The Second Circuit confirmed this week that a "meaningfully close personal relationship" is not required for insider-trading liability where a tipper discloses inside information as a gift with the intent to benefit the tippee. The June 25, 2018 decision on panel rehearing in United States v. Martoma (No. 14-3599) retreats from the panel's original decision and no longer effectively overrules a portion of the Second Circuit's 2014 decision in United States v. Newman, which had refused to infer a tipper's intent to benefit a tippee in the absence of a meaningfully close relationship and a pecuniary or similarly valuable benefit in exchange for the tip. The new panel decision – again a 2-1 ruling – now holds that the requisite relationship described in Newman can be established by proving "either [i] that the tipper and tippee shared a relationship suggesting a quid pro quo or [ii] that the tipper gifted confidential information with the intention to benefit the tippee."
The latest decision again means that insider-trading liability can be established in the Second Circuit "by evidence that the tipper's disclosure of inside information was intended to benefit the tippee," regardless of the nature of the tipper's and tippee's personal relationship. Whether the panel's new effort to avoid outright rejection of Newman will suffice to prevent en banc rehearing and a certiorari petition remains to be seen.
The Martoma case arose out of the Government's investigation of a prominent hedge fund. Mathew Martoma, a portfolio manager at the fund, had had dealings with two doctors who had been involved in the clinical trial of a drug for Alzheimer's disease. The doctors had entered into paid consulting arrangements with the fund under contracts through expert-networking agencies.
The Government alleged that at least one of the doctors had shared confidential safety data about the drug with Martoma, leading Martoma and the hedge fund to build and maintain positions in the securities of the two companies that owned rights to the drug. The Government also alleged that the doctor had given Martoma advance information of the drug trial's failure – and that the fund had then sold off its positions in the two drug companies' stock before the news became public. Martoma was convicted of insider trading and conspiracy to commit securities fraud.
Martoma appealed, claiming that the Government had not proven that the doctor had received a legally sufficient personal benefit in exchange for providing the confidential information. Martoma's argument focused on the interplay among the Supreme Court's 1983 decision in Dirks v. SEC, the Second Circuit's 2014 decision in Newman, and the Supreme Court's 2016 decision in Salman v. United States.
The Dirks case established the framework for tippee liability. The Supreme Court held that the liability of a tippee (such as Martoma) derives from the liability of his or her tipper (such as the doctor) – and that a tipper breaches a fiduciary duty by disclosing confidential information only if he or she benefits directly or indirectly from the disclosure. The Court gave examples of such a personal benefit, including "a pecuniary gain," "a reputational benefit that will translate into future earnings," "a relationship between the [tipper] and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient," or "a gift of confidential information to a trading relative or friend" where "[t]he tip and trade resemble trading by the [tipper] himself followed by a gift of the profits to the recipient." In 2014, the Second Circuit announced a more rigorous construction of Dirks's personal-benefit requirement. The court ruled in Newman that...