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...
