In May, the Second Circuit Court of Appeals reconsidered United States v. Martoma, No. 14-3599 (2d Cir. Aug. 23, 2017) in regards to whether there needs to be a meaningfully close relationship between the tipper and tippee in cases of insider trading. The Securities and Exchange Act of 1934 prohibits individuals from trading securities based on material non-public information, however, conflicting interpretations of the provisions have created inconsistencies in case law.
Martoma, who worked for Steven A. Cohen, a hedge fund manager of SAC Capital Advisors, was originally convicted in February 2014, and sentenced to nine years in prison. Martoma received material nonpublic information from Dr. Sidney Gilman regarding an Alzheimer’s drug. This information led SAC to sell its $960 million stake in Elan Corporation and Wyeth Pharmaceuticals, and avoid over $276 million in losses. On appeal, Martoma argued that Dr. Gilman, the tippee, did not provide material information in exchange for a personal benefit, and the information could not be considered as a gift due to the lack of a close relationship between the two parties.
On August 23, 2017 a divided Second Circuit (2-1) upheld Martoma’s conviction based upon the Supreme Court’s decision this past December in Salman v. United States, which effectively overruled a prior Second Circuit decision, United States v. Newman. In Newman, (which was central to Martoma’s argument on appeal), the Second Circuit held that the SEC must illustrate “a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature” (known as the personal benefit test). In Newman, because there was no close relationship between the tippees and tippers, the parties could not be found liable for insider trading.
However, in Salman v. United States, the Supreme Court found two brothers, with an obviously close relationship, liable for insider trading. The Court found that a gift of non-public material information to a relative or friend satisfies the personal benefit test of Newman. Judge Robert A. Katzmann explained in the majority opinion of Martoma that “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.”
In dissent, Judge Rosemary S. Pooler argued that this decision, affirming Salman, “radically alters insider-trading law for the worse”. The impact of this decision will expand the scope of how liability under insider trading is interpreted. Without the requirement of a close personal relationship between the tippee and tipper or a personal benefit, the U.S. Attorney’s Office for the Southern District of New York will have a longer leash to bring claims against individuals who even share information without an intention to receive a personal benefit. However, the parameters of insider trading have frequently fluctuated since the 1980s. As such, the Second Circuit may go back to the Newman test in the future, especially if this opens the floodgates of insider trading litigation.