Prosecuting Insider Trading Cases Just Got Easier: The Martoma Decision

Mathew Martoma is serving a 9-year prison term for insider trading at the federal prison camp in Miami, FL.  He appealed his sentence and in August the 2nd Circuit upheld his conviction giving prosecutors the broader definition of "benefit" that they sought for prosecuting insider trading cases.

Martoma was a one-hit wonder, portfolio manager at Steven Cohen’s hedge fund SAC Capital (now Point 72 and poised to get back into the business).   His big hit related to call to invest buy shares of pharmaceutical stocks Elan Corporation and Wyeth Pharmaceuticals, during a time when the two companies were developing a drug for Alzheimers called bapineuzumab.  Using Dr. Sidney Gilman as a paid consultant, Martoma believed that the drug was going to show success in clinical trials, so he acquired a large position in the stocks.  Then, after a meeting with Gilman on July 19, 2008, Martoma came away with the feeling that the drug was not going to be the success everyone believed.  Government prosecutors believed that Gilman had passed on confidential information to Martoma.  Martoma contacted Cohen and SAC sold its position in the companies avoiding a $144.6 million loss and then shorted the stock.  That short position resulted in an $80.3 million gain once shares of Elan and Wyeth plummeted on July 29 after Dr. Gilman publicly delivered lackluster news on the drug’s efficacy.  Martoma would receive a $9 million bonus as a result of his work but would later be fired from SAC for not coming up with another winner.  Such is life on Wall Street.

NEW YORK, NY – JANUARY 03: Mathew Martoma (L) walks with his wife Rosemary (C) and his lawyer after leaving Manhattan federal court, following his arraignment on insider-trading charges on January 3, 2013 in New York City. Martoma worked for CR Intrinsic Investors LLC between 2006 and 2008. He was released on $5 million bail after being charged with securities fraud after using insider information to make more than $276 million for his fund and others. (Photo by Spencer Platt/Getty Images)

If we were to pull the common person off of the street and put them on a jury, they would most likely look at the aforementioned scenario and think "guilty."  And that is exactly what happened to Martoma at trial.  You have a rich, privileged, young man, having access to someone who possesses confidential and material information on a publicly traded company, who subsequently makes very profitable.  It looks bad, but what is the law?

The law concerning insider trading is so vague that the SEC even has a disclaimer on the webpage attempting to define the term that directs the reader to ultimately "… consult with an attorney who specializes in securities law."  One needs an attorney because security law violations are so unclear that they are being interpreted by federal judges, particularly those in the 2nd Circuit.

The 2nd Circuit’s Newman decision, which overturned the convictions of Todd Newman and Anthony Chiasson, provided some definition to insider trading laws but prosecutors seemed unhappy with the decision.   The key component of the Newman decision, which raised the ire of prosecutors, was that there was a requirement for a payment from someone on the outside of the company to someone who was leaking the information from the inside of the company (there is more technical legal terms but let’s keep it simple here).  This interpretation was of significance because hedge fund analysts and managers routinely share information on a variety of stocks and positions in those stocks without disclosing their original source of the information.  If, somewhere along the chain, someone had obtained the information illegally (paid for it), then the portfolio manager trading on the information had some protection from prosecution.  In an article from the Harvard Law School Forum on Corporate Governance and Financial Regulation, attorney Jon Eisenberg wrote, "Newman is a well-deserved generational setback for the Government. It reflects the Second Circuits reasonable reaction to Government overreach, and it establishes brighter lines to cabin prosecutorial and SEC discretion in bringing future criminal and civil insider trading actions." Shortly after the decision, prosecutors in the Southern District of New York dropped charges against a number of individuals, some of whom had even pleaded guilty to insider trading.  Despite that minor setback, prosecutions for insider trading have kept coming.

In Martoma’s case, he used Dr. Gilman as a paid consultant until just before the final meeting where the negative information on bapineuzumab was allegedly given (no payment).  The Newman decision implied that there must be something of substance exchanged for the information, like money … something more than friendship.  With no payment, Martoma argued that there was no benefit provided for the information.  It gets technical but the Martoma decision proclaims that "Newman is no longer good law," which opens up a broader definition of insider trading.  Stuart Slotnik, Buchanan Ingersoll Rooney PC, told me, "The government is going to feel more confident going after insider trading cases.  With this decision, prosecutors have more leeway than they did after Newman."

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