Securities Regulation Daily Insider trading ‘gift’ theory attaches regardless of personal relationship
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Monday, June 25, 2018

Insider trading ‘gift’ theory attaches regardless of personal relationship

By Anne Sherry, J.D.

A divided Second Circuit panel concluded that insider trading liability can rest on evidence that a tipper intended to benefit the tippee, even without evidence of a personal relationship between the parties. In amending an earlier opinion, the panel ruled that instructions given to the jury that convicted Mathew Martoma of securities fraud and conspiracy were erroneous but that the government provided ample evidence for a reasonable jury to convict under the correct standard. The dissenting judge argued that the majority improperly substituted a subjective test for an objective one, "rendering Newman a relic" (U.S. v. Martoma, June 25, 2018, Katzmann, R.).

The panel majority amended its controversial 2017 opinion, in which it had concluded that Salman v. U.S. (U.S. 2016) altered the analysis underlying U.S. v. Newman (2d Cir. 2013) such that the latter’s requirement of a "meaningfully close personal relationship" as a predicate to tippee liability was no longer good law. Martoma petitioned for rehearing or rehearing en banc, supported by a group of securities law professors and the New York Council of Defense Lawyers as amici. Martoma and amici argued that the panel improperly overruled circuit precedent, rendered Dirks’ personal benefit requirement meaningless, and raised due process concerns in its judicial expansion of insider-trading liability.

The amended opinion concludes that the instructions given to Martoma’s jury were inconsistent with Newman, but not, as Martoma had argued, because they omitted mention of a meaningfully close personal relationship. The jury instructions were erroneous because they allowed the jury to convict based on evidence of friendship alone, without requiring evidence of a quid pro quo or the tipper’s intention to benefit Martoma. However, the panel majority continued, the error did not affect Martoma’s rights because the government presented compelling evidence that at least one tipper shared a relationship suggesting a quid pro quo and received a personal benefit by disclosing inside information with the intention to benefit Martoma. The panel accordingly affirmed the convictions.

Ambiguity in Dirks. The majority based its conclusion on its reading of an "admittedly ambiguous" sentence of 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 intention to benefit the particular recipient." The majority reads this sentence as providing two unconnected possibilities: "there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or [there may be] an intention to benefit the particular recipient." Judge Pooler, who dissented from the original opinion, also dissented from the amended opinion. Her read of the sentence from Dirks is that the Supreme Court was describing "a relationship … that suggests … an intention to benefit the tippee."

"Whichever way Dirks is read," the majority wrote, "it recognizes that purposely benefitting the tippee with inside information proves that the tipper has received a personal benefit in breach of a fiduciary duty. The question is whether Dirks requires that to be proved with evidence of a relationship or not. We think it clear that the answer is no." While acknowledging that few decisions have relied on an intent-to-benefit theory, the majority said that the legitimacy of this theory has been uncontroversial, noting that it received no objections or challenge when included in the instructions presented to Martoma’s jury.

Newman does not require personal relationship. As for Newman, Martoma relied on its holding that inferring a personal benefit from a personal relationship between the tipper and tippee, where the tippee’s trades resemble the insider’s own trading followed by giving the profits to the recipient, is impermissible in the absence of proof of a meaningfully close personal relationship. Immediately after introducing this concept, however, Newman quoted the Dirks language about quid pro quo or intention to benefit. "In other words, Newman cabined the gift theory using two other freestanding personal benefits that have long been recognized by our case law."

The jury instructions should have informed the jury that it could find a personal benefit based on a gift of information only if it also found that the tipper and Martoma shared a relationship suggesting a quid pro quo or that the tipper intended to benefit Martoma with the inside information. The error did not affect Martoma’s substantial rights, however, because the government produced compelling evidence that the tipper "entered into a relationship of quid pro quo" by charging Martoma $1,000 per hour in consultation sessions that followed shortly after meetings at which the tipper would have learned new information to pass along.

Even if a jury were inclined to conclude that there was no quid pro quo because the tipper did not bill Martoma for two key consulting sessions, it could find that the tipper personally benefited by disclosing inside information with the intention to benefit Martoma. According to the majority, "a jury can often infer that a corporate insider receives a personal benefit (i.e., breaches his fiduciary duty) from deliberately disclosing valuable, confidential information without a corporate purpose and with the expectation that the tippee will trade on it." Here, the majority said, the tipper knew Martoma was seeking information on which to base trading decisions, and the tipper plainly understood how valuable the information he possessed was. From these facts, a reasonable jury could infer that the tipper personally benefited by conveying information with the purpose of benefiting Martoma, even in the absence of evidence of a personal relationship.

Dissent. Judge Pooler began her dissent by stating that the majority opinion "is in derogation of circuit precedent" because a three-judge panel cannot abrogate prior circuit decisions, and yet "only by abrogating Newman could my colleagues announce a new rule that a jury can infer a personal benefit based on a freestanding ‘intention to benefit.’" Referring, therefore, to the majority opinion as "dicta," the dissenting judge stressed that tippee liability must rest on objective evidence. Making objective evidence of personal benefit a prerequisite to tippee liability "avoids turning the rule into a mere formality." Without it, guilt or innocence would rest on "speculation into what a tippee knew or should have known about the tipper’s intent."

The government can demonstrate a personal benefit with evidence of a quid pro quo, or with evidence of a personal relationship suggesting a quid pro quo, or with evidence of other relationships that suggest an intention to benefit the recipient. Without objective evidence of such a relationship, however, there cannot be an inference that a gratuitous tip functioned as a gift. Newman, Judge Pooler argues, made clear that the gift theory does not apply merely because the parties were casual acquaintances or members of the same club or church, but the majority again attempts to rewrite Newman by holding that an uncompensated tip can be found to personally benefit the tipper as long as the tipper intended to benefit the tippee.

In Judge Pooler’s reading of the ambiguous Dirks sentence, it would be difficult to understand why the Court would provide an intention to benefit (a subjective fact) as an example of a personal benefit (an objective fact). It would be nearly as difficult to understand why the Court would have provided an intention to benefit a tippee as an example of a benefit to the tipper. "Intending to benefit somebody is not in itself a benefit," and it is not itself an objective fact or circumstance but rather an inference drawn from objective facts or circumstances. If the majority’s theory is that an intention to benefit a tippee is circumstantial evidence that a tipper is receiving some other benefit, it raises the question why the Dirks Court would have adopted the personal benefit test in the first place.

A proper jury instruction would have asked the jury whether the tipper and Martoma shared a relationship suggesting a quid pro quo or were close enough friends that the provision of information to Martoma could reasonably be understood to be a gift. Judge Pooler also disagreed that the error in the instructions was harmless. The record provided numerous reasons to doubt that the tipper and Martoma shared a meaningfully close personal relationship, and a reasonable jury could have doubted whether the relationship between them suggested a quid pro quo. The majority could have reached the result that it did by holding that the jury instructions were erroneous because they allowed for conviction absent objective evidence of a meaningfully close personal relationship, but harmless because there was objective evidence of a relationship suggesting a quid pro quo. Instead, they took a "detour" that cast doubt on established principles of insider trading law "that we have neither reason nor power to abrogate."

The case is No. 14-3599.

Attorneys: Robert Allen, U. S. Attorney's Office, for the United States. Paul D. Clement (Kirkland & Ellis LLP) for Mathew Martoma.

Companies: Elan Corporation, plc; Wyeth

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