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Prosecuting insider trading charges could be easier after appeals court ruling

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A divided 2nd U.S. Circuit Court of Appeals ruling will make it easier for federal prosecutors to pursue insider trading cases against company executives, say experts.

But some experts say the ruling also leaves a substantial gray area in insider trading law.

The Aug. 23 ruling in United States of America v. Mathew Martoma concerns Mr. Martoma’s conviction for one count of conspiracy to commit securities fraud and two counts of securities fraud in connection with an insider trading scheme.

A consultant had provided Mr. Martoma, a hedge fund manager for New York-based S.A.C. Capital Advisors L.L.C., with confidential information about a clinical trial for an Alzheimer’s medication before it became public, information which Mr. Martoma’s firm used to make $80.3 million in gains and avert $194.6 million in losses, according to the ruling. Although the consultant had received payments from S.A.C. in the past, he was not directly paid for this information.

The ruling is the latest in a series dealing with the relationship between tipsters and their recipients, say experts. In 1983, the U.S. Supreme Court held in SEC v. Dirks that the test of whether there has been a breach of fiduciary duty is whether the tipper will benefit, directly or indirectly, from his disclosure to the “tippee.”

In its 2014 ruling in United States v. Newman, the 2nd Circuit said that in cases when there was not an explicit “quid pro quo” the tipper had to have a “meaningfully close personal relationship” with the “tippee” for the information “gift” to be considered insider trading.

Then, in its 2016 ruling in Salman v. United States, the U.S. Supreme Court said a tipper receives intangible personal benefits with the gift of confidential information to a trading relative or friend in insider trading cases.

The Martoma ruling disagrees with the court’s own ruling in the Newman case and broadens the boundaries of liability, say experts. It states an insider or tipper may be liable if the tipper discloses information with the expectation the recipient would use it for trading or other personal gain, regardless of whether there was a meaningfully close personal relationship.

“The evidence was sufficient to support Martoma’s conviction,” said the majority opinion, in affirming the lower court ruling in the case.

The dissenting opinion states the majority’s ruling “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.”

Jonathan E. Richman, a partner with Proskauer Rose L.L.P. in New York, said whereas before this ruling a gift of information might have had to have been given to a friend or relative to be considered insider trading, “The 2nd Circuit says essentially, it doesn’t matter whom you’re giving it to” — it could be a doorman, he said.

“The 2nd Circuit has made the government’s job easier in prosecuting tipping cases,” said David I. Miller, a partner with Morgan, Lewis & Bockius L.L.P. in New York.

After the Newman decision, prosecutors may have had doubts about filing insider trading cases. But with this ruling, “we may see an uptick even beyond what we’ve already seen in insider trading investigations and enforcement actions.”

“It’s a very important decision,” said Ira M. Feinberg, a partner with Hogan Lovells US L.L.P. in New York. “It makes it easier for the government to establish the personal benefit requirement of insider trading law, and to that extent in some cases, perhaps many cases, it will make it easier for the government to obtain a conviction.”

Harry Sandick, a partner with Patterson Belknap Webb & Tyler L.L.P. in New York, said: “On one level, it shouldn’t change anything, and the best advice, if you are a lawyer and you do securities work, is to tell your clients the same thing you did two weeks ago,” which is, “Don’t make trades while in possession of material, nonpublic information.”

But, he added, “The government will continue to bring insider trading cases and will now have the benefit of a somewhat more lenient standard.”

“It’s a welcome ruling,” said Robert C. Hockett, a professor at the Cornell Law School in Ithaca, New York. In a sense, he said, it restores the law that had been in effect for many decades.

Around the 1990s, however, “some courts began to narrow the gate to make it a little bit harder for prosecutors or regulators to find liability” in insider trading cases, he said.

With this and the Salman ruling, “We now have two fairly wide gateways through which a prosecutor or a regulator can find somebody liable” for insider trading, he said.

However, some experts say the ruling leaves insider trading law unclear.

“The hardest part of this is, it’s going to make some of the lines more blurry, particularly when there’s no money changing hands,” said Carolyn G. Nussbaum, a partner with Nixon Peabody L.L.P. in New York.

Observers say the 2nd Circuit may decide to rehear the case en banc in light of the fact that the latest ruling disagrees with another 2nd Circuit panel’s ruling in the Newman case. But they also note that the 2nd Circuit only takes en banc cases at a rate of about once a year, so the chances of that happening are slim.