Martoma: Second Circuit Abrogates Newman, Broadens Dirks

A Second Circuit Panel held that the Supreme Court's Salman decision abrogated the Circuit's Newman requirement of a "close personal relationship" under the "gift theory" of insider-trading; the dissent claims the Panel decision instead abrogates Dirks' "trading relative or friend" limitation.

Martoma was a portfolio manager at SAC Capital, who traded and tipped Cohen on inside information from scientists developing a potential Alzheimer's drug at Wyeth and Elan. He was convicted of insider-trading under the "gift theory" recognized by the Supreme Court's Dirks opinion: That beyond direct trading, an insider may personally benefit from a "gift" of material non-public information to a trading relative or friend tippee in breach of the tipper's fiduciary-duty (whether directly to the company, "classic," or his source's known duty, "misappropriation").

Martoma argued for reversal based on the Second Circuit's Newman decision, which held that a jury cannot infer the required tipper's "personal benefit" under Dirks without "proof of a meaningfully close personal relationship [with the tippee] that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature." United States v. Newman, 773 F. 3d 438, 452 (2nd Cir. 2014), cert. denied, 577 U.S. ____ (2015) (denying cert. likely because its facts wouldn't make for a "clean" opinion).

In the meantime, the Supreme Court decided United States v. Salman, 137 S. Ct. 420 (2016). Salman involved a tip between close relatives, so presented a good case to reaffirm Dirks' "gift theory;" the Court did. The Salman Court also overruled Newman "to the extent" it required the tipping insider to "receive something of a 'pecuniary or similarly valuable nature'" in return for the gifted tip. Salman, 137 S. Ct. at 428.

Curiously, the Martoma majority first held that Martoma's consulting payments of $1,000 an hour for 43 hour-long sessions with his tipper met Newman's "pecuniary value" standard - the part expressly overruled by Salman. Slip Op. at 18-19.

The majority went further, concluding that Salman's reasoning abrogated Newman's stricter "relationship" requirement. "Salman fundamentally altered [Newman's] analysis …, such that the 'meaningfully close personal relationship' requirement is no longer good law." Slip Op. at 24 (although the nature of the tipper/tippee relationship remains relevant to the jury's determination). As a result, the tipper-personal-benefit requirement is met merely where information is disclosed with expectation that tippee will trade on it and the situation "resembles" a gift of an insider's trading profits. Slip Op. at 27.

A vigorous dissent by Judge Poole noted, among others, that Salman expressly did not overrule Newman's "meaningfully close personal relationship" limitation, but instead only its "pecuniary or similar" restriction. Salman also rejected the Government's invitation to broaden Dirks beyond "trading relative or friend." Dissent at 16-18. Judge Poole's dissent suggests that the majority did just that, effectively broadening Dirks, beyond Salman, and not merely rejecting Newman. Dissent, at 23, 31-32.

The decision is United States v. Martoma, No. 14-3599 (2nd Cir. Aug. 23, 2017)(aff'g insider-trading conviction).

Thomas K. Potter, III ( is a partner in the Securities Litigation Practice Group at Burr & Forman, LLP. Tom is licensed in Tennessee, Texas and Louisiana. He has over 30 years' experience representing financial institutions in litigation, regulatory and compliance matters. See attorney profile. © 2017 by Thomas K. Potter, III (all rights reserved).

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