One issue with which courts dealing with insider trading cases have struggled is how to interpret and apply the personal benefit element of the liability standard. The personal benefit standard was in fact an important part of the U.S. Supreme Court’s 2016 decision in Salman v. United States (as discussed here). Last week, the Second Circuit issued an important decision in the United States v. Martoma, in which the appellate court provided important additional perspective on the personal benefit test. In the following guest post, Brad S. Karp, Geoffrey R. Chepiga, Daniel J. Kramer, Lorin L. Reisner, Audra J. Soloway, and Richard C. Tarlowe of the Paul Weiss law firm take a look at the Second Circuit’s decision in the Martoma case and the appellate court’s discussion of the personal benefit test. I would like to thank the authors for their willingness to allow me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ guest post.
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On Wednesday, in United States v. Martoma, the United States Court of Appeals for the Second Circuit overruled its own 2014 decision in United States v. Newman and altered the standard for determining whether the personal benefit element of insider trading has been satisfied. The decision had been eagerly anticipated as a key test for how courts would interpret the U.S. Supreme Court’s 2016 decision in Salman v. United States.
For more than 30 years, since the Supreme Court’s seminal decision in Dirks v. SEC, the dividing line between lawful trading on material, nonpublic information and unlawful insider trading has been whether the tipper breached a duty in exchange for a “personal benefit.” In most cases, courts have had little difficulty defining the boundaries of that requirement because either the tipper received a financial benefit, or the tippee was a close friend or relative with whom the insider had no legitimate, business reason to be sharing confidential corporate information. In those circumstances, courts have generally permitted an inference of a personal benefit.
In Newman, however, the Second Circuit was faced with a corporate insider (an investor relations employee) who shared information with an analyst at an institutional investor. In order to enforce the dividing line created by the Dirks Court, and avoid chilling legitimate communications between market professionals and company insiders, the Second Circuit in Newman held that, in the absence of an explicit quid pro quo, a gift of confidential information from a tipper to a tippee could only amount to a “personal benefit” when the tipper had a “meaningfully close personal relationship” with the tippee.
On Wednesday, however, the Second Circuit panel majority in Martoma overruled that test and created a new standard for defining the boundaries of the “personal benefit” requirement: a “personal benefit” to the tipper may exist “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 the profits to the recipient.”[1] One judge dissented from the panel’s decision.
If the Second Circuit’s new test for determining “personal benefit” survives a potential en banc review, it will remain to be seen how lower courts implement that test, particularly in the context of communications between a corporate insider and a market professional. It will be incumbent upon the courts to ensure the test has real teeth to address the Supreme Court’s concerns in Dirks and avoid blurring the line between lawful and unlawful trading.
The “Personal Benefit” Requirement
In Dirks v. SEC, [2] the U.S. Supreme Court held that trading on material, nonpublic information is not, without more, unlawful. Rather, tippers must receive a personal benefit for insider trading to be unlawful. [3] The Court viewed it as “essential” that there be a “guiding principle” for market participants “whose daily activities must be limited and instructed by the SEC’s inside-trading rules.”[4] Accordingly, the Court held that the “test” for determining whether such a breach has occurred is “whether the insider personally will benefit, directly or indirectly, from his disclosure.”[5] “Absent some personal gain” by the insider, there has been no breach and thus no duty to refrain from trading.[6]
Prior to the Second Circuit’s 2014 decision in United States v. Newman, the personal benefit requirement was generally not perceived as imposing a particularly high bar. Nonpecuniary benefits, including friendship and “gifts” of information, were generally viewed as sufficient to constitute a personal benefit that triggered a duty to abstain from trading. But in many of those cases, the facts easily permitted an inference of a personal benefit because the tippee was a close friend or relative and therefore the insider had no legitimate reason to be discussing corporate information with them.
In Newman, however, where the tippee was a market professional whose job involved speaking to company insiders, the Second Circuit imposed a more stringent test of what constitutes a personal benefit.[7] In that case, portfolio managers at two hedge funds were convicted after trial based on alleged tips from an investor relations employee to an analyst. The government argued that the personal benefit to the investor relations employee included career advice and friendship.[8] The Newman panel held that in the context of a gift of inside information, a personal benefit to the tipper requires “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.” The panel held that absent potential financial gain in response to the gift, no personal benefit exists.[9] [10]
After the Second Circuit’s decision in Newman, the Supreme Court considered the scope of the personal benefit requirement in Salman. There, the tipper was an investment banker who provided material, nonpublic information about impending mergers to his brother who, in turn, provided the information to Salman, his brother-in-law. In affirming Salman’s conviction, the Court concluded that a gift of confidential information to a trading relative or friend satisfies the personal benefit requirement.[11] The Court characterized the issue presented as a “narrow” one that was “easily...
