The WSJ reports that:
On the morning of March 15, stocks stumbled on news that a key reading of consumer confidence was unexpectedly low.
One group of investors already knew that. They got the University of Michigan's consumer report two seconds before everyone else. ...
The early look at the consumer-sentiment findings comes from Thomson ReutersCorp. TRI.T -0.18% The company will pay the University of Michigan $1.1 million this year for rights to distribute the findings, according to the university. Next year, it will pay $1.2 million.
In turn, Thomson Reuters's marketing materials say the firm offers paying clients an "exclusive 2-second advanced feed of results…designed specifically for algorithmic trading."
The Journal found a law professor to criticize this activity:
This is a "blind spot" in U.S. law, said Richard Painter, a former Republican White House ethics lawyer. Groups, he said, should "not be allowed to selectively disclose market-moving data to people who pay more money—that is not right."
Sadly, however, the Journal failed to find a law professor to defend the practice. Accordingly, I will step into the breach.
At the outset, I should acknowledge that Prof. Painter and I are old friends. He's a very, very smart guy with a vast store of knowledge of both ethics and securities law. But I think he's wrong here.
First, this sort of trading activity is clearly legal. The Supreme Court long ago rejected the argument--which seems implicit in Painter's objection--that insider trading regulation should seek to ensure that all investors had equal access to information. As the late Supreme Court Justice Lewis Powell explained in Dirks v. SEC:
We were explicit in Chiarella in saying that there can be no duty to disclose where the person who has traded on inside information “was not [the corporation’s] agent, ... was not a fiduciary, [or] was not a person in whom the sellers [of the securities] had placed their trust and confidence.” Not to require such a fiduciary relationship, we recognized, would “depar[t] radically from the established doctrine that duty arises from a specific relationship between two parties” and would amount to “recognizing a general duty between all participants in market transactions to forgo actions based on material, nonpublic information.”
Here, the people who trade on the basis of the information they bought from Thomson Reuters are not agents or any other species of fiduciary with respect to the corporation in whose securities they trade or the investors with whom they trade. (This is even more so where they trade in derivatives based on the whole market rather than individual corporate stocks.) As the Journal thus correctly reported:
Even as securities rules bar companies from selective data disclosure, and as authorities vigorously pursue insider trading in all its forms, no law prevents investors from trading on nonpublic information they have legally purchased from other private entities. Trading would be illegal only if the information was passed through a breach of trust, said securities lawyers.
"If someone gives you permission to use the information, then there is no problem," said Steve Crimmins, a former Securities and Exchange Commission enforcement official now at law firm K&L Gates LLP.
Painter knows this, of course, which is why he called it a "blind spot." But is he correct in implying that the law should be changed? No.
If you believe, as I do (see this article), that the law of insider trading is a species of property rights in information, then insider trading ought to be illegal only where the inside trader's use of the infiormation involved a breach of fiduciary duty, misrepresentation, or theft. Where the source of the information voluntarily sells information to end users, there has been no violation of the source's property right in that information and, hence, no basis for liability.
As Judge Ralph Winter explained in his separate opinion in United States v. Chestman:
Information is ... expensive to produce, and, because it involves facts and ideas that can be easily photocopied or carried in one’s head, there is a ubiquitous risk that those who pay to produce information will see others reap the profit from it. Where the profit from an activity is likely to be diverted, investment in that activity will decline. If the law fails to protect property rights in commercial information, therefore, less will be invested in generating such information.
Conversely, if the law does not allow producers of information to profit from the sale of that information, there also will be less invested in producing such information. The Supreme Court recognized this point in Dirks, where it explained that insider trading law must be carefully applied so as to avoid punishing market analysts:
Imposing a duty to disclose or abstain solely because a person knowingly receives material nonpublic information from an insider and trades on it could have an inhibiting influence on the role of market analysts, which the SEC itself recognizes is necessary to the preservation of a healthy market. It is commonplace for analysts to “ferret out and analyze information,” … and this often is done by meeting with and questioning corporate officers and others who are insiders. And information that the analysts obtain normally may be the basis for judgments as to the market worth of a corporation's securities. The analyst's judgment in this respect is made available in market letters or otherwise to clients of the firm. It is the nature of this type of information, and indeed of the markets themselves, that such information cannot be made simultaneously available to all of the corporation's stockholders or the public generally.
Precisely the same analysis applies here. If this so-called "blind spot" were to be patched with legislation banning such transactions, the effect will not be to ensure that all investors have equal access to this sort of information. Instead, the effect will be that nobody will have access to it because such information simply won't be produced:
Richard Curtin, an economist who runs the university's survey, said he knows the deal gives an advantage to select investors.
"Hardly anyone would pay for it if they didn't see a profit motive," Mr. Curtin said. Later, he added: "This research is totally funded by private sources for the benefit of scientific analysis, to assess public policy, and to advance business interests. Without a source of revenue, the project would cease to exist and the benefits would disappear."
And that would help nobody.
Today's mail brought an advance copy of the Research Handbook on Insider Trading, edited by yours truly.
In most capital markets, insider trading is the most common violation of securities law. It is also the most well known, inspiring countless movie plots and attracting scholars with a broad range of backgrounds and interests, from pure legal doctrine to empirical analysis to complex economic theory. This volume brings together original cutting-edge research in these and other areas written by leading experts in insider trading law and economics.
The Handbook begins with a section devoted to legal issues surrounding the US's ban on insider trading, which is one of the oldest and most energetically enforced in the world. Using this section as a foundation, contributors go on to discuss several specific court cases as well as important developments in empirical research on the subject. The Handbook concludes with a section devoted to international perspectives, providing insight into insider trading laws in China, Japan, Australia, New Zealand, the United Kingdom and the European Union.
This timely and comprehensive volume will appeal to students and professors of law and economics, as well as scholars, researchers and practitioners with an interest in insider trading.
Table of Contents (below the fold)
Yahoo Finance reports:
A year ago President Obama signed the so-called STOCK Act. The point of the act was to allow the public to see for themselves if members of Congress and their employees were trading on material, non-public information. "The STOCK Act: Bans Members of Congress from Insider Trading" was the bolded headline at the top of a lengthy and self-congratulatory press release.
Last Monday the White House website took the guts out of the STOCK Act in one run-on sentence under the headline "Statement by the Press Secretary on S. 76." Those so inclined are invited to read the memo themselves. The gist is that disclosures will no longer be practically available for all employees but only for the elected officials, which means staffers, lobbyists, employees, aides and anyone who works for or is close to a serving politician can do whatever they want. Corrupt officials could theoretically still dish insider info with little fear of discovery — it's just hard for them to trade off of the information themselves.
The idea of transparency is to remove doubt about conflicts of interest and malfeasance, real or imagined. When the rules are quietly changed to such a degree, it defeats the purpose entirely.
On the one hand, the STOCK Act's prohibition on insider trading remains intact, which is a good thing. On the other hand, I agree completely with the author that transparency via disclosure was essential. As Justice Brandeis that sunlight is the best disinfectant and electric light the best policeman.
The scandals and routine abuses Peter Schweizer exposed in Throw Them All Out cried out for reform. Congress was dragged kicking and screaming into reform, but now has started chopping back on it. Time to hold their feet to the fire yet again.
Two affiliates of SAC Capital, the giant hedge fund, settled insider trading charges with the Securities and Exchange Commission for $614 million on Friday, in what the agency said was the biggest ever settlement for such cases.
The settlements spare SAC’s founder, the billionaire Steven A. Cohen, who hasn’t been charged with wrongdoing. Mr. Cohen, one of the most successful hedge fund managers in the world, has long been considered a target of federal investigators.
David Zarig comments:
The case against Cohen always looked pretty strong to me, and he's certainly not too big to jail, like, say, HSBC. But still, it's just an insider trading case, and I have found this indictment of the "after he heard from x, he phoned y" method of proof, which would be combined with, presumably, testimony from a former employee about a conversation had with Cohen, to be pretty convincing.
No what will it do to SAC's business?
Interesting paper just posted to SSRN:
Insider trading has received a great deal of bad press in recent decades. Nearly every article in the popular press that has been written about it views the practice in a negative light. However, the economics and legal literature are mixed on the issue. This article examines the economics and legal literature and applies several sets of ethical principles with the goal of determining when insider trading constitutes unethical conduct and when it should be prohibited. The conclusion is that the key to determining when the practice should be prohibited should not depend upon a utilitarian analysis because utilitarian approaches cannot provide clear guidance. A better approach would be to determine whether a fiduciary duty has been breached or whether rights have been violated.
Don Langevoort has posted a very interesting article on the questions of "how or why did the insider trading prohibition survive the retrenchment that happened to so many other elements of Rule 10b-5?," which is linked and summarized here.
Langevoort goes on to observe that:
The Supreme Court’s strange and intellectually ungainly judicial commitment to assertive insider trading regulation, even by some fairly conservative judges, shows how powerful a totemic symbol the prohibition of insider trading has become in “branding” the American securities markets as supposedly open and fair, and American securities regulation as the investors’ champion. Insider trading regulation had already taken on an expressive value far beyond its economic importance, which judges were reluctant to undercut.
My argument is that the Supreme Court embraced the continuing existence of the “abstain or disclose” rule, and tolerated constructive fraud notwithstanding its new-found commitment to federalism, because it accepted the central premise on which the expressive function of insider trading regulation is based: manifestations of greed and lack of self-restraint among the privileged, especially fiduciaries or those closely related to fiduciaries, threaten to undermine the official identity of the public markets as open and fair. The law effectively grants an entitlement to public traders that the marketplace will not be polluted by those kinds of insiders.
As an explanation of what the Supreme Court might have been thinking when it developed the modern insider trading prohibition, Langevoort's argument has much to commend it.
Assuming he's right about that question, however, it leaves open the question of whether the SCOTUS' policy choice makes any sense. I don't think so. I've tackled this issue in several places, most notably in The Law and Economics of Insider Trading: A Comprehensive Primer (February 2001). Available at SSRN: http://ssrn.com/abstract=261277.
In the absence of a credible investor injury story, it is difficult to see why insider trading should undermine investor confidence in the integrity of the securities markets. As Bainbridge (1995, p.1241-42) observes, any anger investors feel over insider trading appears to arise mainly from envy of the insider’s greater access to information.
The loss of confidence argument is further undercut by the stock market’s performance since the insider trading scandals of the mid-1980s. The enormous publicity given those scandals put all investors on notice that insider trading is a common securities violation. If any investors believe that the SEC’s enforcement actions drove insider trading out of the markets, they are beyond mere legal help. At the same time, however, the years since the scandals have been one of the stock market’s most robust periods. One can but conclude that insider trading does not seriously threaten the confidence of investors in the securities markets.Macey (1991, p. 44) contends that the experience of other countries confirms this conclusion. For example, Japan only recently began regulating insider trading and its rules are not enforced. The same appears to be true of India. Hong Kong has repealed its insider trading prohibition. Both have vigorous and highly liquid stock markets.
Let me repeat: If any investors believe that the SEC’s enforcement actions drove insider trading out of the markets, they are beyond mere legal help. And, if the Supreme Court believes that investors believe that, the Court needs help.
Just read two different articles on the titular topic. A student note by Joseph Pahl (106 Nw. U. L. Rev. 1849) says no:
Rule 10b5-2(b)(1) overreaches the statutory authority of the SEC by creating liability under § 10(b) without the existence of deception or manipulation. It is unreasonable to interpret a promise not to disclose confidential information as a simultaneous agreement not to use that information (while keeping it confidential) for an individual's personal benefit. The acts of disclosure and use are temporally separate acts, and it would be perverse to believe that, when an individual agrees not to disclose a piece of information, it is inherently deceitful to use that information for his personal benefit while maintaining confidentiality. ...
Assuming arguendo that 10b5-2(b)(1) is not contrary to the courts' interpretation of the meaning of the statute, the rule does not pass the second prong of the Chevron test: Rule 10b5-2(b)(1) is “arbitrary, capricious, or manifestly contrary to the statute.” ... A confidentiality agreement alone fails to create a situation where a deceptive act is possible by trading without some further fiduciary or fiduciary-like relationship.
I am highly sympathetic to that line of argument, but Professor Steven Cleveland argues that (65 Fla. L. Rev. 73):
To date, commentators [including yours truly, as Cleveland notes] have argued against the rule's validity by applying the Supreme Court's securities law jurisprudence without considering the role of administrative law-despite the Court's comments that the pertinent statute is ambiguous, despite express delegation of rulemaking authority by Congress to the Commission, and despite developments in administrative law subsequent to the Court's relevant securities law decisions. By not considering the role of administrative law, commentators have approached the rule with undue skepticism. Administrative law principles dictate judicial deference to the Commission's rule. The Commission once commanded deference from courts. The time has come to resurrect that deference.
Cleveland makes a thoughtful and reasoned argument. But in my judgment, however, the time for deference has not yet come.
I will once again quote Michael Greve:
I’m teaching something called, fraudulently, administrative “law.” Believe you me: nothing in that corpus juris poses any meaningful constraint on government. E.g., I’m supposed to teach and therefore do teach that judges must bow to any bureaucrat’s take on the law (unless it’s completely nuts) because otherwise the D.C. Circuit might end up running the country and good sense and lawful government might break out.
I will also note that deference ought to be earned rather than given by Supreme Court fiat. To wit, consider Business Roundtable v. SEC, 647 F.3d 1144 (DC Cir. 2011):
Under the APA, we will set aside agency action that is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” ...
We agree with the petitioners and hold the Commission acted arbitrarily and capriciously for having failed once again—as it did most recently in American Equity Investment Life Insurance Company v. SEC, 613 F.3d 166, 167–68 (D.C.Cir.2010), and before that in Chamber of Commerce, 412 F.3d at 136—adequately to assess the economic effects of a new rule. Here the Commission inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.
I believe close examination of the relevant history fo the SEC's adoption of Rule 10b5-2 will reveal precisely the same shortcomings that mandated striking down the proxy access rule. Compare, e.g., both the majority and Judge Winter's separate opinions in the old Chestman case to the proposing and adopting releases for Rule 10b5-2. The first pair is thoughtful, analytical, reasoned. The second one isn't.
John Carney has a provocative post about insider trading (pun intended):
Someone has placed a job placement notice on a controversial online classified ads site seeking "beautiful, sophisticated ladies" to seduce businessmen in hopes of "extracting key pieces of information."
Carney goes on to explore the legality of the business under the securities laws:
Tipper-tippee liability has two important elements. First, there must be a disclosure of material, nonpublic information by someone with a fiduciary duty. Second, the person doing the disclosing—the tipper—must expect a personal benefit as a result of the disclosure. In effect, this means that accidental disclosures do not give rise to insider trading liability for either the tipper or the tippee.
After a detailed review of the relevant law, Carney concludes from his extended analysis that:
The legality of trading on information intentionally extracted from a seduced businessman, in other words, would largely turn on his motivation for revealing the information and the length of the relationship. If he thinks he is just blowing off steam about a business deal to a one-night stand who was going to sleep with him anyway, this entire scheme wouldn't violate any insider trading rules.
What do we think? First, the law is quite clear than an exlicit quid pro quo in which an executive swapped inside information for sex would constitute an illegal tip. Second, "pillow talk" in which information is inadvertently disclosed does not (subject to Carney's correct anlysis of the potential application of Rule 10b5-2).
But, third, there is a tricky precedent out there that Carney does not discuss; namely, SEC v. Dorozhko, 574 F.3d 42 (2d Cir. 2009), which dealt with a question left open in the U.S. Supreme Court U.S. v. O’Hagan decision--i.e., the liability of persons who steal inside information but have no fiduciary duty to either the source of the information or the issuer of the securities in which the thief trades.
I've got a backgrounder on the case here, in which I explain that:
In Dorozhko, the SEC alleged that a computer hacker broke into a health information company’s computer system and used the stolen information to essentially sell the stock short. The Second Circuit tried to finesse the rules discussed below by treating the case as one involving a misrepresentation rather than insider trading: “we recognize that the SEC’s claim against defendant—a corporate outsider who owed no fiduciary duties to the source of the information—is not based on either of the two generally accepted theories of insider trading.” The problem is that the case makes no sense other than as an insider trading case.
An affirmative misappropriation can be actionable under Section 10(b) and Rule 10b-5 if it is committed in connection with the purchase or sale of a security. In order to find that the hacker committed an affirmative misrepresentation, a court first must find a lie. Calling computer hacking a lie is a rather considerable stretch. At most, the hacker “lies” to a computer network, not a person. Hacking is theft; not fraud.
Even if hacking is fraudulent in the sense of an affirmative misrepresentation, it has to be in connection with a purchase or sale of a security to be insider trading. In SEC v. Zandford, 535 U.S. 813 (2002), the Supreme Court emphasized that “the statute must not be construed so broadly as to convert every common-law fraud that happens to involve securities into a violation of § 10(b).” That case, moreover, involved “a fraudulent scheme [by a stockbroker] in which he made sales of his customer’s securities for his own benefit.” The SEC had taken the position that such conduct violated 10b-5 since the 1940s. In contrast, the district court in Dorozhko “found it ‘noteworthy’ that in the over seventy years since the enactment of the Securities Exchange Act of 1934, ‘no federal court has ever held that those who steal material nonpublic information and then trade on it violate § 10(b),’ even though ‘traditional theft (e.g. breaking into an investment bank and stealing documents) is hardly a new phenomenon, and involves similar elements for purposes of our analysis here.’” Dorozhko, 606 F. Supp. 2d 321, 339 (SDNY 2008).
In that light, consider Carney's argument that:
What would also work against the "beautiful, sophisticated ladies" in this case is that they have set out to seduce the businessmen in order to obtain the information. This means that, at least on their part, the disclosure is not accidental. They intend for it to occur. It's easy to see a court believing that the businessman in question would understand this intention and so any disclosure would be in search of a personal benefit.
It might be possible to get around this, however, by training the seductresses well enough so that the businessmen never realize the purpose of the seduction. Obtaining information from a businessman who was unaware that the attentions of a young woman were based on his access to and looseness with insider information, wouldn't give rise to tippee liability. So the company employing the women might retain its freedom to trade on the information.
I think Dorozhko works against Carney here. Theft by seduction likely would be viewed as analogous to theft via hacking.
Anyway, it's an interesting thought experiment. In these politically corret times, however, I don't recommend that law professors use it in class or on an exam. Some hyper-sensitive student doubtless would go running to the dean to complain about your lack of sensitivity to something or other.
Former Berkshire Hathaway Inc. executive David Sokol had harsh words for his onetime mentor, billionaire investor Warren Buffett, the day after Mr. Sokol was notified he wouldn't face regulatory action for his trading activities.
Mr. Sokol was once seen as a potential successor to Mr. Buffett, but his shot at running the Omaha, Neb., conglomerate ended with his resignation in March 2011 amid disclosures he had personally purchased stock in a chemicals company not long before recommending that Mr. Buffett buy it.
Mr. Buffett had praised Mr. Sokol's contributions to Berkshire upon the executive's departure and said he didn't feel the trades were "in any way unlawful." But weeks after the resignation, the Berkshire Hathaway CEO made scathing remarks about Mr. Sokol's actions, calling them "inexcusable" and "inexplicable" and saying they violated the company's code of ethics.
Mr. Sokol's lawyer said Thursday that he was informed that the Securities and Exchange Commission wouldn't take action against his client.
In a sign that the rift is unlikely to heal soon, Mr. Sokol on Friday lashed out at the 82-year-old Mr. Buffett.
"I will never understand why Mr. Buffett chose to hurt my family in such a way, but given that he is rapidly approaching his judgement [sic] day I will leave his verdict to a higher power," Mr. Sokol wrote in an emailed response to The Wall Street Journal.
At the time, I argued that "It's hard to see how what Sokol did qualifies as insider trading under SEC Rule 10b-5." So I'm not surprised the SEC decided to give him a pass.
On the other hand, I also argued that Sokol likely had breached his fiduciary duties to Berkshire Hathaway: "Sokol would have state agency law problems even if he escapes, as I think he will, inside treading liability." So I don't have much sympathy for Sokol's whining about Buffett's criticisms, which strike me as on the mark.
In US v. Whitman, 2012 WL 5505080 (SDNY 2012), "a jury convicted defendant Doug Whitman of two counts of conspiracy to commit insider trading and two counts of substantive insider trading in violation of the federal securities laws. Specifically, the counts charged that Mr. Whitman traded or agreed to trade on material inside information that he received from tippees who had, in turn, obtained the information from inside employees at Polycom, Inc., Google, Inc., and Marvell Technology, Inc." Id. at *1.
In the course of developing jury instructions, Judge Jed Rakoff faced the question of "Whether in a criminal prosecution under the federal securities laws, the scope of an employee's duty to keep material non-public information confidential is defined by state or federal law?" Id.
In the course of answering that question, Rakoff made several interesting observations:
If it is simply a contractual duty, it seemingly would not support a fraud prosecution, since a breach of contract does not necessarily involve any misrepresentation. Cf. S.E.C. v. Cuban, 634 F.Supp.2d 713, 724–26 (N.D.Tex.2009) (holding that although contract may in certain circumstances give rise to misappropriation liability, the agreement “must contain more than a promise of confidentiality”), rev'd, 620 F.3d 551 (5th Cir.2010). Rather, the duty must be of the kind that requires the employee, if he breaches the duty, to disclose the breach—the failure to do so thereby constituting the misrepresentation that is an essential element of fraud.
I agree that a mere contractual duty is not enough to support an insider trading violation and, moreover, go further to specifically reject the Cuban court's suggestion that a contract can ever give rise to the requisite duty. See this blog post.
Back to Judge Rakoff:
... the initial question remains: what is the source of this duty? Defendant here argues that fiduciary and quasi-fiduciary duties are normally a matter of state law, and that the relevant state here is California, where the tippers and their employers were located.[FN3] ... But the Court agrees with the Government's alternate position, that the duty in question is imposed and defined by federal law.
To begin with, Dirks, and indeed all the Supreme Court cases dealing with insider trading, have implicitly assumed that the relevant fiduciary duty is a matter of federal common law, for they have described it and defined it without ever referencing state law. See Dirks, 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911;Chiarella, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348; Carpenter, 484 U.S. 19, 108 S.Ct. 316, 98 L.Ed.2d 275; O'Hagan, 521 U.S. 642, 117 S.Ct. 2199, 138 L.Ed.2d 724; see also A.C. Pritchard, Justice Lewis F. Powell, Jr., and the Counterrevolution in the Federal Securities Laws, 52 Duke L.J. 841, 930–31 & nn. 540–41 (2003) (arguing, based on review of the notes of Justice Powell and interviews with his former clerks, that Justice Powell, the author of Dirks and Chiarella,saw Rule 10b–5 jurisprudence as a species of federal common law). Defendant, indeed, has failed to point to a single case where any federal court has expressly held that the duty was defined by state law. Cf. Cuban, 634 F.Supp.2d at 721 (noting SEC's argument that “no federal court has relied exclusively on state law to determine whether a duty sufficient to support misappropriation theory liability exists”).
FN3. Cf. Stephen M. Bainbridge, Incorporating State Law Fiduciary Duties into the Federal Insider Trading Prohibition, 52 Wash. & Lee L.Rev. 1189 (1995) (arguing that the prohibition against insider trading is best justified on a theory of protecting property rights in confidentiality, which should be determined with reference to state law). Still another possibility—though not advanced by either side here—is that since, under Dirks, the fiduciary duty is ultimately a duty to the shareholders, the relevant law is the law of the state of incorporation, which for two of the three companies here involved—Google and Polycom—is Delaware, see Google Inc. Annual Report (Form 10–K), at 1 (Jan. 26, 2012); Polycom, Inc. Annual Report (Form 10–K), at 1 (Feb. 2, 2012), and for Marvell Technology, is Bermuda. Marvell Technology Group Ltd. Annual Report (Form 10–K), at 1 (Mar. 27, 2012); see also Bainbridge, 52 Wash. & Lee L.Rev. at 1267 n. 320 (“Long-standing choice-of-law rules direct that questions of breaches of fiduciary duty by corporate officers and directors are governed by the law of the state of incorporation.” (quoting Restatement (Second) of Conflicts of Law § 309 (1969))).
Judge Rakoff is correct that insider trading is a species of federal common law, but nevertheless errs by not relying on state law. In the article to which he cites, I argued that:
... the insider trading prohibition is a species of federal common law. Specifically, it is an example of interstitial lawmaking in which the courts are using common-law adjudicatory methods to flesh out Rule 10b-5's bare bones. Once this view of the prohibition is accepted, a choice of law question arises. In crafting a rule of decision for federal common-law cases, courts can either create a unique federal standard or incorporate state law into the federal rule. In the latter case, the cause of action remains federal, but the content of federal law is supplied by the incorporated state law principles. The decision to incorporate state law depends upon whether there are important federal interests that would be adversely affected by doing so. If so, the court will create a uniform federal standard, but if not, the court may incorporate state law.
In order to decide whether state fiduciary duties should be incorporated into the federal insider trading prohibition, we thus must ask two questions: Would incorporation adversely affect prosecution of insider trading under the federal securities laws and, if so, would any identifiable policy goal of those laws be frustrated thereby? Part V addresses the former concern, examining the implications of adopting state law fiduciary duty concepts as the rule of decision. It demonstrates that use of state law principles will at least complicate insider trading prosecutions and probably will substantially limit the prohibition's scope.
In light of that finding, Part VI then turns to the latter concern. Because a unique federal set of fiduciary duties applicable to insider trading is most easily justified if application of state law would frustrate an identifiable federal policy goal, Part VI examines the purported federal interests underlying the insider trading prohibition. As Part VI demonstrates, none of the commonly asserted federal policies requires creation of a unique set of federal fiduciary duties. Rather, the insider trading prohibition is justified solely by the need to protect property rights in valuable information.
Based on this analysis, Part VI argues that it is creation of a unique federal rule -- not incorporation of state law principles -- that would frustrate the policies of the securities laws. The Supreme Court has repeatedly made clear that the federal securities laws do not displace the much broader body of state corporate law. To the contrary, the Court has specifically indicated that questions of fiduciary duty are governed by state law. If the fiduciary duty necessary for insider trading liability is supplied by federal law, a substantial tension thus would develop between the insider trading prohibition and the federalism policies of the securities laws. Incorporating state law fiduciary duties into the prohibition would resolve that tension. Moreover, state law fiduciary duties are generally consistent with the property rights rationale for regulating insider trading. Accordingly, incorporating state law fiduciary duties would advance the federalism policies of the federal securities laws, without frustrating any of the other policies thereof.
Alison Frankel reports that:
On Tuesday, Judges Jose Cabranes and Reena Raggi of the 2nd Circuit Court of Appeals ordered that former Goldman Sachs director and McKinsey chief Rajat Gupta remain free on bail while his lawyers at Wilmer Cutler Pickering Hale and Dorr and Kramer Levin Naftalis & Frankel try to get his insider trading convictionoverturned on appeal. That’s an unusual order from the appeals court, which typically defers to the judgment of the trial court on post-conviction bail. In this case, U.S. Senior District Judge Jed Rakoff, who oversaw the insider trading trial in June, refused to grant Gupta’s bail request.
The bar is quite high for the appeals court to permit a convicted defendant to defer serving a prison term. When Congress enacted the Bail Reform Act in 1984, its intention was to make bail a rare exception for convicted defendants, not the rule. The law said that post-conviction bail would only be granted if the appeal “raises a substantial question of law or fact likely to result in a reversal or an order for a new trial.”
Sadly, at least from a securities fraud pedagogical perspective, the issues seem to be mainly evidentiary errors by the trial judge:
The overall theme of the brief is that at trial, Rakoff granted the government too much leeway to introduce hearsay evidence and afforded too little latitude for Gupta’s evidence.
Holman Jenkins comments on the SEC's investigation of hedge fund guru Steven Cohen. First, the background:
During his heyday in the 1980s and '90s, billionaire hedge-fund manager Steven Cohen never would have had these problems. He was famed as a "tape reader," buying and selling purely in response to numbers dancing on a screen.
Only later, when he began taking an interest in company fundamentals, did he risk collision with the government's Procrustean attempts to regulate the information in share prices via insider-trading law, now threatening to engulf his $14 billion fund, SAC Capital. ...
... Mr. Cohen has not been charged or even publicly named in the legal controversy now brewing up over his firm's Elan trades. A former SAC trader, Mathew Martoma, was officially charged this week with corrupting a doctor involved in the Alzheimer's study to obtain an illegal heads-up. One and all assume, though, that Mr. Cohen is the government's ultimate target.
Next Jenkins makes an observation with which I wish to associate myself fully:
Mercifully absent in the proceedings so far have been the usual claims from prosecutors that the average investor was hurt by SAC's alleged actions. Whoever was a buyer when SAC was selling would have been a buyer anyway, whether SAC's motive in selling was inside information or the maundering of an astrologer.
Secondly, a real wrong can be discerned here even by those immune to the government's usual cant on insider trading. That wrong was the alleged corruption and betrayal of trust by a fiduciary involved in the drug study.
This is vastly preferable to the thrust of much enforcement in the past two decades, when government went further and further afield to convict people who acted on tips they supposedly should have known they shouldn't have known. A nadir was the 2010 arrest of two rail-yard workers who saw suits browsing among the flatcars and deduced their company was for sale.
Damned straight. I wrote of that 2010 case that:
First, there is no inside information here. Inside information long has been defined as " information intended to be available only for a corporate purpose and not for the personal benefit of anyone." SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (C.A.2 1968). What you have here are educated guesses derived from observations of events. There's nothing to suggest secrecy nor is there anything to suggest a communication conveying knowledge.
The Texas Gulf Sulphur case made clear that: " An insider is not, of course, always foreclosed from investing in his own company merely because he may be more familiar with company operations than are outside investors. ... Nor is an insider obligated to confer upon outside investors the benefit of his superior financial or other expert analysis by disclosing his educated guesses or predictions." No need to disclose educated guesses based on familiarity with company operations, which is exactly what we have here.
Second, the SEC is bootstrapping the trades to prove materiality. Granted, a footnote in the Supreme Court’s Basic v, Levinson opinion flatly stated that “trading and profit making by insiders can serve as an indication of materiality.” But Basic was not an insider trading case. Hence, there remains a legitimate question as to whether the allegedly illegal insider trading behavior can serve as proof that the facts on which the insider traded were material. The problem, of course, is the potential for bootstrapping: if the allegedly illegal trade proves that the information is material, the materiality requirement becomes meaningless—all information in the defendant’s possession when he or she traded would be material. Which would suit the SEC just fine, but is damned hard justify, especially in light of the draconian penalties for insider trading.
Third, the Supreme Court has held that plaintiff’s prima facie case must include proof defendant acted with scienter, which the court defined as a mental state embracing an intent to deceive, manipulate or defraud. Here the SEC is trying to conflate materiality and scienter, arguing that if the information is material they must have intended to defraud. This grossly compounds the SEC's effort to endrun the materiality element. they basically want the fact of the trade to prove two elements of the offense.
The SEC has long tried to fudge and finesse the insider trading law. But this case is an especially egregious example of how the SEC seeks to stretch the law beyond any reasonable stopping point. This case should be dismissed and the SEC ought to be sanctioned for having brought it.
If the SEC has really learned its lesson, that would be a great thing. But I'm not holding my breath.