Wall Street

Everything Is Insider Trading Again

The personal-benefit test was nice while it lasted, but now it is gone.

The gift didn't work out well for him.

Photographer: Peter Foley/Bloomberg

In order to convict someone of criminal insider trading, the government needs to prove not only that a corporate insider gave a tip of material nonpublic information to someone who traded on it; it also needs to prove that the insider got a "personal benefit" from tipping the trader. A traditional personal benefit is for the trader to hand the insider a sack of cash representing his cut of the trading profits, but courts and prosecutors have a long history of expanding the test to include squishier benefits. Maybe the insider got some job advice from the tippee, or the satisfaction of conferring a gift on his brother-in-law, or the even weaker satisfaction of looking cool in the eyes of a tippee he barely knew.

But then a few years ago the U.S. Court of Appeals for the Second Circuit, in its Newman decision, ruled: No, the personal-benefit test is a real thing, you have to get a real benefit. Or, if you gave the information without expecting anything in return, it needs to have been given in the context of a "meaningfully close personal relationship." The Supreme Court later narrowed that a bit, ruling in the Salman decision that giving inside information to your brother is obviously insider trading, but it didn't really overrule Newman. A gift of inside information "to family or friends" is insider trading; it's the equivalent of the insider trading in his own account, and then giving the proceeds to his brother as a gift. It's still a personal benefit to the insider, which is what makes it criminal: The insider is stealing corporate information to use for his own benefit. 

Mathew Martoma paid a doctor $1,000 an hour to tell him secret information about a public company's drug trials, and then traded on that information. I mean, technically Martoma's firm (SAC Capital) paid an expert-networking firm, which paid the doctor. And technically the payments were for general consultations, not explicitly for material nonpublic information about the drug trials the doctor was working on. But, come on. A thousand dollars an hour is clearly a "personal benefit." Martoma was obviously guilty of insider trading, and he was duly convicted, and yesterday the Second Circuit duly affirmed his conviction.

For some reason that I have never understood, Martoma's lawyers argued on appeal that he should have been acquitted because he didn't have a "meaningfully close personal relationship" with the doctor. "That's what the money is for!" would have been a perfectly sufficient answer, and indeed the Second Circuit more or less gave it. 1  

But then it went on rather unnecessarily to reverse Newman and hold that anyway, no, you don't need a real personal benefit to satisfy the personal-benefit test. 2 Any "gift" to anyone, even a near-stranger in a commercial relationship, is enough:

Thus, we hold 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,” and the disclosure “resemble[s] trading by the insider followed by a gift of the profits to the recipient,” whether or not there was a “meaningfully close personal relationship” between the tipper and tippee. 3

And in a sense, that is fair enough. For instance:

Imagine that a corporate insider, instead of giving a cash end‐of‐year gift to his doorman, gives a tip of inside information with instructions to trade on the information and consider the proceeds of the trade to be his end‐of‐year gift.  In this example, there may not be a “meaningfully close personal relationship” between the tipper and tippee, yet this clearly is an illustration of prohibited insider trading, as the insider has given a tip of valuable inside information in lieu of a cash gift and has thus personally benefitted from the disclosure.  

I think it is hard to argue that tipping your doorman with inside information, instead of cash, shouldn't be insider trading. 4

But Judge Rosemary Pooler dissented, and I think her dissent is more fundamentally correct:

Today, the majority holds that an insider receives a personal benefit when the insider gives inside information as a “gift” to any person. In holding that someone who gives a gift always receives a personal benefit from doing so, the majority strips the long‐standing personal benefit rule of its limiting power. What counts as a “gift” is vague and subjective. Juries, and, more dangerously, prosecutors, can now seize on this vagueness and subjectivity. The result will be liability in many cases where it could not previously lie.

The word "gift," without restriction, expands insider-trading liability dramatically: If you give information in exchange for a benefit, then you satisfy the personal-benefit test; if you give the information in exchange for nothing, then you satisfy the "gift" test. Everything is insider trading. Judge Pooler again:

Any disclosure of material, non‐public information clearly resembles a gift, in that it provides the recipient with something of value. The rule limiting the gift theory to relatives and friends made it largely unnecessary to ask what distinguished a “gift” from a non‐gift disclosure, in that most insiders have few reasons beyond gift‐giving to share valuable business secrets with close friends or family members. But in other cases, simply telling a jury to distinguish between a disclosure that is a gift, as opposed to one that is not, with no further guidance, invites decision‐making that is entirely arbitrary and subjective.

Maybe that seems fine. But in the Newman case itself, two hedge-fund managers were convicted of insider trading because an investor-relations employee at Dell had disclosed information to an analyst, who disclosed it to other analysts, and it eventually made its way to the managers. Did the investor-relations employee give the analyst that information as a "gift"? Or did he give it out just because, you know, he was an investor-relations employee whose job was to speak to analysts? Those can be hard to tell apart: If you are an investor-relations employee who talks to analysts all day, you will probably have a more pleasant day if they like you. So you try to be helpful and friendly. Maybe you gave them too much information because you were trying too hard -- but in good faith -- to be helpful and friendly. Maybe you gave them too much information because you wanted to give them an illicit gift of inside information. How would a jury be able to tell?

The Newman appeals court looked at the facts and said: Look, they weren't close friends, the IR employee didn't really get anything of value, it just doesn't look like the sort of nefarious disclosure that should create criminal insider-trading liability. The IR employee wasn't stealing the information to use it illicitly for his own benefit, so there's no criminal insider trading here. That analysis struck me as right, and still does. The Martoma court washed it away. 5

The essential purpose of insider trading law is to punish corporate insiders who use inside information for their own benefit, while allowing corporate insiders to use inside information for legitimate business purposes. That much is straightforward. But a secondary purpose of criminal insider trading law really ought to be to grudgingly allow corporate insiders to use inside information for a wide range of semi-legitimate purposes -- neither straightforward business purposes nor straightforward self-enrichment -- that just shouldn't be crimes. 

A chief executive officer telling a golf buddy about an upcoming merger: bad (and illegal). A CEO telling a potential competing bidder about a pending merger, subject to an appropriate confidentiality agreement, in order to induce a higher bid: good (and legal). A CEO telling a big hedge fund about an planned asset sale in order to get its support, or a banker telling a journalist about an upcoming merger in order to get good coverage in the press, or a whistle-blower telling a reporter about a fraud in order to expose it, 6 or an investor relations employee telling a research analyst a piece of data she wasn't supposed to because she wanted her day to be more pleasant: ehhhhhh.

You can dislike those things, but they shouldn't be crimes; they are not the misuse of corporate information to enrich the insider or her buddies. They are just stuff that happens in the market, part of a constant exchange of information driven by motives that are a mix of personal and corporate, selfish and selfless. But are they "gifts"? Now that is for a jury to decide. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

  1. From the opinion (citations omitted):

    Martoma was a frequent and lucrative client for Dr. Gilman, who was paid $1,000 per hour for approximately 43 consultation sessions. At the same time, Dr. Gilman was regularly feeding Martoma confidential information about the safety results of clinical trials involving bapineuzumab. And when Dr. Gilman gained access to the final clinical study efficacy data in July 2008, he immediately passed it along to Martoma. It is true that Dr. Gilman did not bill Martoma specifically for the July 17 and 19, 2008 meetings at which Dr. Gilman provided Martoma with the efficacy data— because, as he admitted at trial, doing so “would [have been] tantamount to confessing that [he] was . . . giving [Martoma] inside information.” But in the context of their ongoing “relationship of quid pro quo,” where Dr. Gilman regularly disclosed confidential information in exchange for fees, “a rational trier of fact could have found the essential elements of the crime [of insider trading] beyond a reasonable doubt” under a pecuniary quid pro quo theory.

    The doctor didn't explicitly bill Martoma for the two sessions where he disclosed obviously material information, but did bill him for 43 other sessions, which is good enough.

  2. You'd think all the money would be enough, and indeed it was. But Martoma's lawyers challenged the jury instruction that the trial judge gave in his case. The judge told jurors that they have to "determine whether the government proved beyond a reasonable doubt that Dr. Gilman and Dr. Ross received or anticipated receiving some personal benefit, direct or indirect," from disclosing information to Martoma, but he also said:

    You may find that Dr. Gilman or Dr. Ross received a direct or indirect personal benefit from providing inside information to Mr. Martoma if you find that Dr. Gilman or Dr. Ross gave the information to Mr. Martoma with the intention of benefit[t]ing themselves in some manner, or with the intention of conferring a benefit on Mr. Martoma, or as a gift with the goal of maintaining or developing a personal friendship or a useful networking contact.  

    "With the intention of conferring a benefit on Mr. Martoma, or as a gift," is a pretty low bar, and Martoma's lawyers argued (correctly) that it conflicted with the Second Circuit's personal benefit requirement in Newman.

    The appeals court could have just said: Yes, that's true, but it doesn't matter, because also Martoma paid the doctors for information, and that's clearly why the jury convicted him, not because of the gift stuff. And it did almost say that:

    Even if the jury instruction was obviously erroneous—which we hold it was not—that error did not impair Martoma’s substantial rights in light of the compelling evidence that Dr. Gilman, the tipper, received substantial financial benefit in exchange for providing confidential information to Martoma.

    But it also went further, to conclude not only that the jury instruction didn't matter, but also that it was correct, and that Newman is no longer good law.

  3. Citations omitted.

  4. It's odd that there are no doorman cases. They seem like fruitful hypotheticals. For instance, if a CEO comes home late one night and says to his doorman "long day, Bob, I was negotiating a big merger with XYZ Co.," and then the doorman buys XYZ call options -- is that insider trading? And if so, how?

    Under the ruling of the Martoma court, it's insider trading, and both the CEO and the doorman are guilty, if the CEO knew that the doorman would trade on it and intended the information to be a gift to the doorman.

    Under fairly well-established law, it's insider trading, and the doorman is guilty, but the CEO is not, if they were in a relationship of "trust and confidence" that the doorman betrayed by trading on the information without the CEO's knowledge.

    Lots of insider trading cases turn on this distinction: Did the CEO tell his doorman intending the doorman to trade and make money, or intending the doorman to keep it within the doorman-resident relationship of confidentiality? (Or, I mean, not on that exact distinction, but on similar ones involving the roommate or golf-buddy duties of confidentiality.) If it's the former, then both the CEO and the doorman are guilty; if the latter, then only the doorman is.

    But what if it's neither? What if the CEO just said it, as sort of a casual observation, without intending the doorman to trade, but without having any expectation of confidentiality either? Then I think -- and this is of course not legal advice -- but then I think neither of them is guilty of insider trading.

    But one thing that expanding the "gift" category does is make this defense harder. Pretty much any gratuitous passing of information can be characterized as a "gift," if you want it to be. If the CEO just says to the doorman "hey, nice weather, I'm going to go work on a merger," then prosecutors can argue that he intended it to be a gift -- and how can the CEO disprove that?

  5. Probably. "The dissenting opinion, by Judge Rosemary S. Pooler, may set the stage for Mr. Martoma’s lawyers to ask for the entire appellate court to consider the appeal." The problem, though, is that this is such a dumb case: Martoma is so obviously guilty -- he paid the doctor for information! -- that it would be weird for the en banc court to reverse this decision, even if the panel went a bit too far in its reasoning. 

  6. The issue in Dirks v. SEC, the Supreme Court case that created the "personal benefit" requirement.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net

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