In United States v. Martoma, 2013 WL 6632676 (S.D.N.Y. Dec. 17, 2013), defendant, Matthew Martoma (“Martoma”), was indicted in Count One for conspiracy to commit securities fraud and in Counts Two and Three for securities fraud. The United States District Court for the Southern District of New York denied Martoma’s motion to dismiss under Morrison v. National Australia Bank, holding that Rule 10b-5 applied to the transactions because they occurred in the United States. 

According to the allegations, Martoma employed an expert-networking firm to facilitate paid consultations with medical experts in the pharmaceutical industry. The firm expressly warned clients that the consultation dialogue should be limited to information already in the public domain. Between 2006 and 2008, Martoma allegedly used the network to form relationships with two doctors (“Doctor One” and “Doctor Two”) involved with clinical trials for a new Alzheimer’s drug being conducted on behalf of two pharmaceutical giants, Élan Corporation and Wyeth Pharmaceuticals, Inc.

During this period, Martoma allegedly organized and attended approximately 42 consultations with Doctor One, who served on the trial’s Safety Monitoring Committee (“SMC”). The indictment alleged that Doctor One gave Martoma confidential information relating to the safety of the new drug. Further, the indictment contended that Martoma obtained confidential information from Doctor Two as well. After receiving the confidential information, Martoma allegedly purchased both Élan and Wyeth stock and instructed his hedge fund employer to do the same.

In July 2009, Doctor One purportedly provided Martoma with additional information indicating that the Alzheimer’s drug was ineffective. Prior to informing the public of the drug’s inefficacy, the government asserted that Martoma caused his employer to sell “virtually all of its approximately $700 million worth” of holdings in Élan and Wyeth. The hedge fund also initiated various short sales and options strategies to profit from any decline in the company’s stock. These actions, according to the government, caused the fund to realize profits and avoid losses equal to $276 million. 

Rule 10b-5 prohibits “any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.” In Morrison v. National Australia Bank LTD., 561 U.S. 247 (2010), the Supreme Court concluded that Rule 10b-5 did not have extraterritorial effect.  For the provision to apply, the transaction at issue had to involve (1) the purchase or sale of a security listed on a US stock exchange, or (2) the purchase or sale of any other security that took place in the United States.

Martoma moved to dismiss Count Two and related parts of Count One, arguing that Section 10(b) did not apply because the subject transactions involved American Depository Receipts (“ADRs”) in Elan Corporation. The court found that the transaction met both tests under Morrison.  Although noting that ADRs could be characterized as “predominantly foreign securities transactions,” the Elan ADRs were listed on “an official American securities exchange.” 

In addition, the transactions occurred in the U.S. and not, as Martoma asserted, in Ireland.  Martoma focused on the fact that the actual shares were on deposit with the Bank of Ireland. The ADRs, in contrast, were “merely ‘receipts that may be redeemed for the foreign stock at any time,’” and, as a result, the “[t]he operative transaction for the issuance of Elan's ADRs— i.e., the deposit of Elan ordinary shares with The Bank of Ireland—was carried out in Ireland.”   

The court, however, disagreed.  Whatever the characterization of the ADRs, the focus of the analysis under Morrison was “where the transactions in the ADRs took place.”  Because the ADRs were listed on the NYSE, the relevant trade contracts, the passing of title, and the liability incurred by both parties to the transaction took place within the United States.

For the foregoing reasons, the court upheld the applicability of Rule 10b-5 to the present facts and denied Martoma’s motion to dismiss.  

The primary materials for this case may be found on the DU Corporate Governance website.