Hey Congress: Here’s A 19-Word Act To Restore Insider Trading Law
The worlds of stock picking and white collar crime were at once upended last month by a federal appeals court’s ruling reversing 31 years of settled insider trading law. The court ruled that, to send someone to jail for insider trading, the government must prove that the corporate insider who leaked the information acted corruptly (in his own self-interest), and that the criminal defendant who profited from the tip knew about that corruption.
The ruling was a departure from the government’s (and most members of the defense bar’s) prior understanding of the law that a defendant could go to jail so long as he knew that the tip must have come from an insider, even if he did not know the circumstances of how it was divulged.
The reason for this wide range of interpretation is that there is no statute banning insider trading. There is only a 1934 statute banning fraud in the purchase or sale of securities generally, and several decades of judicial decisions interpreting that statute to apply to insider trading. The most recent Supreme Court decision addressing the source-of-information aspect of insider trading is the 1983 Dirks case finding that a whistleblower who leaked evidence of an accounting fraud could not be criminally liable because he did not act corruptly, for his own personal benefit. The Dirks opinion contained some confusing language about what facts could establish this “personal benefit” requirement, specifically about whether the giver of a gift obtains a personal benefit by virtue of having made the recipient happy. Last month’s decision reframed the Dirks gift language, requiring a real corrupt bargain with the leaker — “an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or valuable nature” — for anyone trading on the tip to go to jail.
All insider trading “tip” cases involve the transmission of some piece of confidential information from its rightful owners to an unauthorized outsider who trades on it. The tip can be transmitted one of two ways: through a theft or other criminal act, (i.e., where the tip was either physically stolen or hacked, or where an insider was bribed to disclose it); or through some form of negligent leak (i.e., where the tip was left on a lost laptop, or was shared by an insider who mistakenly said too much to an analyst or a friend, or was overheard by an eavesdropper at a restaurant).
It has always been clear, and still is, that anyone trading on stolen tips runs the risk of criminal liability (last month’s ruling clarified that the defendant must know that his tip was stolen, but that aspect of the ruling was expected and less controversial).
Before last month, trading based on negligent leaks was a gray area. If the government believed you had reason to know the tip came from an insider — for example, if it was so specific that it only could have come from an insider — you were likely to be prosecuted. If the tip sounded more like a rumor, prosecution was less likely.
After last month’s decision, there is no gray area: all trading based on negligent leaks is fair game and legal.
The ruling legalizes trading many consider unfair. So long as no bribe is paid to the insider, tips obtained from overly chatty roommates or golf buddies or overserved bar patrons may be freely traded on. Even tips obtained from corporate insiders in one-on-one meetings in violation of the SEC’s selective disclosure rule can be freely traded on, as that rule only restricts the tipper, not the tippee.
Given the high rewards and healthy appetites for risk on Wall Street, it is likely that many analysts are already rushing to exploit these new ground rules. To prevent this, the government could try to appeal last month’s ruling to the Supreme Court, but even if the Supreme Court agreed to hear the case, it would take over a year to rule, and there is little guaranty that the Supreme Court would see the case any differently given the limitations of the 80-year-old statute on which it rests.
The only sure way to restore insider trading law to what most of us thought it was is for Congress to act. Fortunately, the fix is exceedingly simple. Under last month’s ruling, for tippees to be liable, the insider must have breached his fiduciary duty to his company, requiring deliberate self-dealing; merely breaching his confidentiality duty (as in most negligent leak cases) is not enough. Congress can fix that with just 19 words:
“It shall be unlawful to trade based upon material non-public information disclosed in violation of a duty of confidentiality.”
