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From Securities Regulation Daily, January 30, 2019

Martoma seeks SCOTUS review of ‘Dirks-defying’ insider trading decision

By Anne Sherry, J.D.

The Second Circuit applied the wrong standard in upholding the insider trading conviction regardless of personal benefit to the tipper, according to the petition for certiorari.

Mathew Martoma asked the Supreme Court to once again consider the scope of insider trading liability under its Dirks decision. The Second Circuit affirmed Martoma’s conviction despite erroneous jury instructions because the government presented compelling evidence that the insider intended to benefit Martoma, the tippee. Martoma argues that Dirks requires the government to demonstrate that the tipper received a personal benefit, not that the tipper wanted to confer a benefit on the tippee (Martoma v. U.S., January 24, 2019).

The petition challenges the majority opinion of a divided Second Circuit panel, which in June 2018 concluded that insider trading liability can rest on evidence that a tipper intended to benefit the tippee, even without evidence of a personal relationship between the parties. The panel majority amended a controversial 2017 opinion that held that Salman v. U.S. (U.S. 2016) altered the analysis underlying U.S. v. Newman (2d Cir. 2013) such that the latter’s requirement of a "meaningfully close personal relationship" as a predicate to tippee liability was no longer good law. Although the 2018 opinion found that the instructions given to Martoma’s jury were inconsistent with Newman, the error did not affect Martoma’s rights because the government presented compelling evidence that at least one tipper received a personal benefit by disclosing inside information with the intention to benefit Martoma.

Petition. Martoma’s central argument is that whether the government is prosecuting the tipper or the tippee, it must, under Dirks, establish that the tipper received a personal benefit from providing the information. Tipper-tippee liability is rooted in the concept of breach of fiduciary duty, and the existence of such a breach depends on a personal benefit inuring to the insider, Martoma continues. The government does not necessarily need to identify a tangible benefit, but must demonstrate objective facts and circumstances from which a benefit can be inferred, such as a personal relationship. The Second Circuit diluted the standard by focusing on whether the insider intended to confer a benefit on the tippee.

Deciding Salman, the Court declined the government’s invitation to hold that liability can attach whenever information is disclosed for a "noncorporate purpose," including a gift of inside information to a friend, family member, or "anyone else." The Court instead adhered to Dirks, reiterating the presumptive benefit a tipper receives in the event of a personal relationship and leaving Newman intact except to the extent it held that the tipper must receive a pecuniary benefit in exchange for a gift to family or friends.

Without overruling Newman expressly, Martoma continues, the majority adopted a theory that nullified not only the "meaningfully close personal relationship" test, but also the personal benefit requirement itself. It did so based on a sentence in Dirks that could be read to establish that an intention to benefit the tippee constituted a stand alone personal benefit to the tipper, while admitting that "few reported decisions have relied" on this stand alone theory. This amounts to adoption of the same theory that the Supreme Court declined to adopt in Salman, where part of oral argument was spent pondering a "sad guy on the street" hypothetical in which an insider gives a tip to a stranger just to cheer him up.

Suitability for review. The question is important because of New York’s role as the U.S. financial capital and the site of numerous insider trading prosecutions, the petition asserts. Given that "virtually any securities transaction will touch New York," the government will choose that venue rather than have to prove an actual benefit to the tipper in another circuit.

Martoma also points to the "inability of the Second Circuit to settle on a coherent test" as a rationale for review, noting that the court substantially revised its views first in Newman, then in Martoma I, and now in Martoma II. The uncertainty and instability raise concerns of due process and fair notice and could have a chilling effect on the securities markets, which encourage traders to unearth, analyze, and trade on information.

Anticipating challenges in obtaining certiorari, Martoma also asserts that the Second Circuit included an alternative holding that the insider received a financial quid pro quo in order to avoid review by the Supreme Court. The petition argues that if the government had an adequate quid pro quo theory, it would not have relied on a gift theory and a flawed jury instruction, nor would the panel have waited for the Supreme Court to decide Salman and hold reargument after Salman only to amend its 2017 opinion. Martoma had soughten banc review of that opinion, supported by a group of securities law professors and the New York Council of Defense Lawyers as amici. The appeals court also denied Martoma’s petition for rehearing en banc of the 2018 opinion.

The case is No. 18-972.

Attorneys: Alexandra A.E. Shapiro (Shapiro Arato LLP) and Paul D. Clement (Kirkland & Ellis LLP) for Mathew Martoma.

Companies: Elan Corporation, plc; Wyeth

MainStory: TopStory Enforcement FiduciaryDuties FraudManipulation ConnecticutNews NewYorkNews VermontNews SupremeCtNews

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