In December 2014, the U.S. Court of Appeals for the Second Circuit in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), overturned the insider trading convictions of hedge fund managers Todd Newman and Anthony Chiasson.1 The court held that the “personal benefit” that an insider who reveals confidential information must receive in exchange for providing confidential information must be “a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”2 It must be more than a mere friendship, although the benefit need not be monetary.3 The holding has been criticized as making it more difficult to prosecute insider trading cases where it is simply two friends exchanging stock tips.4 The controversy surrounding the Newman holding has started debates as to whether Congress should simply create a statute clearly defining insider trading.5
Currently, there is no statutory prohibition against insider trading. Courts have determined the law of insider trading cases, deciding them under section 10(b) of the Securities Exchange Act of 1934, which is codified in 15 U.S.C. § 78j(b), a general fraud prohibition which bars the use of “any manipulative or deceptive device or contrivance” “in connection with the purchase or sale of any security.”6 Neither the statute nor the related Securities and Exchange Commission (“SEC”) Rule 10b-5 explicitly prohibits insider trading.7 As the court in Newman explains, “the unlawfulness of insider trading is predicated on the notion that insider trading is a type of securities fraud proscribed by Section 10(b) and Rule 10b-5.”8
Representatives in Congress have proposed multiple bills proposing to remove the requirement that the tipper receive a personal benefit for passing information on to the tippee and more generally to clarify the insider trading law.9 Closest to current law is the “Ban Insider Trading Act” introduced on February 27 by Representative Stephen F. Lynch.10 The bill states that it is a federal crime to “purchase or sell any security based on information the individual knows or should know is material inside information.”11 Inside information is defined as information that is nonpublic; and obtained either illegally, directly or indirectly from an issuer with an expectation of confidentiality or that such information will only be used for a legitimate business purposes; or in violation of a fiduciary duty.12
Including “violation of fiduciary duty” in the definition appears to be consistent with the standard from Chiarella v. United States, 445 U.S. 222, 228 (1980), that transacting on non-public, material information is fraud only when one party has a “duty to disclose” arising from a relationship of “trust and confidence” between the parties, although the use of the words “fiduciary duty” in the bill might make the standard much clearer.13 Articles discussing the bill have stated that the “obtaining information with an expectation of confidentiality” prong helps address the problem of trading tips on the golf course.14 As explained above, prosecutors currently have to prove that the corporate insider received a personal benefit. However, under the bill’s standard, the prosecutors only have to show that the information came from the issuer and that the person who tipped knew it came with an expectation of confidentiality to prove insider trading.15
The broadest of the proposals is the “Stop Illegal Insider Trading Act” introduced by Senators Jack Reed and Bob Menendez. Their bill sets out a “simple, bright line rule” that if someone trades on material information that he “knows or has reason to know” is “not publically available,” that constitutes insider trading.16
Commentators have pointed out that because of its focus on whether the information is publically available, the bill could sweep too broadly. In the markets, there are many types of information that are not widely available such as analyst research, expert networks, exchange data fees17, or even the intentions of an important investor, such as Warren Buffet, that are not widely known.18 How much of this information the bill will cover is vague.19
On the other hand, the bill’s exceptions could reduce the risk of too broad an impact. First, the SEC could use the authority granted by Congress to create exemptions from this rule.20 Second, the bill also contains an exception that the term “not publically available” excludes information a person has developed “independently” from “publically available sources.” (20. Id.)) However, the SEC rulemaking process takes a long time and is subject to intense lobbying.21 Also, the second exception raises the same concerns as the bill itself. It is difficult to determine what information is publically available because many types of information are only available to some investors and not to others.22
Although the Senate bill has a Republican co-sponsor, the bills have been introduced by the minority party in Congress and are unlikely to pass.23 Even if a bill were to pass, Congress might end up adding more confusion by attempting to clarify the law. The bill will still have to be interpreted by the SEC and the courts. For example, the term “publically available” in the Senate bill will have to be defined. The House bill presents a similar issue in clarifying what “material” information would be.24 The bill defines material information as that which “would be likely to have a significant effect on the price of a security.” However, for example, we do not know if that would include high frequency trading, where price differences are “measured in pennies.”25 Which of the bills, if either, will gain support will be interesting to see.
1. United States v. Newman, 773 F.3d 438 (2d Cir. 2014); Peter J. Henning, Insider Trading Case Could Push Congress to Define a Murky World, N.Y. Times (Feb. 23, 2015), http://www.nytimes.com/2015/02/24/business/dealbook/insider-trading-case-could-push-congress-to-define-a-murky-world.html?smid=tw-share&_r=0. ↩
2. Newman, 773 F.3d at 452. ↩
3. Id. ↩
4. Insider Trading: There Ought to Be a Law, Bloomberg View (Jan. 5, 2015, 8:00 AM), http://www.bloombergview.com/articles/2015-01-05/insider-trading-should-be-against-the-law. ↩
5. Id. ↩
6. 15 U.S.C § 78j(b). ↩
7. Id.; see also 17 C.F.R. § 240.10b–5. ↩
8. Newman, 773 F.3d at 445. ↩
9. See, e.g., Matt Levine, Congressman Thinks Maybe Insider Trading Should Be Illegal, Bloomberg View (Mar. 4, 2015, 4:37 PM), http://www.bloombergview.com/articles/2015-03-03/congressman-thinks-maybe-insider-trading-should-be-illegal. ↩
10. Press Release, U.S. Congressman Stephen Lynch, Lynch Introduces Bill to Ban Insider Trading (Mar. 2, 2015), available at http://lynch.house.gov/press-release/lynch-introduces-bill-ban-insider-trading. ↩
11. Id. ↩
12. H.R. 1173, 114th Cong. § 2(a) (2015), available at https://www.congress.gov/114/bills/hr1173/BILLS-114hr1173ih.pdf. ↩
13. Chiarella v. United States, 445 U.S. 222, 228 (1980); see Congressman Thinks Maybe Insider Trading Should Be Illegal, supra note 9. ↩
14. Congressman Thinks Maybe Insider Trading Should Be Illegal, supra note 9. ↩
14. Id. ↩
15. Press Release, U.S. Senator Jack Reed, Reed & Menendez Introduce Bill to Clearly Define and Ban Unlawful Insider Trading (Mar. 11, 2015), available at http://www.reed.senate.gov/news/releases/reed-and-menendez-introduce-bill-to-clearly-define-and-ban-unlawful-insider-trading. ↩
16. Matt Levine, Senators Really Think Insider Trading Should Be Illegal, Bloomberg View (Mar. 11, 2015, 6:17 PM), http://www.bloombergview.com/articles/2015-03-11/senators-really-think-insider-trading-should-be-illegal. ↩
17. Peter J. Henning, Court Strikes on Insider Trading, and Congress Lobs Back, N.Y. Times (Mar. 16, 2015), http://www.nytimes.com/2015/03/17/business/dealbook/court-strikes-on-insider-trading-and-congress-lobs-back.html?_r=0. ↩
18. Id. ↩
19. Senators Really Think Insider Trading Should Be Illegal, supra note 16. ↩
21. Henning, supra note 17. ↩
22. Senators Really Think Insider Trading Should Be Illegal, supra note 16. ↩
23. Henning, supra note 17. ↩
24. Id. ↩
25. Id. ↩