Insider Trading

“It’s Complicated:” The Evolving Case Law on How Relationships Impact Insider Trading Liability

Last Wednesday, former SAC Capital Advisors manager Mathew Martoma lost a bid to overturn his 2014 insider trading conviction in the Second Circuit.  United States v. Martoma, No. 14-3599, 2017 WL 3611518 (2d Cir. Aug. 23, 2017).  Martoma, the latest in a string of important insider trading decisions, is significant because the Second Circuit departed from the “relationship test” that had been central to Second Circuit insider trading cases in recent years.  See United States v. Newman, 773 F.3d 438 (2d Cir. 2014).  The departure was based on a 2016 Supreme Court decision, Salman v. U.S., in which the Court rejected the “relationship test” as set forth in Newman, and reaffirmed the standard set in Dirks v. SEC, 463 U.S. 646, 103 S. Ct. 3255, 77 L. Ed. 2d 911 (1983), holding that where a close relationship exists between the tipper and tippee, the government is not required to show that the insider received a benefit of a “pecuniary or similarly valuable nature.”  Martoma had appealed his conviction before Salman was issued, and relied heavily on the Second Circuit’s relationship test outlined in Newman.

In Newman, the Second Circuit overturned the insider trading convictions of two portfolio managers who were “remote tippees,” individuals who traded on inside information but with one or more layers of individuals between them and the insider who originally provided the information.  The insiders in Newman were friends with the tippees but did not gain any personal benefit in exchange for the information provided.  The government argued in that case that it only needed to show that the tippees traded on “material, nonpublic information they knew insiders had disclosed in breach of a duty of confidentiality.”  However, the Second Circuit rejected that argument, explaining that the government was required to show that the insider shared confidential information in exchange for a personal benefit, and that the remote tippees were aware of that fact.  The Second Circuit also held that where there is no quid pro quo exchange for confidential information given by a tipper to a tippee, such information only amounts to a “personal benefit” when the tipper has a “meaningfully close personal relationship” with the tippee.  To meet the test, that relationship must “generat[e] an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”  (Emphasis added.)  Essentially, if there was no potential for financial gain resulting from the gift of information, no personal benefit existed under Newman.  In the immediate aftermath of Newman, many insider trading prosecutions within the Second Circuit became untenable and were dropped.

Martoma’s appeal relied heavily on Newman, which was decided after his original conviction.  He claimed that he and the tipper, a doctor, did not have a “meaningfully close personal relationship,” and that the doctor had not received any personal benefit in exchange for the confidential information he provided Martoma.  Martoma also argued that even if the evidence was sufficient to uphold his conviction, the district court’s jury instructions were insufficient because they did not instruct the jury regarding the “personal benefit” requirement under Newman.  However, while Martoma’s appeal was pending, the Supreme Court issued its decision in Salman v. United States, 137 S. Ct. 420, 196 L. Ed. 2d 351 (2016).  Salman explicitly rejected Newman’s requirement that the tipper must receive something of a “pecuniary or similarly valuable nature” in exchange for a gift to family or friends.  The Court held that providing information to a relative or friend who later trades on it is sufficient to satisfy the personal benefit requirement, although it did not specify how close the relationship must be.  After Salman was decided, Martoma offered supplemental briefing in the Second Circuit, arguing that his conviction still should be reversed because Salman did not overrule Newman’s “meaningfully close personal relationship” requirement.

The Second Circuit rejected Martoma’s argument and held that Salman overruled Newman to the extent Newman required a “meaningfully close personal relationship” between the tipper and tippee.  The court further held that there was no clear error in the jury instructions, and that any alleged error would not have changed the outcome of the trial because the government presented “overwhelming evidence that at least one tipper had received a financial benefit from providing confidential information to Martoma.”

While on its face Martoma appears to have opened the door to a broader range of insider trading prosecutions than were possible under preexisting Second Circuit case law, Judge Pooler’s 44-page dissent calls into question what the effect of the decision will be.  Her dissent argues that the Second Circuit panel went far beyond the limitation previous Supreme Court precedent set, which she said had not been disturbed by Salman.  That limitation was that an insider only receives a personal benefit from gifting information when it is gifted to family or friends—as these people are very unlikely to use the information for valid commercial reasons.  Furthermore, in the dissent’s view, the majority opinion “radically alters insider-trading law for the worse.”  Judge Pooler’s scathing dissent could indicate that the Second Circuit will convene an en banc panel to review the decision.  If en banc review is denied or if the panel affirms the decision, it is expected that Martoma will appeal to the Supreme Court.  In any event, the Martoma opinion may not be the final word on this topic.

Government Leaks Lead to Landmark Insider Trading Case

On May 24, 2017, the SEC for the first time brought charges based on allegations of insider trading on confidential government information. The alleged insider trading scheme involved tips related to three announcements by the Center for Medicare & Medicaid Services (“CMS”) regarding non-public rate changing decisions affecting the stock of issuers in the healthcare industry.

The complaint alleges that from May 2012 to November 2013, Christopher Worrall, a health insurance specialist in the Center for Medicare (“CM”), the CMS component that administers Medicare’s national payment systems and determines Medicare reimbursement rates, tipped his long-time friend David Blaszczak about internal deliberations and planned actions of CMS.  Blaszczak is a consultant specializing in healthcare policy issues and a former CMS employee. READ MORE

The Potential Declawing of the SEC: The Financial CHOICE Act

Gavel and Hundred-Dollar Bill

The Financial CHOICE Act (or “CHOICE Act 2.0”), which would significantly narrow the SEC’s ability to bring enforcement actions and make it more challenging for it to prevail in such actions, is inching its way towards becoming law. On May 4, 2017, the Financial Services Committee passed the Act and it is now slated to be introduced to the House in the coming weeks. As part of the push by the current administration to deregulate, this bill aims to repeal key provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, including those directed towards the SEC.  Although the Act has a long way to go before it is enacted, many of its provisions would have far-reaching consequences and would change the way the SEC operates as we know it.

Should the CHOICE Act 2.0 become law, the following are some of the more important effects it would have on the SEC’s enforcement abilities:

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What to Watch for From the New SEC Chairman

Last Thursday, Jay Clayton was officially sworn in as the new Chairman of the Securities and Exchange Commission.  As the new Chairman takes office, here are a few things we’re keeping an eye on:

Will Chairman Clayton take a position on the recently introduced bipartisan bill that would increase civil monetary penalties in SEC enforcement actions?  The “Stronger Enforcement of Civil Penalties Act of 2017” would significantly increase civil monetary penalties in enforcement actions to as much as $1 million per violation for individuals and $10 million per violation for entities, or three times the money gained in the violation or lost by the victims.  The current maximum civil monetary penalties are $181,071 and $905,353 per violation for individuals and entities, respectively.

Will the new Chairman preserve the directive reportedly issued by former Acting Chairman Michael Piwowar to re-centralize authority to issue formal orders of investigation?  In 2009, the SEC adopted a rule that delegated authority to issue formal orders initiating investigations to the Director of Enforcement, who then “sub-delegated” it to regional and associate directors and unit chiefs within the Enforcement Division.  In February, Piwowar reportedly revoked the “sub-delegated” authority, ordering it re-centralized exclusively with the Director of Enforcement.

Will enforcement actions against public companies increase or decrease after hitting their highest level since 2009 last year?  A recent report issued by the NYU Pollack Center for Law & Business and Cornerstone Research found that the 92 actions the SEC brought against public companies and their subsidiaries in 2016 is more than double the level of enforcement activity from just three years prior. READ MORE

The Call for a Statutory Insider Trading Law

Judge Jed S. Rakoff (S.D.N.Y.) recently made headlines after urging lawyers to draft and advocate for a more straightforward insider trading statute to replace judicially-created insider trading law. During his keynote speech at the New York City Bar’s annual Securities Litigation & Enforcement Institute, Judge Rakoff explained that the law has become overly-complicated since courts were forced to define insider trading by shoehorning the concept into the fraud provisions of the Securities Exchange Act of 1934. As a result, increasingly suspect theories have been developed to address potential insider trading in an expanding variety of scenarios.

In promoting a statutory solution for insider trading law, Judge Rakoff pointed to the Europe Union (“EU”) as an example. He explained that the EU defined insider trading by statute in simple and broad terms, and avoided relying on the framework of fraud.  Considering Judge Rakoff’s influence and expertise in securities law, inquiry into the EU’s approach to insider trading is warranted.

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SEC Reportedly Centralizing Authority to Issue Formal Investigation Orders

According to a report in the Wall Street Journal, the acting Chairman of the Securities and Exchange Commission has centralized authority to issue formal orders of investigation – a critical authority that triggers the ability of SEC staff attorneys to issue subpoenas.  The move, which was not publicized by the SEC, would curb existing powers of the Commission’s enforcement staff.

Since 2009, the power to issue formal orders of investigation had been “sub-delegated” to about 20 senior attorneys within the SEC’s Enforcement Division. However, according to the Journal report, acting SEC Chairman Michael Piwowar ordered the authority to be centralized exclusively with the Director of Enforcement. READ MORE

Insider Trading Around Private Placements: Was Tom Price’s Investment Down Under Above Board?

On February 10, the Senate confirmed Representative Tom Price (R-GA) as Secretary of Health and Human Services, where he will oversee the U.S. Food and Drug Administration (FDA). His nomination has not been without controversy, including several Senators and a coalition of public interest advocacy groups demanding an investigation into whether Price violated insider trading laws when he invested in an Australian pharmaceutical company last summer.  This highlights some basic precautionary steps that public companies can take when considering private placements.

The company Price invested in, Innate Immunotherapeutics, is working to develop a single product. The company is essentially a bet that the drug will succeed in clinical trials and receive FDA approval.  Price was introduced to the company by Representative Chris Collins (R-NY), who sits on the company’s board and is its largest shareholder.  The introduction was regarding a private placement that Innate was offering to select U.S. investors to raise additional working capital for a clinical trial and to “seek approval from the United States Food and Drug Administration for an Investigational New Drug programme in the United States,” among other purposes.  The private placement was priced at $0.18 USD per share, a 12% discount to the stock’s market price in early June 2016 (the stock is publicly traded on the Australian Securities Exchange).  Even though both Price and Collins sit on committees that oversee the health care and pharmaceutical industries, both invested in the private placement last summer.

President Trump nominated Price to head HHS on November 29, 2016.  By then, Innmate’s share price had risen to $0.58 USD.  The stock peaked at $1.39 USD on January 25, 2016, representing a 670% increase on the congressmen’s investments.  Last Friday, when the Senate confirmed Price, the stock closed at $0.71 USD.

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Salman v. U.S.: Supreme Court Resolves Insider Trading Split

On December 6, 2016, the United States Supreme Court affirmed an insider trading conviction in a case where the “insider” obtained no direct pecuniary benefit from the disclosure.  Justice Samuel Alito, writing for a unanimous court, held that a recipient of insider information may still be criminally liable where the insider initially gave the information to a trading relative or friend and thereby received a “personal benefit.”  The court heard oral arguments in October.

Salman v. United States concerned the prosecution of Bassam Salman, a recipient of insider tips from Michael Kara, his brother in law, who in turn received insider information from his brother, Maher Kara.  Salman knew that Michael, who also traded on the information, was getting tips from Maher, a Citigroup banker working on various health care deals.  Maher, the “tipper,” never received any financial or other concrete benefit in the exchange, but testified that he suspected Michael was trading on the information he provided and there was evidence the brothers had a close relationship. READ MORE

Supreme Court Weighs Insider Trading: Friends, Family, and Others

On October 5, 2016, the Supreme Court heard oral arguments in US v. Salman, a closely-watched insider trading case in which the Ninth Circuit held that, where the insider had a close personal relationship with the tippee, a remote tippee could be liable for insider trading even in the absence of a pecuniary benefit to the tipper. In so holding, the Ninth Circuit declined to extend the Second Circuit’s 2014 decision in US v. Newman, which held that insider trading requires proof of “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.”  Early analysis of the arguments in Salman suggests that the Court will, as some have previously predicted , “split the baby” by leaving Salman’s conviction in place while also adopting a rule that would not affect the result in US v. Newman.  Given the Court’s decision to grant certiorari in Salman rather than Newman, this result seems all the more likely.

Bassam Salman was convicted of insider trading after trading on information he received from Michael Kara, his brother in law, who in turn received that information from his brother, Maher Kara. Salman was aware that the information came from Maher, a Citigroup banker working on various health care deals and sharing information very openly with his brother.  Michael also traded on the information and, although he told Maher that he was not trading, Maher suspected otherwise.  Nevertheless, Maher never received any financial or other concrete benefit in the exchange, though there was evidence that he and his brother had a close relationship.

In Salman’s brief, he argued that his conviction was inconsistent with the Court’s seminal 1983 insider trading decision in SEC v. Dirks as interpreted by the Second Circuit in Newman: that insider trading requires proof of “at least a potential gain of a pecuniary or similarly valuable nature.”  That is, to the extent that Maher offered material, non-public information to his brother in violation of his confidentiality obligations to his employer, that activity did not violate insider trading laws because Maher did not receive anything concrete in exchange.

From the outset of oral argument, several justices were noticeably skeptical of Salman’s arguments. Justices Ruth Bader Ginsberg and Anthony Kennedy questioned whether Salman’s conviction was just analogous to standard accomplice liability.  Justice Kennedy observed that where the tippee does the trading and benefits thereby, as in Salman’s case, the tippee is really the recipient of the “gift” of the tip and by traditional analysis is an accomplice to the tipper’s wrongdoing.

In addition, several justices repeatedly went back to Dirks, in which the Court said that it might be possible to infer the required personal benefit “when an insider makes a gift of confidential information to a trading relative or friend.”  As Justice Kennedy observed, Dirks suggested that “there’s a benefit in making a gift,” even if there is no pecuniary exchange.  Justices Elena Kagan and Stephen Breyer both observed that Salman’s suggested approach would be a significant departure from most courts’ interpretations of the original Dirks holding.  Justice Kagan noted that Dirks seemed to indicate that “it’s not only about when there’s a quid pro quo from the tippee to the tipper, but when the tipper makes a gift to the tippee, and in particular a relative or friend.”  Justice Breyer noted outright that if the court embraced Salman’s approach, it was “really more likely to change the law that people have come to rely upon than it is to keep to it.”

The government, by contrast, had urged that there was no conflict among the reasoning upholding Salman’s conviction, SEC v. Dirks, or US v. Newman.  The government urged that Michael and Maher had the kind of “meaningfully close personal relationship” that was not present in Newman, a case that involved several levels of remote tippees, none of whom had particularly close friendships much less a family relationship as in Salman.  By this logic, the result in Salman was entirely consistent with both Dirks and Newman because the “personal relationship” was sufficiently different and satisfied the precedent established by Dirks.

When the government lawyer took the podium, the justices continued to pose challenging questions, but many justices signaled an apparent belief that the government’s position was more acceptable. Some justices did seem concerned that under the government’s proposed rule, non-relatives or non-friends might be swept into liability, but Deputy Solicitor General Michael Dreeben seemed ready to concede some ground on that front.  Toward the end of the argument, Justice Kagan asked whether the court could “separate out that strange, unusual, hardly-ever-prosecuted situation” of non-friends or non-relatives facing liability and Dreeben said he would be “fine with that.”  As described above, his response may open the door for the Court to uphold Salman’s conviction while leaving Newman unchanged.

SDNY Prosecutors Score First Post-Newman Insider Trading Conviction

On August 17, 2016, jurors in a New York federal court convicted Sean Stewart on criminal charges of conspiracy, securities fraud, and tender offer fraud after more than five days of deliberation.  Stewart, a former investment banker for JPMorgan and Perella Weinberg Partners, was charged with leaking confidential information about health care mergers to his father, Robert Stewart, on at least five occasions over the course of four years.  The case provides a victory to Preet Bharara, the United States Attorney for the Southern District of New York, after a series of setbacks in the form of unfavorable decisions in the aftermath of the Second Circuit’s decision in U.S. v. Newman, the repercussions of which have been covered extensively on this blog (see here, here).  As the first conviction post-Newman, U.S. v. Stewart provides some insight into the kinds of facts that might support an insider trading charge in the Second Circuit going forward and is thus worthy of analysis.

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