More Changes to Insider Trading Law

With the ground-shaking decision in Newman, insider trading law became a bit murky. Cases have been filling in the gaps left in its wake. The Mathew appellate Martoma decision helped fill in some more.

From a compliance perspective, this is all chasing butterflies and tilting at windmills. It was clear that Mr. Martoma was involved in insider trading. It was just a question of whether it was illegal. He knew the information he was getting was not supposed to be disclosed to the public. He should not have pushed for its disclosure and he should not have traded on it. At least not according to any self-respecting compliance professional at a trading firm.

But I’m sure enforcement professionals are very interested to see if they can find a way to keep their insider trading clients from going to jail.

For me, the current status of the law is that the Newman decision said the government needed to prove the tipper gained a tangible reward, or “personal benefit,” for providing insider information. The 2016 Supreme Court ruling in Salman v. U.S., said proving a tipper and trader were relatives was enough to meet the “personal benefit” standard.

In the Martoma case, the Second Circuit describes the the “misappropriation theory” of insider trading:

“that a person . . . violates § 10(b) and Rule 10b‐5[] when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.” Id. at 652. It is thus the breach of a fiduciary duty or other “duty of loyalty and confidentiality” that is a necessary predicate to insider trading liability.

It then goes on to the seminal insider trading case of Dirks v. S.E.C., 463 U.S. 646 (1983)

the Supreme Court held that a “tippee”—someone who is not a corporate insider but who nevertheless receives material nonpublic information from a corporate insider, or “tipper,” and then trades on the information—can also be held liable under § 10(b) and Rule 10b‐5 but “only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach.” Id. at 660.2 “[T]he test” for whether there has been a breach of a fiduciary duty or other duty of loyalty and confidentiality “is whether the [tipper] personally will benefit, directly or indirectly, from his disclosure” to the tippee. Dirks, 463 U.S. at 662.

It goes on to cite its own United States v. Newman, 773 F.3d 438 (2d Cir. 2014)

To the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee, where the tippee’s trades ‘resemble trading by the insider himself followed by a gift of the profits to the recipient,’ we hold that such an inference is impermissible in the absence 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.

The Second Circuit comes out with this standard:

Thus, we hold 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 “resemble[s] 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.

For my simplistic compliance perspective, this means that if the tippee pays money or gives something valuable to the tipper in exchange for money, the tippee risks going to jail.

Martoma gave his tipper money through an expert network agency. As a result, his conviction stands.

I think this leaves golf buddies possibly able to trade on insider knowledge, unless they are relatives or betting on the results.

I should point out that there was a blistering dissent in the case and I’m not sure if Mr. Martoma still has enough cash to appeal to the Supreme Court. We may see more in the Martoma case.

I’m sure that you will be reading many more nuanced discussions about this case and its implications from those much more versed in insider trading than me. But, I think this case does little to change the compliance view on insider trading.

If you want more information on the Martoma case or the SAC Capital attack, read Black Edge. It’s well worth the time if you have any interest in the area.