Two Recent Insider Trading Cases Shed Light on 2017 Martoma Decision

The Second Circuit recently decided a pair of insider trading cases that provide additional guidance on the law following the court’s 2017 decision in Martoma.  In United States v. Klein, 2019 U.S. App. LEXIS 858 (2d Cir. Jan. 10, 2019), the Second Circuit upheld Defendant Schulman’s insider trading conviction. Schulman, the “tipper,” did not directly trade on material, non-public information, but rather shared it with Klein, a tippee, who did. On appeal, Schulamn argued that there was insufficient evidence of his criminal intent, and that no reasonable jury could conclude that he disclosed the information with the expectation that Klein would trade on it. The Second Circuit disagreed.

To prosecute a case on insider trading, the government must prove a personal benefit. The critical question on this element is whether the tipper shared the material, non-public information with the tippee intending that the tippee use the information to improperly trade securities. On appeal, Schulman argued that the evidence presented merely suggested that he made one misguided comment to a friend in an effort to show off that he knew something that the public did not. The statement, he argued, was not evidence of intent.

The Second Circuit, however, viewing the various pieces of evidence together, found that Schulman had to have communicated additional information for him to concede that his comment was in fact material, non-public information. Thus, a rationale jury, properly drawing reasonable inferences and using common sense, could conclude Schulman provided Klein with additional inside information.

Further, the Second Circuit held that the trial record was replete with evidence supporting an inference that Schulman told Klein information so that Klein would trade on it. In doing so, the court rejected Schulman’s arguments that Klein’s role as his financial advisor was irrelevant. The fact that Klein and Schulman were close friends did not detract from the relevance of Klein’s profession. On the contrary, it provided additional motive. Similarly, according to the court, a rational jury could have inferred that Klein was acting in accordance with Schulman’s intent from the fact that Klein purchased hundreds of thousands of dollars in securities immediately after meeting with Schulman, even though there were virtually no communications between Schulman and Klein in the months following. Moreover, the court noted that it knew of no requirement in insider trading law that the government adduce evidence of multiple conversations between co-conspirators, or that the government provide direct testimonial evidence regarding a defendant’s intent. Therefore, the absence of evidence of any follow-up conversations with Klein was not persuasive.

Finally, the court noted that Schulman’s evidence at best supported an inference that Schulman did not intend for Klein to trade for Schulman’s benefit. However, it said nothing about whether Schulman intended Klein to trade for his own benefit. Such claim is an independent basis for a guilty finding.

As the district court noted, it is the jury’s job to interpret the facts, and the Second Circuit, in affirming Schulaman’s conviction, adhered to that principle.

One day later, the Second Circuit withdrew and rewrote its opinion in Gupta v. United States, 2019 U.S. App. LEXIS 1005 (2d Cir. Jan. 11, 2019), affirming Gupta’s conviction for another insider trading crime. In this case, the Second Circuit affirmed the Southern District of New York’s decision, which denied Gupta’s motion to vacate his insider trading convictions.  The motion asserted that the court’s instructions to the jury as to “personal benefit,” a necessary element of an insider trading offense, were legally invalid in light of the Second Circuit’s decision in United States v. Newman, 773 F.3d 438 (2d Cir. 2014). Newman was decided after Gupta was convicted. The district court denied the motion to vacate, concluding, among other things, that Gupta had procedurally defaulted the argument by not pursuing his objection on the direct appeal from his conviction and that he had made no showing to excuse such a default.

The Second Circuit granted Gupta’s application for a certificate of appealability on whether any procedural default of this claim may be excused. Where a defendant has procedurally defaulted by failing to raise a claim on direct review, the claim may be raised later only if the defendant can first demonstrate either (1) cause and actual prejudice; or (2) that he is actually innocent. The court found that Gupta could prove neither. In order to demonstrate cause, a defendant must show that the legal basis for the claim was not reasonably available to counsel. Cause is not shown if the claim was merely unacceptable to that particular court at that particular time. At his trial, Gupta objected to the instructions he challenged before the Second Circuit, thus, the court found there was no viable argument that such a challenge was unavailable to his counsel on direct appeal. Further, Gupta did not show prejudice. To constitute prejudice, the instruction must by itself so infect the entire trial that the resulting conviction violates due process. Gupta did not satisfy this standard for a number of reasons. First, Gupta misquoted the trial court’s instruction. Second, the trial court’s instruction was consistent with the Supreme Court’s decision in Dirks v. SEC, 463 U.S. 646 (1983). Third, although contrary to the formulation given in Newman, the instruction could not have prejudiced Gupta because it was correct. The Supreme Court expressly rejected the Newman formulation in Salman v. United States, 137 S. Ct. 420 (2016). The instructions were thus not so flawed as to deny him due process. Lastly, Gupta failed on his claim of actual innocence because he was unable to demonstrate that in light of all the evidence, it would be more likely than not that no reasonable juror would have convicted him of insider trading. There was ample evidence supporting the jury’s conviction.

In this case, the Second Circuit strictly construed the excuses available to a procedural default, and denied Gupta’s motion to vacate. Despite his reliance on Newman, which purportedly made it more difficult for prosecutors to prove insider trading, Gupta’s conviction for such an offense was upheld.

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