As 2019 came to a close, the U.S. House of Representatives passed H.R. 2534: Insider Trading Prohibition Act (“ITPA”) in a 410-13 bipartisan vote.[1] Congressman Jim Himes (D-Conn.) sponsored the bill to establish, for the first time, a statutory definition of insider trading.[2] Congressman Himes celebrated the bill as a long-overdue clarification of insider trading law that will “let potential wrongdoers know exactly what behavior will cross the line.”[3] While the ITPA has not yet passed the Senate, the potential implications of a statutory definition of insider trading are worthy of discussion.
Before delving into the implications of the ITPA, it is helpful to understand how prosecutors use existing law to bring charges against defendants for insider trading. Currently, prosecutors rely on judicial decisions interpreting Section 10(b) of the Securities and Exchange Act of 1934 (“SEA”) and Securities and Exchange Commission (“SEC”) Rule 10b-5.[4] Section 10(b) of the SEA makes it unlawful to “use or employ…any manipulative or deceptive device or contrivance” while trading.[5] The SEC’s Rule 10b-5 makes it unlawful to “employ any device, scheme, or artifice to defraud” while trading.[6] Neither Section 10(b) nor Rule 10b-5 explicitly mentions insider trading, but courts have interpreted these provisions to prohibit individuals who have a fiduciary duty from trading using material, non-public information for personal gain.[7]
Additionally, insiders may not disclose material, non-public information to others for trading.[8] Those who receive such information are called tippees, and there has been difficulty determining whether a tippee may be held criminally liable for acting on information obtained from an insider.[9] In 1983, the Supreme Court held in Dirks v. SEC that a tippee may be criminally liable when an insider breaches a fiduciary duty “by disclosing information to [a] tippee and the tippee knows or should know that there has been a breach.”[10] In determining whether the insider breached his fiduciary duty, courts must focus on whether the insider received a personal benefit from the disclosure.[11] The Court intimated that an inference of personal benefit may arise when an insider makes a “gift of confidential information to a trading relative or friend.”[12]
31 years later, in United States v. Newman, the Second Circuit addressed tipper-tippee liability more directly.[13] The Second Circuit held that a tippee may be convicted if the tippee knew that the tipper breached his fiduciary duty and that the tipper divulged information to the tippee for the tipper’s personal benefit.[14] The Court held that personal benefit cannot be inferred from mere friendship or familial relationships.[15] In 2016, the Supreme Court, in Salman v. United States, rejected the demanding aspects of Newman by holding that a personal benefit may be inferred where there is a familial relationship or friendship that suggests a quid pro quo. In this case, the court considered the mens rea requirement to be whether a tippee knew that the tipper was in a position to benefit by disclosing the information.[16]
The ITPA makes it unlawful for any person to trade while aware of material, non-public information “if such person knows, or recklessly disregards, that such information has been obtained wrongfully.”[17] The ITPA also makes it unlawful to “wrongfully” obtain or communicate material, non-public information (i.e., tipping).[18] By attempting to codify existing law and clarify potential criminal behavior, the ITPA potentially broadens the scope of insider training liability.[19]
ITPA expands mens rea by including a “recklessness” standard. Under current insider trading law, the defendant must have willfully breached a duty.[20] By incorporating a reckless standard, the ITPA relaxes the level of intent required to sustain a conviction.[21] According to Congressman Bill Huizenga (R-Mich.), who voted against the ITPA, a person can be aware of insider information, not use it or act on it, and still be found guilty of insider trading.[22] Rep. Huizenga unsuccessfully introduced an amendment that would strike “aware of” and replace it with “using” insider information.[23]
The ITPA also seems to expand the scope of activities that would potentially trigger criminal liability.[24] The Act specifies actions that constitute “wrongful” acquisition or communication of material, non-public information: obtaining material information (1) through “theft, bribery, misrepresentation, or espionage,” (2) in “violation of any Federal law protecting computer data or the intellectual property or privacy of computer users,” (3) through “conversion, misappropriation, or other unauthorized and deceptive taking of such information,” or (4) in “breach of any fiduciary duty, . . . confidentiality, . . . contract, . . . code of conduct or ethics policy, or . . . any other personal or other relationship of trust and confidence.”[25] In situations in which there may be no breach of a fiduciary duty in the acquisition or communication of material, non-public information, prosecutors may nonetheless bring charges of insider trading under one of the above categories.[26]
It will be interesting to see whether the ITPA moves forward in the Senate and how its potential implications would play out if signed into law. For now, prosecutors continue to rely on case law to prosecute a crime that New York Judge Rakoff considers to be a “straightforward concept that some courts have somehow managed to complicate.”[27]
* Natalie Puletti, J.D., expected May 2022. The George Washington University Law School. Thank you to the lawyers, academics, legislators, and policy researchers who strive to ensure fair markets!
[1] Press Release, U.S. Congressman Jim Himes, Himes Bipartisan Insider Trading Bill Passes House, Newsroom, (Dec. 5, 2019), https://himes.house.gov/media-center/press-releases/himes-bipartisan-insider-trading-bill-passes-house.
[2] Id.
[3] Id.
[4] Rahul Mukhi, Shannon Daugherty, & Destiny Dike, A Look Inside H.R. 2534: Insider Trading Prohibition Act, HARVARD LAW SCHOOL FORUM ON CORPORATE GOVERNANCE (July 25, 2019), https://corpgov.law.harvard.edu/2019/07/25/a-look-inside-h-r-2534-insider-trading-prohibition-act/.
[5] 15 U.S.C. § 78j (2012).
[6] 17 C.F.R. § 240.10b-5 (1951).
[7] See United States v. O’Hagan, 521 U.S. 642, 652 (1997); Chiarella v. United States, 445 U.S. 222, 230 (1980).
[8] See Salman v. United States, 137 S. Ct. 420, 423 (2016).
[9] Expanding Insider Trading? House of Representatives Passes the “Insider Trading Prohibition Act” with Bi-partisan Approval, BAKER BOTTS: INSIGHTS (Dec. 11, 2019), https://bakerbotts.com/insights/publications/2019/december/expanding-insider-trading.
[10] Dirks v. S.E.C., 463 U.S. 646, 654 (1983).
[11] Id. at 647.
[12] Id. at 664.
[13] United States v. Newman, 773 F.3d 438 (2d Cir. 2014).
[14] Id. at 450.
[15] Id. at 453.
[16] Salman, 137 S. Ct. at 427.
[17] Insider Trading Prohibition Act, H.R. 2534, 116th Cong. § 16(A)(a) (1st Sess. 2019).
[18] Id. at § 16A(b).
[19] Lyle Roberts, The Insider Trader Law Is Bad. Will Congress Make It Worse, WALL ST. J. (Jan. 9, 2020, 6:58 PM), https://www.wsj.com/articles/the-insider-trading-law-is-bad-will-congress-make-it-worse-11578614315?ns=prod/accounts-wsj.
[20] 15 U.S.C. § 78ff(a) (2012).
[21] See generally In re Copper Mountain Sec. Litig., 311 F. Supp. 2d 857 (N.D. Cal. 2004).
[22] Nicole Goodkind, Why 12 Republican Representatives Voted Against Banning Insider Trading, FORTUNE (Dec. 10, 2019, 12:00 PM), https://fortune.com/2019/12/10/what-is-insider-trading-prohibition-act-republicans.
[23] Id.
[24] Roberts, supra note 19.
[25] H.R. 2534, § 16(A)(c)(1)(A-D).
[26] See id.
[27] United States v. Pinto-Thomaz, 352 F. Supp. 3d 287, 295 (S.D.N.Y. 2018).