(1) Whether, in a prosecution for insider trading under § 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b), the relevant inside information must have been a “significant factor” in the defendant's decision to buy or sell, or whether - as the court below held - mere “knowing possession” of inside information suffices for a criminal conviction; (2) whether, in a prosecution for insider trading under § 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b), the “fiduciary duty” element must be proved under well-established principles of state law, or whether - as the court below held - courts may define and impose the applicable fiduciary duty as a matter of federal common law; and (3) whether exculpatory testimony given by a witness during a deposition in a closely related federal enforcement proceeding is admissible under Federal Rule of Evidence 804(b) in a subsequent criminal trial when the witness is unavailable, or whether - as the court below held - such testimony may be excluded merely because it was given in a civil rather than criminal proceeding.
Hunton & Williams today filed an amicus brief urging the US Supreme Court to grant certiorari in a case involving intersecting issues of federalism and insider trading law. The brief urges the Supreme Court to resolve a circuit split as to definition of the "fiduciary duty" element in a criminal prosecution for insider trading under §10(b) of the Securities Exchange Act. Shawn Patrick Regan is counsel of record, joined on the brief by Patrick Robson,Joseph Saltarelli, Michael Kruse and Joshua Paster. The brief was filed on behalf of Professor Stephen Bainbridge, the William D. Warren Distinguished Professor of Law at UCLA.
“We are pleased to have been called upon to prepare and submit this amicus brief on behalf of Professor Bainbridge, a preeminent scholar of corporate law and governance,” Regan said. “Where, as here, there is a split among the circuit courts implicating core Constitutional principles and making it difficult for analysts to determine in advance the line between lawful competitive research to advise investors and potential criminal charges, the conflict should be resolved.”
It's my first sole amicus brief, as opposed to those in which I was one of a bunch of signatories. As we summarized the argument:
This Petition presents, inter alia, the question of whether the “fiduciary duty” element of securities fraud is to be defined by existing state law or crafted ad hoc as a new area of federal common law. The Second Circuit’s approach—“implicitly assuming” a federal rule shall govern so as to achieve “uniformity”—is squarely contrary to core tenets of federalism and the precedents of this Court, which limit the circumstances in which federal courts may create a common law rule of decision. (See Part I, infra.) The Second Circuit’s approach also conflicts with the law of other circuits, some of which look to state law to define “fiduciary duty” and some of which suggest courts may look to state law to develop federal common law. When, as here, the stakes involve not only livelihoods but also potential loss of liberty turning on unpredictable and inconsistent approaches (and outcomes), the conflict should be resolved. (See Part II, infra.) Finally, because the basis for the federal insider trading prohibition is the protection of property interests in corporate information and because this Court’s precedents have consistently recognized the preeminence of states with respect to corporation law and property rights, absent action by policymaking branches of government, the fiduciary duty element of insider trading should be defined under state law, not by virtue of emergent notions of federal common law. (See Part III, infra.)
The brief builds on my article Incorporating State Law Fiduciary Duties into the Federal Insider Trading Prohibition, 52 Wash. & Lee L. Rev. 1189 (1995).
The US filed an opposition brief. It's not very good on my issue. If I could file a reply brief, I would argue that: The SG argues (22) that "An insider’s duty not to trade on material non-public information or disclose such information to others for trading purposes is a matter of federal law." But what the SG fails to acknowledge is that, as a former SEC's solicitor once observed, ‘[m]odern development of the law of insider trading is a classic example of common law in the federal courts. No statute defines insider trading; no statute expressly makes it unlawful.’ Gonson & Butler, In Wake of ‘Dirks,’ Courts Debate Definition of ‘Insider,’ Legal Times, Apr. 2, 1984, at 16, col. 1. It remains the case today that no statute defines insider trading:
Other nations have proposed and, in some cases, enacted laws of general applicability against insider trading, see, e.g., European Commission, Proposal for a Regulation of the European Parliament and of the Council on Insider Dealing and Market Manipulation (Market Abuse), at 13, 30–33 COM (2011) 651 final (Oct. 20, 2011) (clarifying European Union (“EU”) regulations on insider trading and proposing EU directive for all EU countries to add criminal sanctions for insider trading in addition to existing administrative sanctions). Congress, however, has never done so, partly because the SEC has generally opposed such proposals on the ground that that any statutory definition of illegal insider trading would inevitably create “loopholes” that would be eventually utilized in much the same way that the tax code generates tax “dodges” that are frequently successful. However, as this very case demonstrates, the judge-made law of insider trading, however flexible, can create potential gaps in coverage that are the functional equivalent of legislative loopholes.
Large corporations that are listed on national exchanges, or even regional exchanges, will have shareholders in many States and shares that are traded frequently. The markets that facilitate this national and international participation in ownership of corporations are essential for providing capital not only for new enterprises but also for established companies that need to expand their businesses. This beneficial free market system depends at its core upon the fact that a corporation—except in the rarest situations—is organized under, and governed by, the law of a single jurisdiction, traditionally the corporate law of the State of its incorporation.
The purposes of the Securities Exchange Act generally and Section 10(b) in particular are usually said to be the protection of investors and the maintenance of public confidence in the securities markets through the imposition of disclosure requirements and prohibitions of fraud.207 If so, the insider trading prohibition seems quite out of place in the federal securities laws. Neither policy justifies a ban on insider trading, nor can either policy explain the state of the law.
Careful examination of the legislative history demonstrates that regulating insider trading was not one of the original purposes of the Exchange Act.168 Neither Section 10(b) nor Rule 10b-5 explicitly regulates insider trading or prohibits nondisclosure of inside information in insider trades. Instead, Congress addressed insider trading in Section 16(b), which permits the issuer of affected securities to recover insider short-swing profits.169 Section 16(b) imposes quite limited restrictions on insider trading. It does not reach transactions occurring more than six months apart, nor does it apply to persons other than those named in the statute or to transactions in securities not registered under Section 12.170 Given that Congress could have struck at insider trading both more directly and forcefully, and given that Congress chose not to do so,171 there is no statutory authority for the creation of a more sweeping *1230 prohibition under Section 10(b).To be sure, Section 10(b) is often described as a “catchall” intended to capture various types of securities fraud not expressly covered by more specific provisions of the Exchange Act.172 What the SEC catches under Section 10(b), however, must not only be fraud, but also within the scope of the authority delegated to it by Congress.173 Nothing in the legislative history suggests that Congress intended Section 10(b) to create a sweeping prohibition of insider trading.174 To the contrary, Section 10(b) received minimal attention during the hearings on the 1934 Act and was apparently seen simply as a grant of authority to the SEC to prohibit manipulative devices not covered by Section 9.175Indeed, if Congress intended in 1934 that the SEC use Section 10(b) to craft a sweeping prohibition on insider trading, the Commission was quite dilatory in doing so. Section 10(b) is not self-executing. It merely proscribes such fraudulent or manipulative devices as the SEC may prohibit by rule. Rule 10b-5, the foundation on which the modern insider trading prohibition rests, was not promulgated until 1942. Nor did the Commission *1231 begin using Rule 10b-5 to regulate insider trading on stock exchanges until the Cady, Roberts decision in 1961.176 Even in Cady, Roberts's wake there were those who thought it did not presage general application of Rule 10b-5 to insider trading.177 As we now know, that short-lived expectation died with SEC v. Texas Gulf Sulphur Co.178 The point remains, however, that the federal insider trading prohibition is a relatively recent administrative and judicial creation lacking any significant statutory basis: “In regulating insider trading under rule 10b-5 the lower federal courts and the SEC have been operating without benefit of support from the legislative history of the 1934 Act or from the language of section 10(b). In plainer words, they have exceeded their authority.”179
Brian Galle poses an age-old question, Why is insider trading illegal? At the risk of annoying my dear friend and mentor Henry Manne, I'm afraid I still think it's because we want to enforce private rights in information. I offer that argument, along with a critique of both arguments in favor of regulating insider trading and arguments in favor of deregulating it, in Insider Trading: An Overview, which is vailable at SSRN: http://ssrn.com/abstract=132529:
Insider trading is one of the most controversial aspects of securities regulation, even among the law and economics community. One set of scholars favors deregulation of insider trading, allowing corporations to set their own insider trading policies by contract. Another set of law and economics scholars, in contrast, contends that the property right to inside information should be assigned to the corporation and not subject to contractual reassignment. Deregulatory arguments are typically premised on the claims that insider trading promotes market efficiency or that assigning the property right to inside information to managers is an efficient compensation scheme. Public choice analysis is also a staple of the deregulatory literature, arguing that the insider trading prohibition benefits market professionals and managers rather than investors. The argument in favor of regulating insider trading traditionally was based on fairness issues, which predictably have had little traction in the law and economics community. Instead, the economic argument in favor of mandatory insider trading prohibitions has typically rested on some variant of the economics of property rights in information. A comprehensive bibliography is included.
There's a shorter justification of the property rights approach in a 2010 post The Whys and Wherefores of Regulating Insider Trading.
You'll also want to read my post Implications of a property rights approach to insider trading.
As for whether the insider trading prohibition should be mandatory or a default rule, I addressed that issue in a 2009 post Why the insider trading prohibition is mandatory rather than just a default rule.
And, of course, you'll want my book Bainbridge's Insider Trading Law and Policy
Alison Frankel reports:
Everyone knows that the hedge fund SAC Capital, now known as Point72, made a bundle when it ditched shares of the pharmaceutical companies Wyeth and Elan based on inside information that their jointly developed Alzheimer’s drug, bapineuzumab (better known as bapi), was a bust. SAC supposedly realized $555 million in profits and avoided losses because trader Mathew Martoma got early word about disappointing bapi test results from a doctor involved in the clinical trials. Both SAC and Martoma have, of course, been held to account for the trades: Martoma was convicted at trial and SAC pled guilty. In all, the hedge fund has forked over nearly $2 billion to the government because it illegally traded on inside information about the bapi trials.
Two days after the rest of the world heard about the discouraging bapi clinical trial results – in other words, after SAC had sold off its stake in Wyeth and Elan – Elan revealed even more bad news. Two patients had contracted a rare and frequently fatal brain disease after taking Elan’s major product, the multiple sclerosis drug Tysabri. Shares of the Ireland-based company, which had already taken a beating after the bapi disclosure, fell another 50 percent on the Tysabri news.
SAC didn’t trade on inside information about Tysabri, and the drop in Elan’s share price after the Tysabri disclosure had nothing to do with SAC’s inside information about bapi. Yet according to a decision Thursday by U.S. District Judge Victor Marrero of Manhattan, the hedge fund may still be liable for an additional $107 million it avoided losing because it had already sold its stake in Elan before the Tysabri news broke. Marrero ruled that holders of Elan American Depository Receipts can proceed with class action claims that SAC must disgorge the losses it avoided incurring in Elan’s Tysabri-related stock drop because it had illegally sold its Elan shares based on inside information about an entirely unrelated drug trial.
As Alison then notes:
This is nuts. Suppose SAC knew that bad news was coming that would chop 10% or so off the stock price. It sells the stock. After the stock is sold by SAC, bad news previously known only to the issuer's CEO is released and the stock drops 50%. Should SAC really face liability? See e.g. Fridrich v. Bradford, 542 F.2d 307 (6th Cir. 1976) (disgorgement balances the desire to deter insider trading without imposing extremely large damage awards).
Donald Langevoort explains that:
In Elkind v. Liggett & Myers Inc., the court held that the plaintiff class is limited in its recovery to the amount of the profits made (in that particular instance, by the defendant-tipper's tippees as a result of the unlawful trading, effectively, a disgorgement measure of damages. In the court's view, such a measure nicely balances the desire to deter insider tipping and trading with the need to avoid "windfall recoveries of exorbitant amounts bearing no relation to the seriousness of the misconduct." Moreover, it is easy to apply:A plaintiff would simply be required to prove (1) the time, amount, and price per share of his purchase, (2) that a reasonable investor would not have paid as high a price or made the purchase at all if he had the information in the tippee's possession, and (3) the price to which the security had declined by the time he learned the tipped information or at a reasonable time after it became public, whichever event first occurred. He would then have a claim and, up to the limits of the tippee's gain, could recover the decline in market value of his shares before the information became public or known to him.
Elkind is fairly candid in its recognition that the principal objective of the insider trading prohibition is the avoidance of unjust enrichment on the part of the insider rather than the prevention of actual harm or injury to other marketplace traders: according to the court, "the reason for the 'abstain or disclose rule' is the unfairness in permitting an insider to trade for his own account on the basis of material inside information not available to others."
A few days after the Canadian pharmaceutical company Valeant announced that it had teamed up with the activist investor William Ackman to bid for Botox maker Allergan, Wachtell, Lipton, Rosen & Katz wrote ateeth-gnashing client alert about the new threat to corporate targets from the unholy alliance of a strategic bidder with an activist hedge fund. Commentators were already raising questions about whether Ackman and Valeant had engaged in insider trading, because Ackman secretly accumulated Allergan shares based on his knowledge of Valeant’s imminent takeover bid. ...
... On Friday, Wachtell – now acting as counsel to Allergan, along with Latham & Watkins – filed a complaint in federal court in Los Angeles that accuses Valeant and Ackman of executing an “improper and illicit insider-trading scheme … flouting key provisions of the federal securities laws.” The suit not only claims that Valeant and Ackman didn’t make adequate disclosures to Allergan shareholders – reviving an old takeover defense tactic from the 1980s – but also pushes the novel theory that Ackman violated a provision of the Williams Act prohibiting anyone except an acquirer from trading on material non-public knowledge that the acquirer has taken “a substantial step” toward launching a tender offer.
Frankel doubts the complaint will hold up, but go read the whole thing and make up your mind.
My take? There's more likely to be a Section 13(d) problem than an insider trading case. Item 7 of Schedule 13D requires the filer (here Ackman and Valeant) to include as exhibits "copies of all written agreements, contracts, arrangements, understanding, plans or proposals relating to: (1) The borrowing of funds to finance the acquisition as disclosed in Item 3; (2) the acquisition of issuer control, liquidation, sale of assets, merger, or change in business or corporate structure, or any other matter as disclosed in Item 4; and (3) the transfer or voting of the securities, finder's fees, joint ventures, options, puts, calls, guarantees of loans, guarantees against loss or of profit, or the giving or withholding of any proxy as disclosed in Item 6."
Frankel tells us that "Pershing and Valeant had first executed a confidentiality agreement in February, though neither that agreement nor an amended version of it was disclosed to the SEC."
If that's all Wachtell has to go on, Achman and and Valeant would at most get a slap on the wrist, espcially if they amend their Schedule 13D to disclose the missing items. Energy Ventures, Inc. v. Appalachian Co., 587 F.Supp. 734, 743–44 (D.Del.1984) (interim injunctive relief deemed inappropriate where corrective filing had been made); University Bank & Trust Co. v. Gladstone, 574 F.Supp. 1006, 1010 (D.Mass.1983) (injunction denied where purchaser had made curative disclosure).
It's a somewhat obscure, but surprisingly interesting question of securities law, which Jay Brown analyzes in this post.
The SEC and US Department of Justice have often overreached in their efforts to police insider trading, especially when they think they can make a big bang by taking down a high profile person (see, e.g., the asinine case against Mark Cuban), but the purported case against Phil Mickelson is one of the most absurd yet.
The NY Times reports that:
In the summer of 2011, a series of winning stock trades raised immediate red flags for financial regulators.
The traders — a cross-section of investors including the championship golfer Phil Mickelson and the high-rolling gambler and golf course owner William T. Walters — collectively reaped several million dollars betting on the consumer products companyClorox and one other stock, according to people briefed on the matter who spoke anonymously because they were not authorized to discuss the investigation.
The trades, options contracts to buy Clorox stock, came just days before the billionaire investor Carl C. Icahn announced an unsolicited takeover bid for the company that drove up the stock price. And trading records indicated that the bets came not just from Mr. Mickelson but also from at least one other investor connected to Mr. Walters and the golfing world, one of the people briefed on the matter said. ...
As federal authorities examine whether Mr. Icahn leaked details of his Clorox bid to Mr. Walters, the people said, they are exploring a theory that Mr. Walters might have passed the information to Mr. Mickelson.
This case stinks. It seems to me that there are two possible theories of liability of here, neither of which stands up to close scrutiny. First, Rule 14e-3 prohibits persons who occupy a certain status such as the offering person, the subject company, or an officer, director, partner or employee or any other person acting on behalf of the offering person or the issuer from tipping off other persons about an impending tender offer. Further, it prohibits thise tippees from trading on the basis of such information. But Rule 14e-3 only applies if the offering person (i.e., the takeover bidder, which would be Icahn in this case) has taken substantial steps towards commencing a tender offer. According to the NY Times, however, "in the case of Clorox, Mr. Icahn never submitted a tender offer." In addition, even if Icahn had taken the requisite substantial steps towards commending a tender offer, Mickelson would have to know or have reason to know that the information was non-public and came indirectly from Icahn.
Second, case law under Rule 10b-5 says that tipping material nonpublic information can sometimes be illegal. None of the players in this case are insiders of Clorox, so the classic disclose or abstain rule would not apply. Instead, the SEC would have to proceed under a misappropriation theory. In order for that to work, the SEC at a minimum would have to prove that (1) Icahn tipped the information to Walters in breach of a fiduciary duty owed to the person or entity who owned the information, (2) that Icahn got a personal benefit for doing so, (3) that Walters passed the information to Mickelson, (4) Mickelson knew or should have known that the information came was material, nonpublic, and had been disclosed to him in violation of a fiduciary duty by the source. It should also be the case that the SEC will have to prove that Mickelson knew or should have known that Icahn got a personal benefit from making the tip, although that issue is currently pending before the Second Circuit.
The SEC's case would break down at several points. First, does Icahn owe a duty to anyone (say the investors in his hedge funds) that was breached by his disclosure? After all, isn't Icahn really disclosing his own intentions? Indeed, Forbes reports that "Icahn himself owned more than 90% of his Icahn Enterprises and had already moved to return all the outside money in his hedge fund." Tipping or trading on the basis of your own intentions is not illegal under Rule 10b-5.
Second, what personal benefit did Icahn get from making the disclosure?
Third, what did Mickelson know and how did he learn it? Can they link his trade to Icahn and, if so, did Mickelson known that Icahn was breaching a fiduciary duty (assuming he was) by making the disclosure.
I am not unsympathetic to the argument that putative shareholder activists like Carl Icahn need watching. As the WSJ reports:
The investigation signals that the FBI and the SEC are concerned about a potential dark side of shareholder activism. Activist investors push for broad changes at companies or try to move stock prices with their arguments. Mr. Icahn, a 78-year-old billionaire, has come to epitomize such activism in U.S. boardrooms.
Investigators are focusing on potentially abusive practices among such activists, including whether they are leaking information about their stakes before making public disclosures—the subject of a Wall Street Journal page-one article in March.
But while abuses by activists should be policed, I just don't see how the SEC or DOJ can possibly make this case stick.
I'm giving a talk at the University of Auckland Faculty of Law today on the titular subject of this post. I'll review of insider trading law, with emphasis on its application to recent cases involving hedge funds. Reviews Preet Bharara’s scorecard, the Galleon case, materiality and the “Mosaic Theory," and tipping chains.
Just as Americans found ways to keep drinking, Wall Street will always look for an edge.
The much-hyped modern insider-trading prosecutions and their results are reminiscent of nothing so much as Prohibition-era government attacks on bootleggers. There is about as much chance of stopping trading on undisclosed financial information as there ever was of stopping the consumption of booze. There is simply too much money sloshing around the world's stock exchanges waiting for an "edge." Information is more mercurial than mercury and will seep into some crevice in the system no matter how many channels are closed. ...
The imagination of wealth seekers in using valuable information in the stock market will always outpace the ability of regulators to cope. The payoffs are too big and too accessible and the number of willing players too great for the practice to be significantly inhibited by scores of convictions. But political reputations can still be made by convincing investors that these prosecutions are in their interest and will significantly alter the market's behavior.
The case for outlawing insider trading is even weaker than it was with alcohol. The latter did in many cases inflict real damage—to careers, family relationships, livers. Insider trading not only does no harm, it can have significant social and economic benefits including a more accurate pricing of stocks.
But that is not the story for today, and it has been told many times (and never seriously refuted). The story for today is that we are repeating the errors of Prohibition. We see federal prosecutors making names for themselves by convicting mostly low-level functionaries. We see the so-called corruption of otherwise good folks, including medical researchers and high-tech specialists, with valuable information. Yet with so much wealth at stake, this "corruption" surely goes far beyond what prosecutors have been able to demonstrate.
It is high time to stop this ridiculous posturing. We really don't need another government failure like Prohibition.
Go read the wohole thing?
Although Congress has mandated extremely draconian civil and criminal sanctions for insider trading, it has never seen fit to define what constitutes insider trading. Admittedly, insider trading is difficult to define with precision, but Congress also was concerned that even if a clear statutory definition could be devised, inside traders would find ways of evading it. See generally Stephen M. Bainbridge, Note, A Critique of the Insider Trading Sanctions Act of 1984, 71 VA. L. REV. 455, 472-73 (1985).
Accordingly, Congress deliberately left the definition of insider trading as vague and unconstrained as possible. In light of the draconian penalties associated with insider trading, however, this decision raises troubling vagueness concerns. As Jonathan Macey bluntly put it, “opposition to a clear, fixed definition for the crime of insider trading constitutes nothing less than a naked power grab by the SEC, a move obviously at odds with the most elemental notions of justice and fair play.” JONATHAN R. MACEY, INSIDER TRADING: ECONOMICS, POLITICS, AND POLICY 64 (1991). Or as Ed Kitch put it, somewhat less bluntly, “[t]he fact that the agency finds it more comfortable to avoid the discipline of defining the offense before bringing the charge is no reason for eschewing the increased fairness and deterrent efficacy that would flow from the exercise.” Edmund W. Kitch, A Federal Vision of the Federal Securities Laws, 70 VA. L. REV. 857, 861 (1984).
According to the WSJ, however, oral argument in an insider trading case pending before the Secomd Circuit suggests that that court may finally be willing to do something about this fundamental unfairness:
In an hourlong hearing in Manhattan, judges of the U.S. Court of Appeals for the Second Circuit signaled that federal prosecutors may have taken too broad a view of insider trading, saying Wall Street needs more of a "bright line" about what constitutes a crime. ...
Two members of the Second Circuit panel in Manhattan expressed concern that the prosecutors' approach is too vague.
"We sit in the financial capital of the world, and the amorphous theory you have gives precious little guidance to all these financial institutions and all these hedge funds out there about a bright-line theory as to what they can and cannot do," Judge Barrington D. Parker said.
The broader federal judiciary is closely watching the appeal, in part, because the law on insider trading is ambiguous.
Daniel Richman, a professor at Columbia Law School, said that because of the statute's ambiguity, most of the law concerning insider trading had been set by the courts, calling the tolerance for this "remarkable."
Remarkable strikes me as valid, but too weak. Try intolerable. Or indefensible. Or appalling.
It is time for courts to finally draw some very bright lines. As for where those lines should be drawn, I direct the interested reader to my article Regulating Insider Trading in the Post-Fiduciary Duty Era: Equal Access or Property Rights? (May 8, 2012). Available at SSRN: http://ssrn.com/abstract=2054814
In my new book, Insider Trading Law and Policy, I discuss liability in cases in which inside information is passed from one tipper to another in a so-called tipping chain:
Suppose, for example, that Tipper tells Tippee #1 who tells Tippee #2 who trades. Can Tippee #2 be held liable? If the preconditions of tipping liability are satisfied, there is nothing in Dirks to foreclose such liability. Donald Langevoort, for example, suggests that liability in tipping chain cases should require a three-part showing: “each person in the chain (1) was given the information expressly for the purpose of facilitating trading based on inside information, (2) knew that the information was material and nonpublic, and (3) knew or had reason to know that it came to him as a result of some breach of duty by an insider.” He goes on to note, however, that tipping chain cases—“albeit without any substantial judicial discussion of the underlying issue”—generally have imposed liability “simply on a showing that the person came into possession of information that he knew was material and nonpublic and which he knew or had reason to know was obtained via a breach of fiduciary duty by an insider.”
In Obus, for example, the Second Circuit opined that:
A tipper will be liable if he tips material non-public information, in breach of a fiduciary duty, to someone he knows will likely (1) trade on the information or (2) disseminate the information further for the first tippee’s own benefit. The first tippee must both know or have reason to know that the information was obtained and transmitted through a breach and intentionally or recklessly tip the information further for her own benefit. The final tippee must both know or have reason to know that the information was obtained through a breach and trade while in knowing possession of the information.
Obus, 693 F.3d at 288. The court further explained that the tippee could be held liable on the basis of “conscious avoidance,” citing SEC v. Musella, 678 F. Supp. 1060, 1063 (S.D.N.Y.1988), for the proposition that Dirks was “satisfied where the defendants, tippees at the end of a chain, ‘did not ask [about the source of information] because they did not want to know.’ ” Obus, 693 F.3d at 288–89.
As the WSJ reported on Monday, this issue is now on appeal before the Second Circuit:
The appeal is being pursued by Todd Newman and Anthony Chiasson, two portfolio managers whose 2012 insider-trading convictions were a significant victory for prosecutors. ...
The original trial judge told jurors that Messrs. Chiasson and Newman could be convicted of insider trading even if they hadn't known that the person who leaked the information had done so in return for a "personal benefit."
Lawyers for Messrs. Newman and Chiasson say prosecutors must show that their clients knew the tippers were somehow compensated for the tips and that the judge's instruction was erroneous. The inside tips on which the pair traded were conveyed through a network of analysts before reaching analysts who worked for Messrs. Chiasson and Newman, the lawyers said in court documents. Their clients didn't seek out or knowingly use inside information, they said.
Prosecutors have said they need only show that people who used the tips were aware the tipper disclosed the nonpublic information in breach of a fiduciary duty when they traded on it.
Even if the instruction was erroneous, the jury would have concluded the two men inferred the information was given in exchange for a reward, prosecutors said in court documents.
Given the phrasing of the Obus standard, the jury instruction may well hold up on appeal. On the other hand, the seminal Dirks v. SEC decision makes clear that the requisite breach of fiduciary duty is one in which the tipper gets a personal benefit in return for the tip, so shouldn't the personal benefit requirement be made explicit?
The problem here is that the Obus case erroneously phrased the Dirks standard. According to the Second Circuit:
The [Supreme] Court held that a tipper like the analyst in Dirks is liable if the tipper breached a fiduciary duty by tipping material non-public information, had the requisite scienter (to be discussed momentarily) when he gave the tip, and personally benefited from the tip. Id. at 660–62, 103 S.Ct. 3255. Personal benefit to the tipper is broadly defined: it includes not only “pecuniary gain,” such as a cut of the take or a gratuity from the tippee, but also a “reputational benefit” or the benefit one would obtain from simply “mak[ing] a gift of confidential information to a trading relative or friend.” Id. at 663–64, 103 S.Ct. 3255. When an unlawful tip occurs, the tippee is also liable if he knows or should know that the information was received from one who breached a fiduciary duty (such as an insider or a misappropriator) and the tippee trades or tips for personal benefit with the requisite scienter. See id. at 660, 103 S.Ct. 3255.
The highlighted text is the source of the problem. It suggested that the personal benefit and fiduciary duty requirements are separate. Under Dirks, however, they are one and the same:
In determining whether a tippee is under an obligation to disclose or abstain, it thus is necessary to determine whether the insider's “tip” constituted a breach of the insider's fiduciary duty. ... [The] test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach.
463 U.S. at 661-62. In other words, no personal benefit, no breach. Therefore, it seems to me, the jury should have been instructed that the prosecution has to prove that the tippees knew of recklessly avoided knowing that the tipper got a personal benefit.
if you believe the SEC, insider trading is a scourge that must be eliminated from our capital markets:
Because insider trading undermines investor confidence in the fairness and integrity of the securities markets, the SEC has treated the detection and prosecution of insider trading violations as one of its enforcement priorities.
Given all the effort the SEC spends on enforcing its absurd rules against insider trading and imposing the draconian penalties for violating those rules, one would expect that the SEC staff would be purer that Caesar's proverbial wife. But it turns out not to be the case:
People working for the U.S. Securities and Exchange Commission who owned stock in companies under investigation were more likely to sell shares than other investors in the months before the agency announced it was taking enforcement actions, according to a new academic paper.
SEC employees holding shares of five firms including JPMorgan Chase & Co. and General Electric Co. (GE) in 2010 and 2011 sold stock in 62 percent of the trades they initiated, compared with 50 percent among all the investors who traded those shares in that period, Emory University accounting professor Shivaram Rajgopal reports in the paper.
Rajgopal, who plans to present the work today at a University of Virginia accounting seminar, said in a telephone interview that while the analysis doesn’t prove misconduct it points out a suspicious pattern.
Of course, this isn't the only time the SEC has failed to police itself. To cite but one sore point, the SEC consistently fails to comply with the internal control rules it requires corporations to comply with.
Maybe in the future, the SEC will be a but less sanctimonious about its enforcement program.
But I doubt it.
Update: Broc Romanek claims to have debunked the study. Since I don't share his faith in the integrity of SEC (or any other government) employees, I'm not inclined to give the SEC a pass on this one.
Update 2: Steven Davidoff thinks the SEC staffer's gains are attrobutable to "dumb luck" rather than insider trading.
Got my copies today of Insider Trading Law and Policy. From the book description:
This compact text (260 pp) is for use in law school classes on insider trading, securities regulation, or business associations. It offers a clear and direct exposition of the law and policy concerns raised by this important and high-profile area of the law. The author provides sufficient detail for a complete understanding of the subject without getting bogged down in minutiae. Faculty interested in teaching a short course on insider trading or making insider trading a major part of a course in securities or corporate law will find the text highly teachable, while students taking such a course using other materials will find it a useful study aid.
Dr Paul Fryer reviews the Research Handbook on Insider Trading edited by yours truly in 2014 Journal of International Banking Law and Regulation 64-65:
This handbook, edited by Stephen M. Bainbridge, Professor of Law at the University of Californi, is designed to provide a broad overview of research focusing on insider trading, predominantly in the United States but also offer global perspectives from Asia, Australasia, and Europe. It also seeks to provide an additional dimension by critically examining some of more challenging and under-explored aspects of financial crime. ...
This research handbook is, in parts, highly innovative with chapters that focus on areas not generally associated with insider trading activities, such as gender and the impact of social media activities. However, the vast majority of chapters focus on "nuts and bolts" issues that academics and practitioners in this field with be familiar with. Stephen Bainbridge and his contributors have produced a valuable reference source for scholars and practitioners of corporate law who wish to gain a greater understanding of insider trading.