(Article from Securities Law Alert, July 2018)
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On June 25, 2018, the Second Circuit held that Dirks’ personal benefit requirement can be satisfied with evidence that the tipper gifted confidential information with an intent to benefit the tippee, even in the absence of evidence of a personal relationship between the tipper and tippee[1]. U.S. v. Martoma, 894 F.3d 64 (2d Cir. 2018) (Katzmann, J.) (Martoma II).[2]
Background
In U.S. v. Newman, 773 F.3d 438 (2d Cir. 2014), the Second Circuit addressed the question of when “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.” The Newman court held 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.”
Not long afterwards, the Supreme Court in Salman v. U.S., 137 S.Ct. 420 (2016), held that Dirks’ personal benefit requirement is satisfied whenever a tipper makes a gift of confidential information to a trading relative or friend, even if there is no tangible benefit to the tipper.[3] The Salman Court explained that “[i]n such situations, the tipper benefits personally because giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds.” The Salman Court specifically found Newman’s requirement that the tipper also “receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends . . . inconsistent with Dirks.”
Newman’s “Meaningfully Close Personal Relationship” Test Remains Good Law After Salman
Last year, in U.S. v. Martoma, 869 F.3d 58 (2d Cir. 2017) (Katzmann, J.) (Martoma I), the Second Circuit found that “Salman fundamentally altered the analysis underlying Newman’s ‘meaningfully close personal relationship’ requirement such that [it] is no longer good law.”[4] On reconsideration, the Second Circuit in Martoma II determined that it was not necessary to address whether “Newman’s gloss on the gift theory is inconsistent with Salman.” The Martoma II court reasoned that “there are many ways to establish a personal benefit” within the meaning of Dirks.
The Martoma II court then considered the contours of Newman’s “meaningfully close personal relationship” test. The court explained that “[t]he term . . . is new to our insider trading jurisprudence, and, viewed in isolation, it might admit multiple interpretations.” But the Martoma II court found that “Newman provided substantial guidance” because “[i]mmediately after introducing the ‘meaningfully close personal relationship’ concept, Newman held that it ‘requires evidence of a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit [the latter].’” Based on this language, which originates from Dirks, the Martoma II court determined that “Newman cabined the gift theory using two other freestanding personal benefits that have long been recognized by our case law.”
An Intent to Benefit the Tippee, Standing Alone, Is Sufficient to Satisfy the Personal Benefit Requirement
Significantly, the Martoma II court found that an “intent to benefit [the tippee] is a standalone personal benefit under Dirks,” even without evidence of a relationship between the tipper and the tippee. The court determined that the “key sentence” in Dirks (which was quoted in Newman) should be read as stating, “there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or there may be an intention to benefit the particular recipient.”[5] The Martoma II court found this interpretation “more consonant with Dirks as a whole.” The court reasoned that Dirks’ “personal benefit requirement is designed to test the propriety of the tipper’s purpose.” “Because the existence of a breach depends in large part on the purpose of the disclosure,” the Martoma II court explained that “it makes perfect sense to permit the government to prove a personal benefit with objective evidence of the tipper’s intent, without requiring in every case some additional evidence of the tipper-tippee relationship.”
The Martoma II court offered the example of a tipper who “discloses inside information to a perfect stranger and says, in effect, you can make a lot of money by trading on this.” The court stated that “[t]he 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.” The court emphasized that this “is precisely what, under Dirks, the personal benefit element is designed to test.”
Judge Pooler, Dissenting, Expresses Her View That an Intent to Benefit the Tippee Cannot Alone Satisfy the Personal Benefit Requirement
In a dissenting opinion, Judge Pooler stated that she found no basis in the language of Dirks or Second Circuit precedent to allow the government to satisfy the personal benefit requirement solely with evidence of the tipper’s intent to benefit the tippee, absent any evidence of a relationship between the two. She explained, “[e]ven assuming arguendo that there was any ambiguity on the topic in our precedents, Newman removed it by requiring a ‘meaningfully close personal relationship’ in order to prove personal benefit via the gift theory.” She expressed her view that “[w]ithout objective evidence of such a relationship, . . . the inference that a gratuitous tip functioned as a gift will not be available.”
Judge Pooler emphasized that “[m]aking the inquiry into ‘whether the insider receives a direct or indirect personal benefit’ by disclosing confidential information ‘requires courts to focus on objective criteria.’” Id. (quoting Dirks, 463 U.S. 646). But under the majority rule, “[t]he only objective facts the government would have to prove would be the communication of material non-public information. All of the protections of the personal benefit rule—a clear guide for conduct, preventing liability for slip ups and other innocent disclosures—would erode.”
[1] In Dirks v. S.E.C., 463 U.S. 646 (1983), the Supreme Court held that the “test” for tippee liability is “whether the insider [the tipper] personally will benefit, directly or indirectly, from his disclosure.” The Court noted that “[t]here are objective facts and circumstances that often justify [ ] an inference” of a personal benefit. The Court offered the examples of “a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient.” The Court stated that “[t]he elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend.”
[2] Please click here to read our discussion of the Newman decision.
[3] Please click here to read our discussion of the Supreme Court’s decision in Salman.
[4] Please click here to read our discussion of the Second Circuit’s decision in Martoma I.
[5] The Martoma II court found the Second Circuit had previously adopted this same reading of Dirks in U.S. v. Warde, 151 F.3d 42 (2d Cir. 1998). There, the Second Circuit stated that “[t]he ‘benefit’ element of § 10(b) is satisfied when the tipper ‘intends to benefit the . . . recipient’ or ‘makes a gift of confidential information to a trading relative or friend.’”