In a previous post I noted that United States v. Martoma can be read as an attempt to eliminate the personal benefit standard. By holding “that an insider or tipper personally benefits from a disclosure of inside information whenever the information was disclosed ‘with the expectation that [the recipient] would trade on it,’ Salman, 137 S. Ct. at 428, and the disclosure ‘resemble[s] trading by the insider followed by a gift of the profits to the recipient,’ id. at 427 (quoting Dirks, 463 U.S. at 664), whether or not there was a ‘meaningfully close personal relationship’ between the tipper and tippee” the Second Circuit potentially changed the face of insider trading. The aforementioned can be said to cover all intentional transmission of material nonpublic information because what is a gift other than giving something of value to another person. Thus, the Second Circuit has effectively replaced personal benefit with the tipper’s expectation that a recipient will trade. This is a huge change to the insider trading landscape. If true, it arguably reads fraud out of law that sounds in fraud.
Putting aside whether the Second Circuit went too far, or whether it is ultimately right or wrong, let’s discuss the more interesting question of “why”. Why was it necessary to make such a bold move? What has happened since United States v. Newman that required a redefinition of the law? Were there many insider trading cases that fell through the cracks, post-Newman, so scofflaws and ne’er-do-wells the world over were making a killing on MNPI? I tend to doubt it. And yet, the majority opinion seems very concerned that businessmen and women are saving their cash and gifting their doormen MNPI rather than a holiday bonus.
So let us examine this hypothetical. Let’s assume I am the CEO of a publicly traded company. It has been a very busy quarter for my company. We are absolutely crushing revenues and gross margin, but no one knows it. It is a virtual certainty that the stock is going to skyrocket when we release earnings in a few days. As I come down from my apartment, I see Ralph, the doorman. I also notice that the lobby is decorated in a festive, holiday theme. It is only then that I realize that I never got Ralph a gift … no card … no check … no crappy, tin of cookies. In a blink of an eye, rather than opening my wallet and taking out a few crisp hundred-dollar bills, I decide to give Ralph a secret tip of corporate information, worth potentially millions of dollars, because I fully expect him to trade on it. Naturally, Ralph trades and makes a tidy sum.
Is there anyone out there who thinks that this is NOT insider trading? Of course it is!!! It is under Dirks and it was under Newman, it is under Salman and it is under Martoma. I stole the information from my company, and gave it to my doorman with the expectation he would trade. But Ralph is not a meaningfully close friend, some will cry. True, so if we need a personal benefit reason, try intent to benefit (see Dirks, and Newman; see also my blog piece Intent to Benefit: What is Old is New Again). But come on, people, did anyone really believe Newman made it permissible for CEO to tip Ralph? I cannot imagine anyone taking the position that under Newman, this was not a crime.
This is a silly, concocted set of circumstances. In Martoma, however, the majority opinion uses this exact hypothetical as a way to upend Newman. Because there is no evidence of a meaningfully close personal relationship between CEO and Ralph, the majority says Newman went too far in defining gift to a trading relative or friend. For those who have not been following it very closely, the opinion holds that a gift to anyone — be it doorman, taxi driver, beloved aunt, or best friend — of material nonpublic information is the same kind of improper, so long as the tipper has an expectation that the recipient is going to trade.
This is the problem I have with Martoma. By eliminating the “meaningfully close personal relationship” standard, it tries to fix something that wasn’t actually broken. Rather than exploring real-world problems that happen every day, where answers might benefit Wall Street professionals, the Second Circuit broadens the scope of personal benefit so that it has become what Newman cautioned about, “a nullity.”
There are run-of-the-mill issues that could benefit from thoughtful analysis rather than worrying about a rash of insider trading doormen. Here is a hard one, made harder in light of Martoma’s overturning Newman. In the real world, Wall Street analysts seek information from investor relations people, authorized to speak on behalf of public companies. These are professional and permissible interactions and relationships. However, during the course of repeated calls to companies and meetings at conferences or analyst days, quasi-personal relationships can develop. Thus, investment professionals and corporate officers can have multi-faceted relationships. Partly social, partly professional.
If, in the course of a relationship such as this, a corporate official, still relatively junior at her job, reveals more than she should about her company, knowing the investment professional is going to trade (and, of course, she must know this because information gathering to trade is the reason investment professionals interact with public companies) under Martoma this could be considered insider trading. However, under Newman, it would not.
Martoma asks the following: (1) was the disclosure intentional. (Answer: yes); (2) did the insider have an expectation the recipient was going to trade (Answer: yes); (3) could this be considered a gift (Answer: yes, because what is a gift but the intentional giving of information without an expectation of something in return). Thus, under Martoma, both parties could be convicted of insider trading.
Newman asked the following: (1) was the disclosure intentional. (Answer: yes); (2) did the insider have an expectation the recipient was going to trade (Answer: yes); (3) could this be considered a gift to a trading relative or friend (Answer: No, after an analysis of whether these people had a “meaningfully close personal relationship” the rule of reason would lead to the conclusion that this was not insider trading because the relationship was not of the nature or kind where one party to it would commit fraud and give the other a gift of potentially millions of dollars. Because in the real world that only happens when the tipper and tippee have a very close relationship.) This is not to say that depending on the facts the investor relations person and the analyst cannot be convicted of insider trading, they simply should not be shoehorned into a personal benefit category that requires actual friendship as a prerequisite. This is straight Dirks, and it has never been overturned by the Supreme Court.
I suggest that this hypothetical is far more likely to occur than the doorman hypothetical. That’s why Newman’s meaningfully close personal relationship requirement was important. It could prevent innocent people from being indicted because most people understand that only people in truly close relationships gives gifts worth hundreds of thousands of dollars … you know, unless you’re out of cash and the doorman has his hand out for a tip.
This is the relationship the Second Circuit needs to address, but once again, we are in wait and see mode to know what the law is.
Gregory Morvillo is a partner at Morvillo LLP
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