A Brief Look Into Dated Insider Trading Laws

Stephen Kim

In a recent New York Times opinion piece, Robert J. Jackson Jr., an SEC Commissioner, and Preet Bharara, a former U.S. Attorney for the Southern District of New York, argued that U.S. insider trading laws are outdated and allow fraudsters to engage in misconduct that benefits them at the expense of investors. Jackson, Jr. and Bharara claim that current laws fail to hold bad actors accountable for insider trading because the government relies on an antiquated law that prohibits “fraud” without defining “insider trading.” The lack of such definition, they argue, creates a cloud of legal uncertainty that makes enforcement against insider trading difficult. In response to this legal uncertainty hovering around the financial markets, Jackson, Jr. and Bharara have announced a new panel called the Bharara Task Force on Insider Trading to propose new insider trading reforms. This task force will address critical uncertainties currently surrounding insider trading laws that hinder the SEC’s enforcement against insider trading.

The Absence of a Definition for “Insider Trading”

Jackson, Jr. and Bharara believe strongly that insiders who engage in misconduct that harms investors should be held accountable. They claim that difficulties of holding bad actors accountable for insider trading arise from the lack of a clear standard of what an illegal insider trading is.

The current insider trading law is based on Section 10(b) of the 1934 Exchange Act, which prohibits “fraud” in securities markets without very using the words “insider trading.” Over the years, courts have thereby attempted to interpret the statute to ban insider trading. However, the absence of a statutory definition of “insider trading” creates a continuous struggle by courts to define illegal insider trading using broad anti-fraud provisions. As a result, courts differ on whether certain conducts could be considered as illegal insider trading. As Jackson, Jr. and Bharara argue with more concrete examples, a big cloud of uncertainty looms over the legality of misconduct regarding activities related to insider trading.

An Example of Legal Uncertainty on Insider Trading

Jackson, Jr. and Bharara mention several examples that illustrate the legal uncertainty on insider trading. One example is a situation in which an insider in a corporation (like a corporate officer) gives a friend nonpublic information and the friend illegally profits by trading on that information. In that context, whether the insider can be convicted of illegal insider trading can depend on whether a court is convinced that a certain type of evidence, such as a close relationship between the tipper and tippee, can constitute a “benefit” that was obtained by tipping his friend. For example, in U.S. v. Newman, the Second Circuit concluded that, in order to convict an insider for insider trading, “the Government must prove that beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit.” A year later, in U.S. v. Salman, the Ninth Circuit declined to follow Newman’s holding that evidence of a close relationship between tipper and tippee is insufficient of itself to demonstrate that the tipper received a personal benefit. Instead, the Ninth Circuit held that gifts of confidential information to a relative or friend can constitute as evidence that the tipper received a personal benefit. Thus, courts take different approaches on whether certain evidence may or may not be used to implicate that a tipper received a personal benefit.

On the other hand, the Supreme Court has clarified some legal uncertainties surrounding insider trading laws. Recently, for example, the case of Salman was brought to the Supreme Court, which dealt with the question whether proof of a pecuniary benefit was required to prove illegal insider trading when a tipper provided material nonpublic information to a trading friend or relative. The Court rejected the Second Circuit’s ruling in Newman that, in the context of giving confidential information to friends or family members, pecuniary benefit was needed to prove illegal insider trading. Instead, the Court held that in the context when the tipper gives valuable information to close friends or family members, “the jury can infer that the tipper meant to provide the equivalent of a cash gift.” Thus, the Supreme Court clarified that evidence of pecuniary benefit is not needed when the tipper gives confidential nonpublic information to a close friend or relative. However, we must strongly note that this holding only provided a narrow clarification to insider trading laws.

The Pressure on the SEC and Congress

Scholars and commentators have also criticized other shortcomings of current insider trading laws. However, the fact that Congress has never defined “insider trading” is the key source of all the frustration that is amounted from the lack of clarity in insider trading laws.

Jackson, Jr. and Bharara thus reasonably voice their strong concern over the uncertainty in insider trading laws which could allow misconduct that harms investors to roam free in the financial markets. They recognize that Congress could update the insider trading laws or that the SEC could clarify them because they have the authority to do so. Therefore, they announced the creation of the Bharara Task Force on Insider Trading precisely so that the SEC and Congress would re-evaluate current insider trading laws after hearing their reform proposals.

Conclusion

In this day and age where many of us assume that, given the highly modern state of financial markets, the law has been continually updated to give clarity to both insiders and the government on what is and what is not legal misconduct, Jackson, Jr. and Bharara opinion piece sheds light to the public that insider trading laws are not clear than what we might think them to be. In actuality, the insider trading laws are riddled with uncertainties that may allow misconduct by insiders that harms investors to occur in financial markets. Therefore, Jackson, Jr. and Bharara may propose, for example, a specific law addressing “insider trading,” in which a cause of action is created that would allow law enforcement to target insiders for insider trading, regardless of whether benefits are conferred between tippers and tippees. Given their emphasis on the lack of definition of “illegal insider trading,” I suspect that they are more likely to instead propose a clear definition of “insider trading” so that courts will no longer have to struggle whether a certain conduct would be illegal insider trading. Whatever their proposals might be, however, we can only but look forward to them and hope that Congress and the SEC will consider those proposals, ultimately leading to a rethinking of and eventual clarity in insider trading laws.