Via Hugh Hewitt, I learned that the NY Post reports:
Howard Dean acknowledged yesterday that he sold $15,000 in stock in five Vermont banks in 1991 after getting "inside information" from a state banking regulator soon after he became Vermont governor. Dean yesterday portrayed the sale as a bid to avoid a conflict of interest - not an attempt to profit from inside information.
Trading by a government official in possession of material nonpublic information potentially is an insider trading violation. To be sure, classic insider trading (the so-called disclose or abstain rule) is irrelevant. Classic insider trading occurs when an insider or other fiduciary trades in the stock of the company to whom he owes fiduciary duties. As governor, Dean owed no duties to the banks in whose stock he traded or the other shareholders thereof. So no liability there.
An alternative theory of insider trading, however, is potentially applicable. Under the so-called misappropriation theory, liability arises where the trader breaches a fiduciary duty owed to the source of the information. Suppose, for example, that Acme Corporation is planning a big contract with Ajax Corporation. When announced, the stock of both companies is expected to rise. I am a lawyer working for Acme. I owe fiduciary duties to Acme. I owe no duties to Ajax. If I trade in Acme stock, that is classic insider trading. If I trade in Ajax stock, that is misappropriation. I used confidential information belonging to Acme to make a personal profit by trading in Ajax stock. In doing so, I breached my fiduciary duties to Acme. (If you're wondering why a securities fraud issue like insider trading is bollixed up with fiduciary duties, you need to read my book.)
So what would have to be shown to say that Dean committed insider trading? Key issues: First, that he had a fiduciary duty to the source of the information - presumably the state of Vermont - not to use information learned in his official capacity for personal gain. There is precedent for imposing such a duty. Second, that he traded while in possession of material nonpublic information. The information evidently was nonpublic, but was it material? Information is material where there is a substantial likelihood that the reasonable investor would consider it important in making decisions. Dean's people claim "the regulator's report was 'innocuous.'" We'll need some enterprising reporter to track down the regulator's report to find out (unless it's buried away in Dean's sealed records). Third, in some circuits it is not enough to trade while in possession of material nonpublic information. Instead, you must trade on the basis of the information - in other words, there must be a causal link between the information and the trade. Dean claims that he sold to avoid a conflict of interest. Possible, maybe even probable. A claim that the sale was made to avoid a conflict of interest rather than on the basis of inside information, however, would be an affirmative defense with the burden of proof on Dean. As the Post points out, moreover, he didn't sell other stocks that also presented at least some potential for similar conflicts of interest. (Update: See also Newsweek's report on Dean's conflicts of interest.) Finally, he must have made a profit or avoided a loss. Did he? According to the Post article, the AP is reporting that the bank stocks were headed down, which suggested he avoided a loss. (Update: AP report here.) Dean's people are claiming that long-term the bank stocks went up, but the long-term is irrelevant for this purpose.
Based on what we know so far, which admittedly isn't much, it looks like a plausible case could be made. The main issue would be the contents of the report. Was the information material? There is no way of knowing without seeing the report. The other key issue would be whether Dean can make out an affirmative defense that he traded to avoid a conflict of interest rather than on the basis of the information in question.
Update: Mark Kleiman thinks I'm impugning Dean unfairly:
Prof. Steve Bainbridge of UCLA says that Dean's explanation that he sold the stock to avoid potential conflicts of interest is "possible, even probable." But Bainbridge then goes on at great length to speculate that (1) IF the information in the report was negative; and (2) IF as a result of that information he sold the stock; and (3) IF by selling the stock Dean avoided a loss; and (4) IF a particular theory of fiduciary responsibility is adopted, THEN Dean might possibly have been guilty of something, UNLESS he could show that he actually sold the stock to avoid a conflict of interest. Of course, all of this is merely theoretical, since any case would have been long since barred by the statute of limitations.
From the SEC's website:
Examples of insider trading cases that have been brought by the SEC are cases against: ... Government employees who learned of such information because of their employment by the government....
Second, while I find Dean's explanation for his sale plausible, if not wholly immune from being questioned, the law of insider trading makes motive irrelevant. If you traded while in possession of material nonpublic information, you are liable. In a few jurisdictions (like the 9th Circuit), you must have traded on the basis of the information. Even there the claim that you traded for some other reason than the material nonpublic information in your possession, however, is an affirmative defense. From the SEC's website:
Rule 10b5-1 provides that a person trades on the basis of material nonpublic information if a trader is "aware" of the material nonpublic information when making the purchase or sale. The rule also sets forth several affirmative defenses or exceptions to liability. The rule permits persons to trade in certain specified circumstances where it is clear that the information they are aware of is not a factor in the decision to trade, such as pursuant to a pre-existing plan, contract, or instruction that was made in good faith.
In Dean's case, there was no pre-existing plan (he decided to sell and sold). So he would have trouble making out the affirmative defense. Finally, it is well-established that insider trading liability can be established by circumstantial evidence.
I will concede, however, that all of this arguably says more about the insider trading laws than Howard Dean. The law of insider trading has become a set of hyper-technical rules largely divorced from their legitimate policy function of protecting property rights in information. (See, e.g., Insider Trading Regulation: The Path Dependent Choice between Property Rights and Securities Fraud.) The fact that they can be applied in such a straightforward way in this situation illustrates that point quite forcefully. As for Dean, the question will be whether this is an isolated incident with a plausible explanation.
