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 Insider Trading 

Lawrence Hartman

Lawrence Hartman

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Our contributor, Lawrence Hartman, wrote this post to help us understand laws pertaining to insider trading and the Martoma Rule.

            Every so often, a new trailblazing area of the law is carved out for particular distinction, then, forever thereafter, commonly referred to by the name of the defendant.  Matt Martoma was a high-powered trader working at a major New York hedge fund when the government targeted his billionaire boss Steve Cohen.  He was also my friend and next-door neighbor for over a year, at FPC Miami, so I had plenty of time to understand nuances of his case that didn’t particularly make the news.      

            Insider trading, in general terms, is the trading of a company’s stocks or other securities by individuals with access to confidential or non-public information about the company.  While Federal law defines an “insider” as a company’s officers, directors, or someone in control of at least 10% of a company’s equity securities.  However, as you can imagine, things are more complicated than that?  When an “insider” is not directly trading on the information then there has to be some sort of nexus between the trader and the insider by way of a “benefit,” in order to fall afoul of the law, which can include an assumed quid pro quo or even just an intention to benefit.  So, as you can imagine, it’s a shapeshifting area of the law driven by judicial interpretation leaving a wide gap of uncertainty.  The government then uses the leverage of that uncertainty to put extreme pressure on anyone and everyone associated with that activity, intended to take out a daisy chain of defendants all the way to the top.  After all, some nice juicy press goes a long way toward catapulting a US Attorney into the spotlight.

In Matt’s case, the government put tremendous pressure on Matt to plead out and turn state’s evidence, but he refused, intent on proving his innocence.  During the trial, Matt’s attorneys were having a field day with a key witness catching him in lie-after-lie when the Court recessed for the day.  The next morning, the witness returned with a newly remembered, airtight, version of events never before mentioned in any statement or interview.  He claimed these new facts arose from hypnotically induced refreshed recollections from repressed memory.  Huh?!?  The Judge allowed it and the jury bought in since it was clearly good enough for the judge.  The case against Matt itself, was based on a new theory of insider trading carved out especially for this case and narrowly upheld on appeal in a 2-1 decision by the Court of Appeals.  The Supreme Court declined to hear the case and thus, the Martoma Rule was born.

Now, as for the specifics of where insider trading law now stands, the vast majority of insider trading law is understandably out of the Second Circuit in New York, where Wall Street is located.  For decades, courts deemed the personal benefit requirement to be satisfied if the government proved either tangible (e.g., money) or intangible (e.g., friendship) benefits to the tipper, under a case known as Dirks.  The next key case is Newman, in which the defendants’ guilt was overturned when the Second Circuit Court of Appeals determined that casual career advice given between colleagues and conversation between church acquaintances were insufficient to convict a tipper, when the tipper seemingly had no reason to believe the information would be traded upon.  That was followed by the Salman case, which is slightly more convoluted.  In that case, a tipper gave information to his brother to “fulfill whatever needs he had,” along with the knowledge that his brother would trade on it.  His brother, however, then also passed the information along to Salman, whose sister was engaged to the tipper.  Salman, a third-party tippee (so to speak) used that information to trade and was convicted in the Northern District of California in 2013.  Which brings us to Martoma. 

Matt Martoma had a consultant on his payroll that he regularly used to help him better understand biotech companies, which were Matt’s specialty.  This consultant was on the clinical trial team analyzing the efficacy of an important drug in one of the companies Matt was trading.  Matt received information from the consultant, 10 days before the information went public, and traded on the information making $80.3 million in gains and avoiding $194.6 million in losses in the process.  The Second Circuit held that the personal benefit requirement was satisfied by Martoma’s payments to the doctor.  The Court, however, also issued two lengthy opinions in an effort to further clarify the personal benefit analysis, attempting to elucidate upon the distinctions between Salman and Newman with a slightly more nuanced version of the personal benefit test, which it said could be satisfied in one of two ways:  (1) if the tipper and tippee share a quid pro quo relationship (akin to the “meaningfully close personal relationship” test of Newman), or (2) if the tipper simply intended to benefit the tippee.  There have since been additional nuances raised by a case known as Gupta but the contortions the Second Circuit Court took to reach its decision in Martoma (and it’s 2-1 decision on appeal) make it clear that Federal insider trading targets still have plenty to worry about.  The law is still murky and can be twisted to suit an ambitious prosecutor’s purposes.

With that in mind, damage control is a major consideration when facing or threatened with insider trading charges.  After all, Matt Martoma received a 9-year sentence, despite assurances from his high-power and high-paid legal team that he’d beat the charges.  The law isn’t nearly as clear as we’d like to believe and it’s little more than a crapshoot when your case goes before a jury.  The big problem with that, of course, is that the government is the House, with the odds in its favor, which helps to explain it’s 97+% conviction rate.  So, kindly bear that in mind as you consider your legal strategy because decisions you make now will have a huge impact on your future.

About the author:  Lawrence Hartman, is a Columbia Law School grad who has done deals worth hundreds of millions of dollars over his lengthy career as a Wall Street attorney, General Counsel of a publicly traded REIT, internet entrepreneur and international financier.  He also, found himself on the other side of the process as a defendant and then inmate, learning all too well that things don’t work how they teach in law school.  He served 7-1/2 years utilizing his legal background to gain unique insights and perspectives vital for mitigating criminal legal exposure.      

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