John P. Anderson has emerged as a leading voice in the insider trading debate, with an insightful book and a number of important articles. In a recent blog post, he discusses a new article by my friend and colleague Andrew Verstein. He begins by explaining that:
The courts have interpreted Section 10b of the Securities and Exchange Act as prohibiting insiders from trading in their own company’s shares only if they do so “on the basis of” material nonpublic information. This element of scienter for insider trading liability is sometimes tricky for regulators and prosecutors to satisfy because insiders who possess material nonpublic information at the time of their trade will often claim they did not use that information. The insider may claim that her true motives for trading were entirely innocent (e.g., to diversify her portfolio, to pay a large tax bill, or to buy a new house or boat). Such lawful bases for trading can be easy for insiders to manufacture and are often difficult for regulators and prosecutors to disprove.
He then moves on to Verstein’s forthcoming article, Mixed Motives Insider Trading, (Volume 106 of the Iowa Law Review), which "charts a 'third way' to resolve the ongoing use-versus-possession controversy."
The SSRN abstract to Professor Verstein’s article follows:
If you trade securities on the basis of careful research, then you are a brilliant and shrewd investor. If you trade on the basis of a hot tip from your brother-in-law, an investment banker, then you are a criminal. What if you trade for both reasons?
There is no single answer, thanks to a three-way circuit split. Some courts would forgive you according to your lawful trading motives, some would convict you in keeping with your bad motives, and some would hand the issue to the jury. Sometimes called the “awareness/use” debate or the “possession/use” debate, the proper treatment of mixed motive traders has occupied dozens of law review articles over the last thirty years.
This Article demonstrates that courts and scholars have so far followed the wrong reasons to the wrong answers. Instead, this Article takes trader motives seriously, drawing on insights and solutions from the broader jurisprudence of mixed motive. This analysis generates a new legal test and demonstrates the test’s superiority.
Professor Anderson points out that he has "argued elsewhere that a strict 'use' test best complies with Section 10b’s scienter requirement" but goes on to observe that:
Professor Verstein’s primary-motive test offers a significant improvement over the strict awareness test reflected in both SEC Rule 10b5-1 and the Insider Trading Prohibition Act recently passed by the House of Representatives. For these reasons, Professor Verstein’s proposal warrants serious consideration as regulators and legislators consider paths to reform.
