U.S. v. Newman

“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.

Former Hedge Fund Manager’s Civil Rights Suit Against New York U.S. Attorney Permitted to Proceed into Discovery

Shortly into his tenure as United States Attorney for the Southern District of New York, Preet Bharara announced a crackdown on insider trading, indicating that it would be his office’s “top criminal priority” and that investigations would utilize novel and “covert methods” to achieve convictions, including using wiretaps and informants.  According to Bharara, “every legitimate tool should be at our disposal.”  Over the next several years, federal prosecutors in Manhattan initiated nearly 100 insider trading cases against some of Wall Street’s leading names, and secured more than 80 convictions, many through guilty pleas.  For his work, Time magazine featured Bharara on its February 13, 2012 cover under the headline: “This Man is Busting Wall Street.”

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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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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

Remote Tippees Beware: Even if the DOJ Can’t Reach You After Newman, The SEC Can

The fall-out from the Second Circuit’s decision in U.S. v. Newman continued last week in SEC v. Payton, when Southern District of New York Judge Jed S. Rakoff denied a motion to dismiss an SEC civil enforcement action against two former brokers, Daryl Payton and Benjamin Durant, one of whom (Payton) had just had his criminal plea for the same conduct reversed in light of Newman.  Although the United States may be unable to make criminal charges stick against some alleged insider traders under a standard of “willfulness,” Judge Rakoff found that the SEC had sufficiently alleged that related conduct of the two brokers at the end of the tip line was “reckless,” satisfying the SEC’s lower civil standard.

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The Continuing Fall-Out from the Second Circuit’s Insider Trading Decision in Newman

Wall Street

Last week, a New York federal judge struck another blow to prosecutorial efforts to secure insider trading convictions in tipper-tippee cases. As discussed in detail here, the U.S. Attorney’s Office for the Southern District of New York suffered a high-profile defeat in an insider trading case last month, when the Second Circuit issued its decision in U.S. v. Newman, No. 13-1837, 2014 WL 6911278 (2d Cir. Dec. 10, 2014). In Newman, the Second Circuit found that prosecutors in tipper-tippee cases must prove both that the tipper (the individual disclosing inside information in breach of a duty) received a personal benefit in exchange for the disclosure, and that the tippee (the individual receiving and trading on the information) knew about the tipper’s receipt of that benefit. In the wake of Newman, U.S. Attorney Preet Bharara and others expressed concerns that the decision could limit future insider trading prosecutions.

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No Knowledge, No Jail: Second Circuit Clarifies Scope of Tippee Insider Trading Liability

On December 10, 2014, the Second Circuit issued an important decision (U.S. v. Newman, No. 13-1837, 2014 WL 6911278 (2d Cir. Dec. 10, 2014)) that will make it more difficult in that Circuit for prosecutors, and most likely the SEC, to prevail on a “tippee” theory of insider trading liability. Characterizing the government’s recent tippee insider trading prosecutions as “novel” in targeting “remote tippees many levels removed from corporate insiders,” the court reversed the convictions of two investment fund managers upon concluding that the lower court gave erroneous jury instructions and finding insufficient evidence to sustain the convictions. The court held, contrary to the government’s position, that tippee liability requires that the tippee trade on information he or she knows to have been disclosed by the tipper: (i) in violation of a fiduciary duty, and (ii) in exchange for a meaningful personal benefit. Absent such knowledge, the tippee is not liable for trading on the information.

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