On Insider Trading, an Appeals Court Comes to Its Senses

Given the circumstances of the case, it was no surprise when Mr. Martoma was convicted in 2014 and sentenced to nine years in prison.

Yet earlier this year, thanks to an appeals court opinion that tied the hands of prosecutors and threatened to unleash an open season for insider trading, Mr. Martoma’s lawyers argued that he’d been wrongly convicted and should go free.

“If the Martoma conviction had been thrown out, prosecutors would have to ask, what’s the point?” said Richard B. Zabel, former deputy United States attorney in Manhattan and now general counsel for the hedge fund Elliott Management, “It would have been profoundly demoralizing for anyone who cares about law enforcement.”

Fortunately, that’s not going to happen. A few weeks ago, a three-judge panel of United States Court of Appeals for the Second Circuit slammed the door on Mr. Martoma’s appeal. The court also seized on his case to issue a sweeping ruling on insider-trading law, and took the rare step of all but overruling its own earlier decision that was the basis of the request, in United States v. Newman.

The effect is to restore the full legal arsenal at the disposal of prosecutors. Of course, whether they will use it as aggressively as Preet Bharara, the United States attorney in Manhattan whom President Trump fired in June, remains to be seen. (A permanent replacement for Mr. Bharara hasn’t been named.)

Martoma “wasn’t a hard case,” said John C. Coffee Jr., a professor at Columbia Law School and an expert on white-collar crime. “In fact, it’s one of the easiest insider-trading cases I’ve ever seen.” While the appellate panel may have overreached in its eagerness to limit the damage from Newman, he said, the upshot is that “the odds have again swung to the prosecutors’ advantage.”

Both the Newman and Martoma appeals turned on the relationship between the person who conveys inside information (the “tipper”) and the person who receives and trades on it (“the tippee”). To be guilty of insider trading, the tipper needs to personally benefit, directly or indirectly, from the disclosure, the Supreme Court has held.

Until Newman, this benefit was construed quite broadly, and could easily be inferred if the tipper and tippee were relatives, friends or even acquaintances. But in Newman, the Second Circuit held prosecutors to a much higher standard, ruling that the relationship must be “a meaningfully…

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