the tippee would be liable if the tippee traded on the information. As Judge Pooler pointed out in her dissent, this standard circumvents hurdles the government previously had to overcome, including proof of a close personal relationship between the tipper and the tippee or some other meaningful benefit for the tipper from the tip.26 Instead, all the government would have to prove to establish tipping liability is that the insider gave material, nonpublic information "intending to benefit the recipient." And as the panel noted, intent to benefit the tippee can be inferred from circumstantial evidence, not just explicit statements of the kind put forth in the panel's hypothetical.27

Given the nebulous standard of whether the tipper "intended to benefit" the tippee and given the ability to infer this intent from circumstantial evidence, Martoma II creates considerable uncertainty as to where the line of liability may be drawn in future cases.

The Rise of 18 U.S.C. § 1348 to Prosecute Insider Trading

Against the backdrop of uncertainty under Section 10(b) tipping jurisprudence, prosecutors have begun increasingly to charge insider trading, including in tipping cases, under 18 U.S.C. § 1348 in tandem with Section 10(b). Section 1348, which was adopted in the Sarbanes-Oxley Act, mirrors the mail and wire fraud statutes. Courts have interpreted the law to impose less stringent requirements on the government than traditional tipping jurisprudence.28

For example, in tipping cases brought under Section 10(b), it must be shown that the tipper 1) intentionally or recklessly communicated, 2) material, nonpublic information, 3) in breach of a fiduciary duty or confidentiality owed to shareholders or the source of the information, 4) for a personal benefit to the tipper, 5) with scienter.29 In contrast, under Section 1348, courts have held that the government need only prove 1) fraudulent intent, 2) a scheme or artifice to defraud, and 3) a nexus with a security.30 Thus, the fiduciary duty and personal benefit requirements that have been constructed under Section 10(b) tipping jurisprudence need not be proven in Section 1348 cases. Because Section 1348 broadly covers a scheme or artifice to defraud or otherwise obtain money or property through fraud, prosecutors have used Section 1348 to charge various theories of insider trading, including the classical,31 misappropriation32 and tipping33 theories of liability.

The government's use of twin charges under Section 10(b) and Section 1348 has increased over the years and appears to be paying off for the government. In one such recent case, United States v. Blaszczak, defendant Worrall, who worked at the Centers for Medicare & Medicaid Services (CMS), provided information about proposed changes in CMS reimbursement practices to Blaszczak, who shared it with Deerfield Capital partners Olan and Huber. At trial, Judge Kaplan rejected proposed jury instructions for the Section 1348 charges that would have required the jury to find both that Worrall breached his fiduciary duty in exchange for a personal benefit and that the tippees knew of the benefit and breach.34 The tippees were each convicted on the Section 1348 charges but acquitted on the Section 10(b) charges.35  The case is currently being appealed to the Second Circuit.36

Notably, an October 2018 law review article written by the Department of Justice Fraud Section chief and assistant chief notes that "the case law surrounding section 1348 offers prosecutors something of a fresh start in interpreting a securities fraud statute. Section 10b-5, for all of its versatility, has been interpreted so extensively that the case law underlying it is, at times, unhelpful to the government."37 The article further notes that "a wide variety of [10b-5] cases across the circuits [] can cause confusion for prosecutors and judges alike. Section 1348 . . . offers a simpler approach."38 The authors also highlighted that Section 1348 has a lower scienter requirement (knowingly) than 10b-5 (willfully), does not require a purchase or sale of a security as 10b-5 does, and has a longer maximum sentence (25 years) than 10b-5 does.39

Conclusions

The law around tipping has been in flux for the past several years, and will likely continue to be in flux as the Second Circuit and other courts grapple with complex issues relating to the Supreme Court's decision in Salman and the Second Circuit's decisions in Newman and Martoma. For now, Martoma II has embraced a broad theory that tippers are liable when they give material, nonpublic information to a tippee with an intent to benefit the tippee, which can be proven based on circumstantial evidence. Judge Pooler's strong dissent insisting that this theory is not consistent with precedent suggests that the issue is not settled. And indeed, Martoma has filed a petition for certiorari,40 leaving open the possibility that the Supreme Court will soon weigh in on these issues again. 

In light of this shifting case law, the government has turned to another more versatile tool in its belt, 18 U.S.C. § 1348. In light of the uncertainty presented in Section 10(b) and 10b-5 law and the lower bar presented by the elements of Section 1348, tipping charges under Section 1348 may become increasingly more common.

This client alert was republished by The Harvard Law School Forum on Corporate Governance and Financial Regulation.

  1. Press Release, Sec.'s & Exch. Comm'n, SEC Charges NFL Player and Former Investment Banker with Insider Trading (Aug. 29, 2018); Press Release, Sec.'s & Exch. Comm'n, SEC Charges U.S. Congressman and Others with Insider Trading (Aug. 8, 2018); Press Release, Sec.'s & Exch. Comm'n, SEC Detects Silicon Valley Executive's Insider Trading (July 24, 2018).
  2. Tipping occurs when an insider, the "tipper," gives material, nonpublic information to another person, the "tippee," and the tippee then trades on that information.
  3. United States v. Martoma, 894 F.3d 64 (2d Cir. 2017) (hereafter Martoma II).
  4. As of this publication, a cert petition is pending before the US Supreme Court in United States v. Martoma. See generally Petition for Certiorari, United States v. Martoma, 894 F.3d 64 (2d Cir. 2018) (No. 14-3599). The Court has not decided whether it will hear the appeal.
  5. Dirks v. SEC, 463 U.S. 646 (1983).
  6. Id. at 659.
  7. Id. at 660.
  8. Id. at 662.
  9. Id.
  10. See United States v. Jiau, 734 F.3d 147, 153 (2d Cir. 2013).
  11. Dirks, 463 U.S. at 664.
  12. United States v. Newman, 773 F.3d 438, 452 (2d Cir. 2014).
  13. Salman v. United States, 137 S. Ct. 420 (2016).
  14. Id. at 427–28.
  15. Martoma II, 894 F.3d at 69.
  16. Id. at 68.
  17. United States v. Martoma, 869 F.3d 58, 69 (2d Cir. 2017) (hereafter Martoma I).
  18. Id. at 70 (citations and quotation marks omitted).
  19. Id. at 67, 73–74.
  20. Martoma II, 894 F.3d at 77.
  21. Id. at 76.
  22. Dirks, 463 U.S. at 646, 664 (1983).
  23. Martoma II, 894 F.3d at 74.
  24. Id. at 74.
  25. Id. at 75.
  26. Id. at 84 (Pooler, J., dissenting).
  27. Id. at 76.
  28. See United States v. Mahaffy, 693 F.3d 113, 125 (2d Cir. 2012); United States v. Melvin, 143 F. Supp. 3d 1354 (N.D. Ga. 2015); United States v. Hatfield, 724 F. Supp. 2d 321, 324 (E.D.N.Y. 2010); United States v. Motz, 652 F. Supp. 2d 284, 294 (E.D.N.Y. 2009); United States v. Mahaffy, No. 05-CR-613, 2006 U.S. Dist. LEXIS 53577, at *34 (E.D.N.Y. Aug. 2, 2006).
  29. SEC v. Obus, 693 F.3d 276, 286, 289 (2d. Cir. 2012).
  30. See Mahaffy, 693 F.3d at 125; Motz, 652 F. Supp. 2d at 294; Hatfield, 724 F. Supp. 2d at 324; Mahaffy, 2006 U.S. Dist. LEXIS 53577, at *34.
  31. See, e.g., Second Superseding Indictment at 21, 61, United States v. Turino, (No. 2:09-CR-132-RLH-RJJ), 2010 WL 4023000 (D. Nev., Mar. 24, 2010) (alleging a Section 1348 violation for violating a duty to shareholders by selling shares based on false statements and inside information).
  32. See generally Complaint, United States v. Fei Yan (S.D.N.Y July 11, 2017) (No. 17-MAG-5156) (involving an alleged misappropriation case).
  33. See generally Melvin, 143 F. Supp. 3d 1354 (involving a case of tipping).
  34. See Stewart Bishop, Medicare Insider Trading Case Beset By Flaws, 2nd Circ. Told, Law360 (Mar. 11, 2019, 7:17 p.m.), https://www.law360.com/articles/1136609/medicare-insider-trading-case-beset-by-flaws-2nd-circ-told; Brief and Special Appendix for Defendant-Appellant Theodore Huber at 15–16, United States v. Blaszczak (2d Cir. Mar. 5, 2019) (No. 18-2811), 2019 WL 1177546, at *15–16.
  35. Worrall, the tipper, was convicted of the wire fraud and conversion of government property, but acquitted on the charge of securities fraud. See Brendan Pierson, Four found guilty in insider trading case linked to U.S. health agency, Reuters (May 3, 2018), https://www.reuters.com/article/us-usa-crime-healthcare/four-found-guilty-in-insider-trading-case-linked-to-us-health-agency-idUSKBN1I42P4.
  36. See generally Brief and Special Appendix for Defendant-Appellant Theodore Huber, supra note 34.
  37. Sandra Moser and Justin Weitz, 18 U.S.C. § 1348—A Workhorse Statute for Prosecutors, 66 DOJ J. Fed. L. & Prac. 111, 120 (2018).
  38. Id. at 120–21.
  39. Id. at 121–122.
  40. See supra note 4.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions