August 25, 2017

United States v. Martoma: The Second Circuit's Latest Attempt to Clarify the "Personal Benefit" Requirement in Insider Trading Cases


The Second Circuit has implemented yet another significant change to insider trading law. In United States v. Martoma, issued on August 23, 2017, the court walked back much of what it said, just three years earlier, on what is required to prove a "personal benefit" in insider trading cases involving individuals who provide material, non-public information (tippers) to individuals who trade based on that information (tippees).

For decades, the test was whether a tipper would benefit, directly or indirectly, from his disclosure of inside information. Then, in 2014, the Second Circuit heightened the standard in United States v. Newman, holding that the government must prove that the tipper received a personal benefit based on a "meaningfully close personal relationship" with a tippee that carried "at least a potential gain of a pecuniary or similarly valuable nature." In 2016, the Supreme Court partially narrowed Newman, holding in Salman v. United States that a tipper can personally benefit from tipping to a relative or friend who then trades, irrespective of any pecuniary gain. Salman left open the question, however, of whether the tipper and tippee need to have a "meaningfully close personal relationship."1

In Martoma, a divided panel answered this open question in the negative, eliminating Newman's "meaningfully close personal relationship" requirement. In its place, the Martoma court held that a tipper benefits from a disclosure of insider information whenever it is disclosed with the expectation that the tippee will trade on the information. This Advisory will discuss the evolution of the relevant case law and offer some initial takeaways from the Second Circuit's groundbreaking decision.

Overview of Insider Trading (Dirks, Newman, and Salman)

The government has long prosecuted insider trading by traditional corporate insiders (e.g., corporate officers) who trade based on material, non-public information, or where an individual "misappropriates" information to trade in breach of a duty owed to the owner of that information. The government has also prosecuted tippers and tippees where corporate insiders (or others who misappropriate information) do not themselves trade, but instead provide the information to outsiders who trade based on that information.

In Dirks v. SEC, the Supreme Court established the standard for tipper and tippee liability, noting that "[t]he need for a ban on some tippee trading is clear" and that "[n]ot only are insiders forbidden by their fiduciary relationship from personally using undisclosed corporate information to their advantage, but they may not give such information to an outsider for the same improper purpose of exploiting the information for their personal gain."2 Thus, the Court held that, in order to determine whether a tipper breached his fiduciary duty, the relevant inquiry is "whether the insider personally will benefit, directly or indirectly, from his disclosure."3 The Court stated that while a personal benefit could include pecuniary gains or reputational benefits that later result in future earnings, a breach may also occur when the tipper provides information to a trading relative or friend. Importantly, the Court reasoned that a breach can occur when an insider "makes a gift of confidential information to a trading relative or friend," as the "tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient."4 Furthermore, the Court stated that a tippee is equally liable if he knows or should have known of the tipper's breach.

In December 2014, the Second Circuit in United States v. Newman reversed the convictions of two hedge fund portfolio managers accused of insider trading where their tippers were merely acquaintances.5 The Second Circuit held that to establish liability for a tipper, a "personal benefit" cannot be inferred from a personal relationship absent "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."6 The Second Circuit also held that a tippee must know that the tipper disclosed information in exchange for a personal benefit. Other courts, citing Dirks and other longstanding Supreme Court precedent, rejected the Second Circuit's suggestion in Newman that a tipper must receive some tangible benefit.7

Two years later, in Salman v. United States,8 the Supreme Court unanimously reaffirmed longstanding principles of insider trading liability, rejecting the Second Circuit's ruling in Newman that someone who provides a tip to a family member or friend must receive something of a "pecuniary or similarly valuable nature." In Salman, the Court concluded that an investment banker made a gift of material, non-public information to his brother, who both traded on the information and passed it along to others, including his brother-in-law. The Court stated 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."9 The Court further observed that while Dirks held that the mere "disclosure of confidential information without personal benefit is not enough," Dirks also squarely held that a "personal benefit can often be inferred from objective facts and circumstances . . . such as a relationship between the insider and the recipient that suggests a quid pro quo from the latter . . . [or] when an insider makes a gift of confidential information to a trading relative or friend."10

Factual Background of Martoma

Before either Newman or Salman were decided, Mathew Martoma, a former hedge fund portfolio manager at S.A.C. Capital Advisors (SAC), was convicted of insider trading. In July 2008, Martoma learned that a clinical trial for bapineuzumab, an experimental Alzheimer's drug that was being developed by Elan Corporation and Wyeth, had gone poorly. A physician who had worked on the trial, Dr. Sidney Gilman, provided this information to Martoma in breach of a confidentiality agreement. Over a two-year period, Martoma had cultivated a relationship with Dr. Gilman through an expert networking agency. As a result of the information that Martoma received, SAC entered into substantial short-sale and options trades that would be profitable if Elan's and Wyeth's stock fell. After the news related to the bapineuzumab clinical trial was made public, Elan and Wyeth stock plummeted, and the trades made in advance of the announcement resulted in approximately $275 million in gains and losses avoided for SAC.

Martoma was convicted following a trial in February 2014 and was subsequently sentenced to nine years in prison, one of the longest jail terms ever imposed in an insider trading case. Martoma appealed his conviction to the Second Circuit, arguing that the jury had not been properly instructed and that the evidence presented at trial was insufficient to convict him in light of Newman (which had been decided after his conviction). Specifically, Martoma argued that Dr. Gilman was only a casual acquaintance and, although he was at times a paid consultant, he was not paid for two consulting meetings during which he allegedly delivered the ultimate information related to the bapineuzumab clinical trial.

The Second Circuit's Decision in Martoma

After asking for supplemental briefing and argument in light of Salman, the Second Circuit issued its long-awaited opinion on August 23, 2017 in a 2-1 decision authored by Chief Judge Katzmann.11

The Second Circuit principally addressed Martoma's argument that the jury instructions in his case were erroneous in light of Newman. Specifically, Martoma argued that Newman's requirement that the tipper have a "meaningfully close personal relationship" with a tippee, thereby proving the tipper received a personal benefit from his gift of inside information, survived the Supreme Court's decision in Salman. The Second Circuit rejected that argument, finding that the logic of Salman meant that "Newman's meaningfully close personal relationship requirement can no longer be sustained."12

Central to the Martoma court's analysis was its conclusion that Dirks, which was "strongly reaffirmed in Salman," held that a "corporate insider personally benefits whenever he discloses inside information as a gift with the expectation that the recipient would trade on the basis of such information."13 This is because "such a disclosure is the functional equivalent of [the insider] trading on the information himself and giving a cash gift to the recipient."14Applying the "logic" of Dirks and Salman, the Martoma court held that "an insider or tipper personally benefits from a disclosure of inside 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 the profits to the recipient, whether or not there was a meaningfully close personal relationship between the tipper and tippee."15

To illustrate why the "meaningfully close personal relationship" requirement is unworkable, the Second Circuit provided an example of a corporate insider who, in lieu of giving cash to his doorman, provides a tip of inside information and instructs the doorman to trade on the information and treat the proceeds of the trade as his end-of-the-year gratuity. The Martoma court stated that this would be a clear example of insider trading because the tipper disclosed valuable inside information with the expectation that the doorman would trade on it and, thus, the tipper personally benefitted from the disclosure.

A lengthy dissent was written by Judge Pooler. The dissent argued that the majority's ruling was inconsistent with Dirks and inappropriately overturned Newman. In this regard, the dissent noted that (i) the Supreme Court in Salman left untouched Newman's holding "that the inference of a personal benefit from a gift is impermissible in the absence of proof of a meaningfully close personal relationship," and (ii) the only way the Second Circuit could overturn this holding would be by sitting en banc.16 The dissent also argued that, by "holding that someone who gives a gift always receives a personal benefit from doing so, the majority strips the long-standing personal benefit rule of its limiting power" and "radically alters insider-trading law for the worse."17

In response to the dissent's criticisms, the majority noted that liability is limited to instances where the tipper expects that the tippee will trade on the information. Thus, the majority noted, the government is still required to prove that the tipper received a personal benefit, but need not prove that the personal benefit is a gift to someone with whom the tipper had a "meaningfully close personal relationship." The majority specifically stated that not all disclosures will meet this test, including disclosures by corporate insiders who blow the whistle on suspected fraud or who inadvertently disclose material, non-public information. The majority also opened the door to "other situations in which the facts do not justify the inference that information was disclosed with the expectation that the recipient would trade on it."18 In short, the majority concluded, contrary to Newman, that it is possible to provide information as a gift to someone with whom one does not share a "meaningfully close personal relationship."

The Second Circuit also rejected Martoma's challenge to the sufficiency of the evidence, finding that although Martoma did not pay Dr. Gilman for the meeting where Dr. Gilman provided the most critical information, their relationship as a whole had the opportunity to "yield future pecuniary gain." In this regard, the Second Circuit noted that Martoma was a frequent client of Dr. Gilman and paid him $1,000 per hour for approximately 43 consultation sessions during which Dr. Gilman regularly disclosed confidential information. Therefore, the Second Circuit held that the evidence in the case was sufficient to allow a jury to find the essential elements of the crime of insider trading beyond a reasonable doubt under a pecuniary quid pro quo theory.19


How Much Is Really Clarified by Martoma? Insider trading jurisprudence has developed as a layering of opinion atop opinion, adding element atop element. Unlike other cases, Martoma removes, rather than adds, at least one of those layers by no longer requiring the government to prove how "meaningful" and "close"the relationship was between tipper and tippee. While the decision simplifies one element, however, the focus now shifts from the nature of the tipper-tippee relationship to another fact-specific determination that courts historically have avoided: Can the government prove that the tipper expected the tippee to trade on the material, non-public information? Furthermore, the decision leaves important questions unanswered. For example, must the disclosure "resemble trading by the insider followed by a gift of the profits to a recipient" and, if so, what does it mean to "resemble"? The Second Circuit's example of a doorman who receives material, non-public information in lieu of an end-of-the-year gratuity is simple enough, but what about cases where the tip of information is not clearly in lieu of cash?

What About the Other Half of Newman? There were two controversial holdings in Newman, only the first of which was addressed by Martoma. The Newman panel also held that, in order to establish liability for a downstream tippee, the government must prove that the tippee knew that the tipper disclosed information in exchange for a personal benefit. After Salman and Martoma, does this part of Newman survive? There was no suggestion by either opinion that it did not. Assuming this upstream knowledge requirement survives, does it have any teeth now that the "meaningfully close" requirement has been eliminated?

Is This the Last Word on Martoma? Despite its apparent impact, the future of the Martoma decision is unclear. The majority acknowledged that it was ordinarily not appropriate for a panel to reverse existing Second Circuit precedent but concluded that the intervening Supreme Court ruling in Salman necessitated the court's holding. While en banc rehearings before all the judges on the Second Circuit are rare, Judge Pooler's forceful dissent, the impact of Salman and the quantity of insider trading cases brought in the Second Circuit could result in en banc review. Alternatively, Martoma may seek review by the Supreme Court, although grants of certiorari also are rare and one may be unlikely here without a clear circuit split.

*Danielle Pingue contributed to this Advisory. She is a Harvard Law School graduate employed at Arnold & Porter Kaye Scholer LLP and is not admitted to the District of Columbia Bar.

© 2017 Arnold & Porter Kaye Scholer LLP. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

  1. For a discussion of Newman and Salman, see the following APKS advisories:Second Circuit Rejects Government's Expansive Theory of Insider Trading(December 2014);Supreme Court Reaffirms Broad Scope of Insider Trading Liability(December 2016).

  2. 463 U.S. 646, 659 (1983).

  3. 662.

  4. Id. at 664.

  5. 773 F.3d 438 (2d Cir. 2014) abrogated by Salman v. United States, 137 S. Ct. 420 (2016).

  6. Id. at 452.

  7. See e.g., United States v. Salman, 792 F.3d 1087 (9th Cir. 2015),cert. granted in part, 136 S. Ct. 899 (2016), and aff'd, 137 S. Ct. 420 (2016); S.E.C. v. Payton, 97 F. Supp. 3d 558 (S.D.N.Y. 2015).

  8. 137 S. Ct. 420 (2016).

  9. 428 (internal quotation marks omitted).

  10. Id. at 427 (internal quotation marks omitted).

  11. No. 14-3599, 2017 WL 3611518 (2d Cir. Aug. 23, 2017).

  12. Id. at *6 (internal quotation marks omitted).

  13. Id. ;at *6 (internal quotation marks omitted).

  14. Id.

  15. Id. (internal quotation marks and citations omitted).

  16. Id. at *16, *22 (internal quotation marks omitted).

  17. Id. at *11.

  18. *9 (internal quotation marks omitted).

  19. *10.


John A. Freedman
John A. Freedman
Senior Pro Bono Counsel
Washington, DC
Joshua R. Martin
Joshua R. Martin
Senior Counsel
Washington, DC
Michael D. Trager
Michael D. Trager
Senior Counsel
Washington, DC
Subscribe Link

Email Disclaimer