Second Circuit Overrules Limitation on Insider Trading Liability Established in US v. Newman |

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Second Circuit Overrules Limitation on Insider Trading Liability Established in US v. Newman


Last week, a divided panel of the US Court of Appeals for the Second Circuit issued another in a series of important insider trading decisions regarding the personal benefit requirement in the context of gifting confidential information, sustaining the conviction of Mathew Martoma, a former portfolio manager. In doing so, the panel expressly overruled a significant aspect of the Court’s 2014 decision in United States v. Newman, holding that a “meaningfully close personal relationship” was no longer required, at least in the Second Circuit, to prove both civil and criminal insider trading when a tipper makes a gift of material, non-public information. Under the panel’s ruling, the personal benefit requirement may be satisfied whenever an insider discloses material, non-public information with the expectation that the recipient will trade on it and the disclosure resembles a gift of trading profits from the insider to the recipient — even if the recipient is not a friend or relative. This holding drew a sharp rebuke from one of the judges on the panel, who both challenged the majority’s reasoning and criticised the panel for overruling a decision of an earlier panel without convening an en banc session of the full Court.

Notably, even though the Martoma decision abrogated a significant gloss on the personal benefit requirement that limited the reach of insider trading laws in the Second Circuit, the decision left standing an equally important limiting aspect of Newman, namely that to prove insider trading the government still must establish that the tippee knew (or consciously avoided knowledge) that the tipper disclosed the inside information in order to obtain a personal benefit. That aspect of Newman remains a critical limitation on insider trading liability, particularly for remote tippees who, unlike immediate tippees, may not know of the tipper’s personal benefit.

The Court also emphasised that not every disclosure of inside information will result in insider trading liability; instead, only disclosures of such information that are made with the intent that the tippee will trade on the basis of that information (i.e., the functional equivalent of a gift of cash derived from illicit trading) will satisfy the personal benefit requirement. The shift in focus to the tipper’s intent, as opposed to the nature of the relationship between tipper and tippee, should still serve to meaningfully limit insider trading liability in the business context in which these issues typically arise. In the usual case, the government will likely be hard-pressed to demonstrate that the tipper’s purpose was to make a gift of trading profits to someone who was not a friend or the source of a pecuniary or other tangible benefit.

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