Fascinating new article by Don Langevoort:
The Second Circuit’s en banc decision in SEC v. Texas Gulf Sulphur Corp.[1] (“TGS”) is approaching its 50th anniversary, and it’s still well-known for several important holdings. Perhaps the most celebrated (or condemned) accepted the SEC’s argument that corporate insiders have a duty to “abstain or disclose” from trading while in possession of material nonpublic information. The opinion makes a bold claim that the law in play (Rule 10b-5’s antifraud prohibition) “is based in policy on the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information.”[2] From that comes a command of considerable breadth: “[A]nyone in possession of material inside information must either disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence, or he chooses not to do so, must abstain from trading in or recommending the securities concerned while such inside information remains undisclosed.”[3]
There is a standard story among legal scholars about this expression of naked egalitarianism—that it was either a triumphant or seditious idea (depending on perspective) that had its moment in the sun in the 1970s, but which the Supreme Court put to death 12 years later in Chiarella v. United States. In a forthcoming article (part of a symposium on TGS to appear in the SMU Law Review, available here), I look back, as a matter of legal archeology if nothing else, on the pathway from TGS to Chiarella and beyond, and show that the real story is much more complicated. ...
In the early post-TGS cases, the commission seemed much more interested in building out its vision than pursuing egalitarianism per se. It was bolstered in this by a counter-narrative at the time that TGS didn’t really mean what it said,[4] which got further traction in the mid-1970s as the American Law Institute—with the support of the securities law establishment—sought to recodify the regulatory infrastructure, including insider trading. The Federal Securities Code rejected the egalitarian approach as not an apt reflection of then-current law. There was also political pushback, naturally enough, especially given the threat of draconian private damage liability and the recognition that loose language in TGS could be put to use in upsetting many lucrative “market information” practices on Wall Street. Suffice it to say that by 1976, the SEC—in a well-publicized speech by Commissioner Philip Loomis, who had argued TGS in the Second Circuit—explicitly disavowed market egalitarianism as neither good law nor good policy.
There are more intriguing archeological details, but this is enough to make it curious that the Supreme Court in Chiarella resurrected egalitarianism in order to kill it again. (The Second Circuit decision on review had also disavowed mere possession as a source of duty). My impression is that Wall Street used it as a boogeyman, and that lawyers in the Solicitor General’s Office (perhaps still under the spell of Frank Easterbrook) were content to let it be so used because they wanted to reorient insider trading law away from anything like TGS or Cady Roberts. Thus we got the strange—and entirely inaccurate—claim from Justice Lewis Powell that “we cannot affirm petitioner’s conviction without recognizing a general duty between all participants in market transactions to forego actions based on material, nonpublic information.”[5] His narrower fiduciary duty test, supposedly needed to counter rampant egalitarianism, was a choice, not a necessity.
In the article, Don notes (at 4 n.14):
As Steve Bainbridge points out in his criticism of TGS in this symposium the key paragraph that promotes marketplace egalitarianism contains non-sequiturs, overbroad language and one-off citations, obscuring the inventiveness of the philosophy being promoted. Stephen M. Bainbridge, Equal Access to Information: The Fraud at the Heart of Texas Gulf Sulphur (this volume). Bainbridge thus concludes that the opinion was a fraud of its own, so that it and all the case law that followed were (and are) illegitimate. Though I agree that the bold proclamation of an egalitarian ideal and resulting disclosure duty was new to TGS, I disagree about the illegitimacy, for reasons explained herein.
The article to which Don is referring is Equal Access to Information: The Fraud at the Heart of Texas Gulf Sulphur (August 7, 2017). UCLA School of Law, Law-Econ Research Paper No. 17-14. Available at SSRN: https://ssrn.com/abstract=3014977:
The Texas Gulf Sulphur decision was the seminal moment in the creation of the modern federal insider trading prohibition. In the half century since it was decided, however, courts and commentators have overlooked the glaring flaw in the court’s analysis.
In the key part of the opinion, in which the court laid out the equal access standard, the court grossly misrepresented the precedents on which it relied. The court cited two state law opinions that were wholly irrelevant to the problem at hand. It cited two law review articles, but those articles simply do not say what the court claimed they said. Finally, the court made a bald, unsupported statement of Congressional intent that is demonstrably false.
The insider trading prohibition thus rests on a foundation of sand.
Setting aside our disagreement about the legitimacy of the moves made by the TGS court, I concur with Don's observation that Powell's fiduciary duty-based regime was not necessitated by section 10(b). In my article, Regulating Insider Trading in the Post-Fiduciary Duty Era: Equal Access or Property Rights? (May 8, 2012). UCLA School of Law, Law-Econ Research Paper No. 12-08. Available at SSRN: https://ssrn.com/abstract=2054814, I argued that:
Like equal access, the fiduciary duty approach lacked any basis in the text or legislative history of the statute and rule. Like equal access, precedent weakly supported Powell’s approach. Instead, like equal access, basing insider trading liability on a fiduciary duty to disclose was essentially a matter of judicial fiat. It was the deference his colleagues paid Powell on securities law matters that turned it into law, rather than its intrinsic merits. Unlike equal access, however, Powell’s approach lacked any obvious link to the purposes of the securities laws and, moreover, created a clear conflict with the federalism-based limits on those laws.
