Insider Trading Isn't Illegal?

I think it's safe to say that if you work in this industry, you're familiar with the concept of insider trading. What do we know? You can't trade in a company's stock based on material non-public information. If you do, the Securities and Exchange Commission ("SEC") could hunt you down and make your life very, very miserable. Isn't that what time and experience have taught us? In the past, I've blogged about the SEC's renewed and aggressive interest in pursuing a variety of insider trading violations (see Husbands and Wives Insider Trading and "There's a Reason They Call it "Insider" Trading). With more sophisticated technology and monitoring mechanisms, even the smallest trades are not below the line of scrutiny, and it's an area where I've been advocating the use of caution for a while now. However, what was left unsaid in those many recounts of insider trading crackdowns was the fact that although there have been prosecutions and penalties and repercussions for trading based on material non-public information, there isn't actually a federal law that specifically makes insider trading illegal. Now, that tide may be changing, with multiple bills in pending in Congress that intend to create a federal statute to address this legislative hole. In today's blog I'll catch you up on what's happening on that front.

How Can That Be?

I already know what you are thinking: "Huh? Insider trading is illegal." I mean, isn't that why we've seen dozens of successful prosecutions in the last few years? You know what I'm talking about - and we've seen it all. CEOs, hedge fund managers, employees who accidentally passed on inside information to their wives, friends having brunch together and sharing small talk about their jobs. I think the variety of circumstances is broad, with one commonality: the SEC has been successful in working with the Justice Department to bring charges, obtain convictions and levy penalties. Jail time has been a very real outcome in some of these cases. So how could this all happen if insider trading is NOT illegal?  Well, technically it's not. And, although the SEC has been successful in pursuing these cases, they have had to use loopholes to do so - relying on general antitrust laws and decades of case law (and, I'm not a lawyer, but I'm told that case law is subject to interpretation by individual judges, so the application of that could vary widely). The bottom line is there isn't a statute that specifically addresses insider trading, which leads to potential ambiguity and inconsistencies in the courts.

Why the Interest Now?

We've established that there are no clear federal insider trading laws on the books, but what's the sudden interest in creating one? The initial catalyst was a landmark ruling (December 2014) by the Second U.S. Circuit Court of Appeals (U.S. v. Newman) that overturned two "key" insider trading convictions, dealing a blow to the Justice Department and the SEC. At the time, the Wall Street Journal summarized the situation as follows: "...a federal appeals court overturned two insider-trading convictions and ruled it isn’t always illegal to buy or sell stocks using inside information.

The ruling raised the bar for prosecutors on a crime that is already hard to prove, and it will likely limit the types of cases the government can pursue.

Specifically, the three-judge panel of the Second U.S. Circuit Court of Appeals said prosecutors must prove traders knew that the person who provided an inside tip gained some sort of tangible reward for doing so. The judges also said it may be legal to trade on inside information, even if it gives an investor an unfair advantage in the markets, as long as the tipper didn’t commit an illegal breach of his or her duty."

What's the Fallout?

The Newman decision has created a still ongoing fallout, making it more challenging for the SEC and Justice Department to pursue insider trading cases. As a result, some pending cases have been dropped, others who were successfully convicted are now seeking review of their cases, and Congress is taking action to statutorily define insider trading and also to reverse the requirement under the appellate decision that:

• "the tippee know both that the tipper breached a duty of confidentiality and

• the tipper received a personal benefit of “some consequence.”

What's Happening in Congress?

There are currently three bills pending in Congress that seek to define insider trading. The National Law Review describes them as follows:

"Two bills introduced by Democrats have been pending without bipartisan support and have stalled.  The broadest of these is the Stop Illegal Insider Trading Act, which was introduced by Sen. Jack Reed (D – RI) and Sen. Robert Menendez (D – NJ). The Stop Illegal Insider Trading Act would make it illegal to trade on “material information” that the person “knows or has reason to know” is not publicly available – excluding information a person developed from publicly available sources.

The second bill is the Ban Insider Trading Act of 2015, which was introduced by Rep. Stephen Lynch (D – MA), and would redefine “material” nonpublic information as information that would likely affect the stock’s price if it were made public.

Most recently, Rep. Jim Himes (D – CT) and Rep. Steven Woman (R – AK), introduced the first bill with bipartisan support, which would ban trading based on material, nonpublic information that the person knew or recklessly disregarded was wrongfully obtained."

What's Next?

It's not clear what the outcome of any of these efforts will be, but what we do know is that the fallout from the Newman decision has caused a ruckus, and there is more pressure than ever to find a consistent way for the courts to define insider trading. It's quite possible that any new legislation in this area will trigger a need to revamp the insider trading policy, educate employees and possibly adjust some practices and procedures. We'll keep you informed on any new developments in this area.

-Jenn