Second Circuit

“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.

Second Circuit Ruling Creates Challenge for Securities Class Action Plaintiffs

The Second Circuit recently considered the extraterritorial application of the U.S. securities laws in the private securities class action context, bringing some clarity to an area of the law that is increasingly important given the globalization of financial markets.

In re Petrobras Securities, 862 F.3d 250 (2nd Cir. 2017), was an appeal of a class certification order in a securities class action related to an alleged multi-year money-laundering and kickback scheme involving Petróleo Brasileiro S.A. (“Petrobras”), the Brazilian state-owned oil and gas company. The district court had certified two classes of investors who purchased Petrobras American Depository Shares (ADS) and debt securities, and who brought misrepresentation claims under the Securities Act of 1933 and the Securities Exchange Act of 1934 against Petrobras, its subsidiaries, and its underwriters. Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), held that the anti-fraud provisions of the securities laws have no extraterritorial effect, and as a consequence apply only to transactions in securities that occur on a U.S.-based exchange or that are otherwise “domestic.” Petrobras ADS shares satisfied the first requirement, but the company’s debt securities are traded over-the-counter, not on a U.S. exchange. Prior decisions had limited “domestic” transactions to ones where (1) the purchaser “incurred irrevocable liability within the United States to take and pay for a security . . . or to deliver a security” or (2) “legal title to the security . . . transferred in the United States” (see, e.g., Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 68 (2d Cir. 2012)), but how this test implicated the standards for class certification was not clear. READ MORE

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

Second Circuit Halts Constitutional Challenge to SEC Administrative Proceedings

On June 1, the Second Circuit in Tilton et al. v. SEC, No. 15-2103 (2d. Cir. Jun. 1, 2016), echoed recent Seventh and D.C. Circuit decisions (respectively, Bebo v. SEC, No. 15-1511 (7th Cir. Aug. 24, 2015), cert. denied, 136 S. Ct. 1500 (Mar. 28, 2016), and Jarkesy v. SEC, No. 14-5196 (D.C. Cir. Sept. 29, 2015)) in finding that constitutional or other challenges to SEC proceedings cannot go forward in court until the administrative proceeding ends; review can only be sought as an appeal from a final decision by the Commission.  The Second Circuit’s decision in Tilton creates unanimity among the circuit courts that have addressed the issue to date, although, as we previously reported, the Eleventh Circuit is likely to rule on the issue sometime this year in Hill v. SEC, No. 15-12831. Unless the Eleventh Circuit bucks this trend and creates a circuit split, it now looks unlikely that the Supreme Court will weigh in on this issue (particularly because the Supreme Court previously denied a petition to review the Seventh Circuit’s decision in Bebo).

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Second Circuit Applies Omnicare to Affirm Dismissal of Securities Fraud Actions

On March 4, 2016, the Second Circuit affirmed the dismissal of two related securities actions against Sanofi Pharmaceuticals, its predecessor Genzyme Corporation, and three company executives (collectively, “Sanofi”).  In doing so, the Second Circuit offered its first substantial interpretation of the Supreme Court’s March 2015 decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318 (2015), which addresses how plaintiffs can allege securities claims based on statements of opinion.

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The Ripple Effects of U.S. v. Newman Continue: SEC Lifts Administrative Bar on Downstream Insider Trading Tippee and Tipper Requests that Third Circuit Vacate SEC Settlement

The ripple effects of the Second Circuit’s landmark insider trading decision, United States v. Newman, 773 F.3d 438 (2d Cir. 2014), were felt again last week.  On Tuesday, February 23, 2016, the U.S. Securities and Exchange Commission (“SEC” or the “Commission”) ruled that Former Neuberger Berman Analyst Sandeep “Sandy” Goyal, whom the SEC previously barred from the securities industry after he pled guilty to insider trading, could participate in the industry again. The SEC’s rare decision to lift an administrative bar order resulted from Newman, (previously discussed at length here), which led to Goyal’s criminal conviction being vacated and the civil claims against him being dropped by the SEC.  Newman raised the bar for what prosecutors in tipper/tippee insider trading cases have to show by holding that tipper/tippee liability requires the tipper to receive a “personal benefit” amounting to a quid pro quo or pecuniary benefit in exchange for the tip and the tippee to know of that benefit.  Despite the SEC’s decision to drop the administrative bar against Goyal in light of Newman, as recently as SEC Speaks on February 19-20, 2016, SEC Deputy of Enforcement Stephanie Avakian affirmed that insider trading cases “continue[] to be a priority” for the Commission.   Nonetheless, the ripple effects of Newman continue to call the government’s ability to successfully bring both criminal and civil cases into question.

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Second Circuit Splits With Fifth Circuit Setting Up Possible Supreme Court Review: Are Internal Whistleblowers Protected Under Dodd-Frank?

On September 10, 2015, a divided panel of the Second Circuit issued an opinion in Berman v. [email protected] LLC, No. 14-4626 (2nd Cir. Sept. 10, 2015), creating a split with the Fifth Circuit on an issue that has also divided lower federal courts: whether the anti-retaliation provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act apply to tipsters who claim retaliation after reporting internally, or only to those retaliated against after reporting information to the SEC.  The Second Circuit, granting Chevron deference to SEC interpretive guidance, held that Dodd-Frank protections apply to internal whistleblowers.  This stands in contrast to the Fifth Circuit’s holding in Asadi v. G.E. Energy (USA), LLC, 720 F.3d 620 (5th Cir. 2013), where that court found that on their face, the Dodd-Frank anti-retaliation provisions unambiguously limited protection to whistleblowers reporting to the SEC, and that, therefore, the SEC’s contrary guidance was not entitled to deference.  Given this Circuit split, Supreme Court review is possible.

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SEC Guidance Supports its Position That Internal Whistleblowers are Protected Under Dodd-Frank

On August 4, 2015 the Securities and Exchange Commission issued interpretive guidance elaborating its view that the anti-retaliation provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act apply equally to tipsters who claim retaliation after reporting internally, as well as those who are retaliated against after reporting information to the SEC.  The guidance reflects that there is a split among federal courts over whether Dodd-Frank’s whistleblower retaliation provisions apply to internal as well as external reporting, and recognizes that the only circuit court to decide the issue to date, the Fifth Circuit, has taken a contrary position to that of the Commission in Rule 21F, the regulation the SEC adopted to implement the whistleblower legislation, holding that internal reports are not protected by Dodd-Frank. Whether internal reports qualify for Dodd-Frank coverage has important implications because, among other things, Dodd Frank provides enhanced recoveries (including two times back pay) and longer time frames (six years) for bringing a retaliation claim than would be available under the anti-retaliation provisions in the Sarbanes-Oxley Act of 2002.

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United States Supreme Court Poised to Address Standard for Insider Trading Following Second Circuit’s Decision in United States v. Newman

​Today, the Solicitor General filed a petition for a writ of certiorari in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), asking the United States Supreme Court to address the standard for insider trading in a tipper-tippee scenario.  Specifically, the Solicitor General argues that the Second Circuit’s Newman decision is in conflict with the Supreme Court’s 1983 decision in Dirks v. SEC, 463 U.S. 646 (1983), and the Ninth Circuit’s recent decision in United States v. Salman,  No. 14-10204 (9th Cir. July 6, 2015).   Because the Supreme Court grants certiorari in nearly three out of four cases filed by the Solicitor General, the likelihood of a cert grant in Newman is particularly high.

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Don’t touch that remote (tippee)? Salman reflects Ninth Circuit’s view on Newman

In United States v. Salman, the Ninth Circuit recently held that a remote tippee could be liable for insider trading in the absence of any “personal benefit” to the insider/tipper where the insider had a close personal relationship with the tippee. This opinion is significant in that it appears at first glance to conflict with the Second Circuit’s decision last year in United States v. Newman, in which the court overturned the conviction of two remote tippees on the grounds that the government failed to establish first, that the insider who disclosed confidential information in that case did so in exchange for a personal benefit, and second, that the remote tippees were aware that the information had come from insiders. READ MORE