Source: http://clsbluesky.law.columbia.edu/2017/09/13/latham-discusses-how-second-circuit-broadened-personal-benefit-test-for-insider-trading/
Timestamp: 2019-04-21 04:06:19+00:00

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On August 23, 2017, the Second Circuit issued its second significant decision on insider trading liability in the past three years, United States v. Martoma. In its 2014 decision in United States v. Newman, the Second Circuit limited the circumstances in which the government could prove insider trading on evidence that someone privy to inside information (a tipper) passed that information to another person (a tippee) who then traded on the information. Last year, the US Supreme Court’s decision in United States v. Salman called into doubt some of the limits imposed in Newman, but the scope of the Court’s curtailment was uncertain at that time. While Martoma certainly leaves important questions unanswered, the decision will reinvigorate the ability of the Department of Justice and the Securities and Exchange Commission (SEC) to pursue insider trading cases based on a wide variety of relationships and interactions between insiders and tippees.
In addition to continuing to pursue tipping cases charging a broad range of non-monetary benefits, 17 years after Dirks, the SEC enacted Regulation FD and broadened who could be charged for disclosing material non-public information. Regulation FD generally prohibits intentional selective disclosure of material non-public information to market professionals and to security holders under circumstances in which it is reasonably foreseeable that the holder will trade on the basis of the information. In the event of unintentional disclosure, an issuer must promptly disseminate the material information. Regulation FD was adopted not under the antifraud provisions of the Exchange Act, but under the reporting requirements of Section 13, and it does not require a showing of benefit to the person making the improper disclosure.7 For its part, the Department of Justice has been aggressive in advancing the types of conduct that meet the Dirks personal benefit test in recent years. Newman, Salman, and Martoma are all products of increased criminal focus on insider trading that includes tippees.
Notably, the Martoma majority did not reach the other significant aspect of Newman’s holding: that a tippee must have knowledge that the insider’s disclosure of confidential information was for the specific purpose of obtaining a personal benefit. This may remain an avenue for an alleged tippee defendant to challenge the adequacy of the government’s proof that he or she should be held liable for securities fraud.
In light of Judge Pooler’s dissent and the tension it highlights between the Newman and Martoma decisions, Martoma’s case may be a candidate for en banc review by the full Second Circuit, though the Second Circuit rarely grants such review.35 Indeed, Martoma may argue that the majority went too far in eliminating important restrictions on what constitutes unlawful sharing of information in the absence of a financial benefit, essentially eviscerating the personal benefit requirement.
Second, as noted above, the Martoma opinion left undisturbed Newman’s requirement that the tippee possess knowledge that the insider disclosed confidential information for the specific purpose of obtaining a personal benefit. Defendants may seek further limits on the types of facts that will support an inference that a tippee knew that an insider sought to benefit from the disclosure of information. Among the important questions left unanswered is whether the same evidence that supports the inference that the insider would benefit from the disclosure can, by itself, also support an inference that the tippee knew of the benefit, or whether the knowledge component instead requires something more. This requirement is significant in the context of hedge funds and other asset managers, where a recipient of information may be uncertain as to its source. For example, like the facts in Newman, if the source of the information is several levels away from the person who actually made the trade, then whether or not the downstream tippee knew that the information was disclosed for a personal benefit will be an important factor in defending against any charges.
Periodically there are calls for Congress to provide a legislative definition of insider trading similar to that found in other countries. Following the decision in Newman, legislation was proposed in both the House and the Senate that would have broadened the federal securities laws to prohibit almost any trading on confidential information.37 Neither bill went forward. Earlier this year, Southern District of New York Judge Jed Rakoff, who has written a number of significant opinions on federal securities law issues, including the Ninth Circuit’s opinion in Salman (for which he sat by designation), renewed the call for legislation, saying, “The United States, by failing to recognize, unlike most other developed countries, that a meaningful effective straightforward, simple ban on insider trading is best achieved through statute rather than judge made law, has created unnecessary uncertainty and difficulty in dealing with the problem of insider trading.”38 The SEC has traditionally been lukewarm to such efforts, believing that legislation would unnecessarily limit its enforcement efforts. The agency’s view seems unlikely to change anytime soon. Speaking at a New York University School of Law forum this month, new SEC Chairman Jay Clayton touted the US approach to confronting unlawful insider trading, which cases such as Dirks, Newman, Salman, and now Martoma endeavor to define. Responding to an audience question asking whether Congress should pass legislation addressing the issue, Clayton explained, “Some places that have a code-based insider-trading regime, my sense is [that] it doesn’t work any better and in fact it’s probably not as effective as our regime.”39 Given the Chairman’s stance on the efficacy of the current system, it appears that, for now at least, the fact-intensive nature of these cases will ensure that the government and defendants will both continue to probe the outer limits of the various rules articulated by the courts in this continually developing area of law.
Beyond securities fraud, the Martoma court’s holding may also impact insider trading enforcement in the commodities markets. Using authority enacted pursuant to the Dodd-Frank Act, the Commodity Futures Trading Commission (CFTC) recently brought its first two insider trading actions based on misappropriation of confidential information.40 In promulgating the rule at issue in those actions, Rule 180.1, the CFTC stated that cases applying the comparable language of SEC Rule 10b-5 would guide its application.41 The Second Circuit’s clarification of the personal benefit requirement may speed the CFTC on a path to applying its insider trading authority to tipper-tippee cases like those pursued by the SEC.
The principal significance of Martoma is its abandonment of Newman’s “meaningfully close personal relationship” test and its shift to a test focused on whether 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.”42 The decision serves as an important reminder (as if one was necessary) of the aggressiveness of the Department of Justice and the SEC in bringing cases that charge tipping.
Martoma is also a reminder that financial institutions and other market participants must take care in dealing with expert networks, such as the arrangement between Martoma and the research physicians alleged to have tipped him. For public company executives and directors, and those who counsel them, the case is also an important reminder that even the most casual discussion about confidential company information could lead to a lengthy and intrusive insider trading investigation.
1 The Court recognized 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.” Dirks v. Securities and Exchange Commission, 463 U.S. 646, 659 (1983).
2 Id. at 660, 662.
5 See, e.g., Brief for the Securities and Exchange Commission as Amicus Curiae Supporting the Petition of the United States for Rehearing or Rehearing En Banc at 12-13, United States v. Newman, No. 13-1837 (2d Cir. Jan. 29, 2015) (No. 298) (collecting cases).
6 John C. Coffee, Jr., The SEC and the Securities Analyst, N.Y.L.J., May 30, 1991, at 5.
7 Selective Disclosure and Insider Trading, Securities Act Release No. 7881 (Aug.15, 2000). Regulation FD was enacted pursuant to Section 13 of the Exchange Act (not an antifraud provision) and the adopting release makes clear that selective disclosure on its own is not fraud.
8 United States v. Newman, 773 F.3d 438, 452 (2d Cir. 2014).
11 Salman v. United States, 137 S. Ct. 420, 427 (2016).
15 United States v. Martoma, No. 14-3599, 2017 WL 3611518, at *1 (2d Cir. Aug. 23, 2017).
24 Dirks, 463 U.S. at 658.
25 Martoma, 2017 WL 3611518, at *8 (internal citations, quotation marks and alterations omitted).
31 Id. at *11 (Pooler, J., dissenting) (emphasis in original).
32 Id. (Pooler, J., dissenting).
33 Id. (Pooler, J., dissenting).
34 Id. at *22 (Pooler, J., dissenting) (quoting Salman, 137 S. Ct. at 426).
35 While the Second Circuit does not keep official statistics on rehearings en banc, our research indicates that the Court has only granted rehearing en banc ten times since 2000, and twice in the past five years. See Poventud v. City of New York, 750 F.3d 121 (2d Cir. 2014); United States v. Ganias, 824 F.3d 199 (2d Cir. 2016).
36 For example, the Court noted that a disclosure of information to a reporter could fall on either side of the line depending on the facts and circumstances surrounding the tipper’s relationship and prior dealings with the reporter. Martoma, 2017 WL 3611518, at *8 n.8.
37 Peter J. Henning, Court Strikes on Insider Trading, and Congress Lobs Back, N.Y. TIMES (Mar. 16, 2015), https://www.nytimes.com/2015/03/17/business/dealbook/court-strikes-on-insider-trading-and-congress-lobsback.html?mcubz=1&_r=0.
38 Carmen Germaine, Rakoff Urges Securities Bar to Write Insider Trading Law, LAW360 (Mar. 1, 2017), https://www.law360.com/articles/897188/rakoff-urges-securities-bar-to-write-insider-trading-law.
40 In re Motazedi, CFTC No. 16-02 (Dec. 2, 2015) (imposing $316,000 in sanctions for trading oil and gas futures using confidential information about employer’s trades); In re Ruggles, CFTC No. 16-34 (Sept. 29, 2016) (imposing $5.25 million in sanctions for misappropriating employer’s confidential information to benefit personal trading in oil and gas futures and options).
41 17 C.F.R. § 180.1; Prohibition on the Employment, or Attempted Employment, of Manipulative and Deceptive Devices and Prohibition on Price Manipulation, 76 Fed. Reg. 41,398, 41,407 (July 14, 2011).
42 Martoma, 2017 WL 3611518, at *8 (internal citations, quotation marks and alterations omitted).
This post comes to us from Latham & Watkins LLP. It is based on the firm’s client alert, “Divided Second Circuit Broadens Personal Benefit Test for Insider Trading Liability,” dated September 6, 2017, and available here.

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