In my article, Regulating Insider Trading in the Post-Fiduciary Duty Era: Equal Access or Property Rights, in Research Handbook on Insider Trading 80 (Edward Elgar Publishing; Stephen M. Bainbridge ed. 2013), I argued that:
In Chiarella and Dirks, the Supreme Court based insider trading liability on a breach of a disclosure obligations arising out of a fiduciary relationship. The resulting narrowing of the scope of insider trading liability met substantial resistance from the Securities and Exchange Commission (SEC) and the lower courts. Through both regulatory actions and judicial opinions, the SEC and the courts gradually chipped away at the fiduciary duty rationale. In recent years, the trend has accelerated, with several developments having substantially eviscerated the fiduciary duty requirement.
The current unsettled state of insider trading jurisprudence necessitates rethinking the foundational premises of that jurisprudence from first principles. This essay argues that the correct rationale for regulation insider trading is protecting property rights in information. Although that rationale obviously has little to do with the traditional concerns of securities regulation, this article further argues that the SEC has a sufficiently substantial advantage in detecting and prosecuting insider trading that it should retain jurisdiction over the offense.
In the course of that article, I discussed insider trading Under Sarbanes-Oxley § 807 and 18 USC § 1348:
Section 807 of the Sarbanes-Oxley Act added a new § 1348 to the US Criminal Code, which provides that:
Whoever knowingly executes, or attempts to execute, a scheme or artifice—
(1) to defraud any person in connection with any security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934; or
(2) to obtain, by means of false or fraudulent pretenses, representations, or promises, any money or property in connection with the purchase or sale of any security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934
shall be fined under this title, or imprisoned not more than 25 years, or both.[1]
Neither the text nor its sparse legislative history shed much light on what Congress intended it to do. About all one can say for sure is that Congress intended to significantly increase the penalties in securities fraud cases and to make it easier for prosecutors to prove such cases by eliminating the so-called “technical elements” of existing provisions such as § 10(b) and Rule 10b-5.[2] Is Powell’s fiduciary duty requirement such a technical element?
In US v. Mahaffy,[3] defendant stockbrokers tipped nonpublic information to defendant day traders in return for cash. The case could and should have been prosecuted under the misappropriation theory. In Mahaffy, however, the prosecutors charged the defendants with violating § 1348. In upholding the charge as a proper one, the district court did not require the prosecution to prove that the tippers had breached a duty of confidence arising out of a fiduciary relationship owed either to the source of the relationship or to the persons with whom the tippees traded. Indeed, of the Supreme Court trilogy, the district court mentioned only O’Hagan and only in passing.[4]
“The Mahaffy decision [thus] reflects the first step of a potential sea change in the elements required of the government to prove a criminal insider trading violation.”[5] It casts aside, albeit sub silentio, the need for the prosecution to show a breach of a duty to disclose arising out of a fiduciary relationship or similar relationship of trust and confidence. Instead, by analogizing “§ 1348 to an honest services fraud case,” Mahaffy “requires only a material misrepresentation, not a violation of confidence.”[6] Although the SEC will be unable to avail itself of § 1348 potentially significant gutting of the fiduciary duty requirement, since the SEC lacks power to bring criminal cases, § 1348 thus must nevertheless be counted as having knocked one more brick out of the wall.
Now Karen Woody has posted an article length treatment of Section 807:
Since Sarbanes-Oxley, there has been a sleepy provision of the criminal code that could present an end-around to the morass of insider trading precedents under Rule 10b-5. Under 18 U.S.C. §1348, the government can bring an insider trading case under the more general umbrella of securities fraud, which has scant jurisprudential precedent. In other words, the heavily-litigated personal benefit test found in Dirks may not apply to a charge of insider trading under §1348. The elements required to prove a charge under §1348 are similar to other fraud-based offenses such as mail and wire fraud, health care fraud, and bank fraud. Whether §1348 was intended to apply to insider trading in particular is an open question, and a broader question is whether the jurisprudential interpretation for the elements of the crime of insider trading as defined under Rule 10b-5 should be imported into the judicial interpretation of § 1348. In other words, if the conduct that constitutes criminal insider trading under Rule 10b-5 exists only if the elements of the Dirks test are met, then a §1348 charge for criminal insider trading may create an entirely new scheme and definition of the crime. This Article analyzes the potential of this dual paradigm, and argues that, given the uncertainty and shifting parameters of insider trading prohibitions, application of §1348 to insider trading should be afforded the rule of lenity.
Woody, Karen E., The New Insider Trading (October 1, 2019). Arizona State Law Journal, Forthcoming; Washington & Lee Legal Studies Paper No. 2019-22. Available at SSRN: https://ssrn.com/abstract=3474570 or http://dx.doi.org/10.2139/ssrn.3474570
Recommended reading.
