On June 25, 2018, the Second Circuit amended its opinion in United States v. Martoma, an insider trading case that has received significant attention as a vehicle to clarify the “personal benefit” element of tippee liability in insider trading cases in the Second Circuit.  While the Second Circuit again upheld the insider trading conviction of former S.A.C. Capital Advisors portfolio manager Mathew Martoma, this time it appears to have breathed life back into its “meaningfully close personal relationship” requirement for establishing insider trading liability against an individual who receives and trades on confidential information (a “tippee”).  Those  following the evolution of insider trading doctrine should pay close attention to lower courts’ interpretations of the “meaningfully close personal relationship” test, and what prosecutors must show to satisfy this requirement, in the wake of Martoma.

In order to establish criminal insider trading liability against a tippee, the government must prove that the defendant: (i) traded in securities while (ii) in possession of material, nonpublic information that he knew was (iii) obtained as a result of a breach of duty and (iv) provided by the “tipper” (typically the corporate insider who disclosed the confidential information) in exchange for a personal benefit.[1]  The Supreme Court has long held that a personal benefit can be shown by “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,” or when a corporate “insider makes a gift of confidential information to a trading relative or friend.”[2]

In United States v. Newman, the Second Circuit held that such a personal benefit could be “inferred from a personal relationship between the tipper and tippee, where the tippee’s trades resemble trading by the insider . . . followed by a gift of the profits,” only upon a showing of “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.”[3]  Thus, Newman raised the specter that tippee insider trading without something akin to a kickback to the tipper may not be actionable.[4]  The Supreme Court revisited the personal benefit requirement in Salman v. United States in 2016, taking issue with this interpretation.  There, the Court held that, to the extent Newman found that “the tipper must also receive something of a pecuniary or similarly valuable nature in exchange for a gift to family or friends,” “this requirement is inconsistent with Dirks.”[5]

Against this backdrop, the Second Circuit again confronted the personal benefit requirement in Martoma in 2017.  Martoma was convicted of insider trading and conspiracy to commit securities fraud for trading on clinical trial information provided by two doctors under obligations to keep the information confidential.[6]  On appeal, Martoma challenged both the sufficiency of the evidence presented at trial and a jury instruction for failing to satisfy the personal benefit requirement as articulated in Newman (which was released following Martoma’s conviction).[7]  In its initial August 2017 opinion, the Second Circuit held—over a vigorous dissent—that the “logic of Salman abrogated Newman’s ‘meaningfully close relationship’ requirement,” and upheld the conviction.[8]  On June 25, however, the Second Circuit vacated its October 2017 opinion.[9]  In an amended opinion released simultaneously, the panel again upheld the conviction, but this time held that it “need not” reach the question of “whether Newman’s gloss on the gift theory is inconsistent with Salman.”[10]

According to its revised reasoning, the “gift theory” interpreted in Newman is only one means to establish a personal benefit.[11] Other, “independently sufficient bases” to establish such a benefit include evidence of a relationship that suggests a quid pro quo or a tipper’s intent to benefit a tippee.[12]  Turning to the case at hand, the panel found that the jury was properly instructed on these “quid pro quo” and “intent to benefit” theories and that the government presented sufficient evidence of such relationships between Martoma and one of the doctors.[13]  Thus, the Second Circuit held, a rational trier of fact could have found Martoma guilty beyond a reasonable doubt, despite the fact that the jury was improperly instructed on the gift theory as interpreted by Newman.[14]  The panel again reached its decision over a strong dissent from Judge Pooler, who criticized the majority for recasting Newman’s “meaningfully close personal relationship” standard from an objective to a subjective one and improperly overruling a prior panel decision.[15]

Finally, the panel attempted to clarify Newman, explaining that a “meaningfully close personal relationship” cannot be read in isolation because “[i]mmediately after introducing the . . . concept, Newman held that it requires evidence of a relationship between the insider and the recipient that suggests a quid pro quo from the [tippee], or an intent to benefit the [tippee].”[16]  “In other words, Newman cabined the gift theory using two other freestanding personal benefits that have long been recognized by our case law.”[17]

Thus, while the Second Circuit’s abrogation of Newman has been vacated, it remains to be seen whether or the extent to which the “meaningfully close personal relationship” requirement is still good law or, as a practical matter, how difficult it will be for prosecutors to establish sufficient evidence of the requisite relationship.  Companies and others concerned with insider trading law will want to pay close attention to the ways in which lower courts thread the needle interpreting Newman as both constrained by Salman and clarified by Martoma.

[1] See Salman v. United States, 137 S. Ct. 420, 427–29 (2016).

[2] Dirks v. SEC, 463 U.S. 646, 664 (1983).  For a more in-depth analysis of these legal standards, see Jonathan S. Kolodner, Matthew Solomon & Alexander Janghorbani, Second Circuit Clarifies Meaningfully Close Relationship No Longer Required, Cleary Gottlieb Alert Memorandum (Aug. 24, 2017), https://www.clearygottlieb.com/-/media/organize-archive/cgsh/files/2017/publications/alert-memos/second-circuit-clarifies-meaningfully-close-relationship-no-longer-required-8-25-17.pdf.

[3] 773 F.3d 438, 452 (2d Cir. 2014) (internal quotation marks omitted) (emphasis added).

[4] For further analysis of Newman, see Second Circuit Reverses Insider Trading Convictions of Remote Tippees, Cleary Gottlieb Alert Memorandum (Dec. 15, 2014), https://www.clearygottlieb.com/-/media/organize-archive/cgsh/files/publication-pdfs/second-circuit-reverses-insider-trading-convictions-of-remote-tippees.pdf.

[5] Salman, 137 S. Ct. at 428 (internal quotation marks omitted).

[6] See United States v. Martoma, No. 14-3599, 2017 WL 9620394, at *2-3 (2d Cir. June 25, 2018) (“Martoma II”).

[7] See id. at *5.

[8] United States v. Martoma, 869 F.3d 58, 61–63  (2d Cir. 2017), opinion amended and superseded, No. 14-3599, 2017 WL 9620394 (2d Cir. June 25, 2018).

[9] See Order to Vacate, Martoma II (2nd Cir. June 25, 2018), ECF No. 225.

[10] Martoma II at *4.

[11] See id. at *9-10.

[12] See id. at *9.

[13] See id. at *9-10.

[14] See id. *10-11.

[15] See id. at *11-12 (Pooler, J., dissenting) (“Newman and a consistent line of cases preceding it make clear that a meaningfully close relationship cannot be proven without objective evidence about the nature of the tipper-tippee relationship.  Bare speculation into insiders’ motives has always been insufficient . . . .”).

[16] Id. at *9 (internal quotation marks omitted).

[17] Id.