Less than three years after the U.S. Court of Appeals for the Second Circuit instituted a new test for the personal benefit element of insider trading violations in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), the Court of Appeals in United States v. Martoma, No. 14-3599 (2d Cir. Aug. 23, 2017), expressly overruled the remaining vestiges of that test, which had already been narrowed by the U.S. Supreme Court in Salman v. United States, 137 S. Ct. 420 (2016).

The recent cases all addressed the Supreme Court's seminal decision in Dirks v. SEC, 463 U.S. 646 (1983), which held that liability for insider trading under §10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder requires the insider disclosing material nonpublic information to have received or expected a personal benefit in exchange for disclosing the information. Dirks provided a broad definition of personal benefit, holding that it could be satisfied by (among other things) “a gift of confidential information to a trading relative or friend.” 463 U.S. at 664.

In a 2-1 decision, the Court of Appeals in Martoma held that Newman's gloss of a “meaningfully close personal relationship” as part of the personal benefit test was “no longer good law.” Slip Op. at 24. Instead, the majority ruled, liability requires the government to prove that the tipper expected the tippee would trade on the information and the tip “resembled trading by the insider followed by a gift of the profits” to the tippee. Id. at 26.

From 'Dirks' to 'Salman'

In the United States, unlike other jurisdictions, merely trading on material nonpublic information is not enough to incur liability: There must also be a breach by the tipper of a fiduciary duty or other duty of trust and confidence. In the 1980s, the Supreme Court established the principle that the federal securities laws do not “create a system [of] providing equal access to information necessary for reasoned and intelligent investment decisions.” Chiarella v. United States, 445 U.S. 222, 232 (1980). In Dirks, the Supreme Court held that the test for what constitutes a breach of fiduciary duty is whether the tipper “personally benefits, directly or indirectly, from the disclosure.” Id. at 662. The court elaborated that personal benefit can mean not just pecuniary gain, but also “a reputational benefit that will translate into future earnings,” and that “objective facts and circumstances [] often justify” an inference of benefit. Id. at 663-64. Examples of such “facts and circumstances” include “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.” Id. at 664. The elements of improper exploitation of nonpublic information “also exist when an insider makes a gift of confidential information to a trading relative or friend.” Id. The Supreme Court reasoned: “The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.” Id. The concept of information as a gift plays a pivotal role in both Salman and Martoma.