SPRING 2019 TODAY’S GENER AL COUNSEL
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issued an amended opinion (Martoma II), with Judge Pooler once against dissenting. The court reached the same result as before and affirmed the conviction in the case before it. But it modified its holding that Salman implicitly overruled the “meaningfully close personal relationship” aspect of Newman. Instead, the court stated that it was not necessary to decide whether Salman entirely abrogates Newman’s “meaningfully close personal relationship” test. Judge Katzmann emphasized that there are many ways to establish a personal benefit to the tipper, including pecuniary gain; a reputational benefit that will translate into future earning; a relationship between the tipper and tippee that suggests a quid pro quo; the tipper’s intent to benefit the particular tippee; and (the scenario involved in the Salman case) a gift in the form of confidential information to a relative or friend where the tip, and the resulting trade, resemble trading by the insider himself, followed by a gift of the profits to the recipient.
I N TEN T TO BEN EFIT
In one of the points that provoked the strongest disagreements from the dissent, the panel made clear that an intention by the tipper to benefit the tippee in question was itself sufficient to support a finding of personal benefit to the tipper, even without additional evidence of a relationship between the tipper and tippee. Although Martoma II held that it was not deciding whether Newman’s “meaningfully close personal relationship” test had any continued vitality, it is difficult to discern when it would apply. In PintoThomaz, Judge Rakoff suggested that the test “only applies, at most, to situations where a fact-finder is asked to infer an adequate personal benefit simply from the relationship between the tipper and tippee” — which he said would be “in the rarest of cases.” Judge Rakoff in Pinto-Thomaz further attempted to build on Martoma II in defining how to understand and
apply the personal benefit requirement in tippee insider-trading cases, and to simplify what he described as the needless complexity created in some of the case law since the personal benefit element was adopted in Dirks. Trading by a corporate insider on material information was understood to breach a duty to the company, and thus give rise to a violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. But what about where the insider did not trade, but tipped a non-insider who did? In Dirks, the
Insider trading is a variation of the species of fraud known as embezzlement. Supreme Court held that the tippee’s liability derived from the insider’s breach, meaning that the tipper had to have breached a duty and that the tippee had to have known about it for the tippee to be liable. Dirks looked to the tipper’s personal benefit as the touchstone for determining whether the tipper had breached a duty. In that case, the alleged tipper was seen as acting to blow the whistle on corporate wrongdoing, and thus the court concluded that he was not acting for a personal benefit and therefore his tipping behavior was not a breach of duty. In keeping with its understanding of Dirks, the majority in Martoma II did not focus on the issue of personal benefit in isolation, but rather framed the question as an either/or: Was the tip given for a personal benefit, constituting a breach of fiduciary duty, or a legitimate corporate purpose, which would not be a breach? The court stated: “The tipper’s intention to benefit the tippee proves
a breach of fiduciary duty because it demonstrates that the tipper improperly used inside information for personal ends and thus lacked a legitimate corporate purpose.” In this view, it seems that the finding of personal benefit is most important to prove the absence of a legitimate corporate purpose, such as whistleblowing, for divulging confidential corporate information. Judge Rakoff in Pinto-Thomaz elaborated further on the corporate purpose issue. In his view, “insider trading is a variation of the species of fraud known as embezzlement,” in which an embezzler takes property (inside information) of another (the corporation) and uses it for his or her own benefit. What matters, he stated, is the purpose for which the insider disclosed the information, whether for “personal advantage,” or “a corporate or other permissible purpose.” Indeed, Judge Rakoff suggested that the Dirks court could have “averted subsequent confusion” by using the term “personal purpose” or “personal advantage” rather than “personal benefit.” Yet he concluded that “Dirks was quite clear as to the wide breadth of its understanding of a personal benefit.” Whether future courts will follow Judge Rakoff’s lead in setting forth the doctrinal support for insider trading cases is uncertain. And it is possible that the Supreme Court may provide further or contrary guidance. But in light of Salman, Martoma II and now Pinto-Thomaz, the law in the Second Circuit has plainly traveled a long way since Newman.
