United States: Insider Trading - 2018 Annual Review

Last Updated: January 24 2019
Article by Morrison & Foerster LLP


"The crime of insider trading is a straightforward concept that some courts have somehow managed to complicate." So lamented United States District Court Judge Jed Rakoff in December 2018. His unorthodox first sentence of a decision denying a motion to dismiss an insider trading indictment in fact understates the ambiguity and confusion that pervades the law of insider trading. Grappling with the uncertainties created by a line of cases following the U.S. Court of Appeals for the Second Circuit's controversial 2014 opinion in United States v. Newman, judges in the Second Circuit found themselves having to determine the criminal culpability of a defendant—as they did for Mathew Martoma—based in part on close consideration of what it means to be a friend. Perhaps because of this uncertainty—what former U.S. Attorney Preet Bharara referred to as "[t]he shoddy state of American insider-trading law"—the types of cases brought by the Department of Justice ("DOJ") in 2018 were relatively safe cases that did not test the outer limits of the puzzling state of insider trading law.

Civil insider trading cases in 2018 did not yield significant changes in the law. As has been the growing trend over the past few years, the Securities and Exchange Commission ("SEC") chose to bring the overwhelming proportion of its insider trading enforcement cases as either settled matters or actions filed in parallel with a criminal matter. Not surprisingly, the SEC's recent pursuit of fewer contested SEC-only cases led to fewer court opinions examining how the evolving law of insider trading applies in a civil enforcement action. If you are looking for an SEC insider trading trial in 2018, you will not find one—the SEC tried a grand total of zero insider trading cases in 2018. The lack of trials or of reported decisions involving the SEC does not, however, mean that the SEC is no longer enforcing laws against insider trading. Rather, the SEC's efforts largely manifest themselves in civil complaints alongside criminal indictments and in settled actions, as well as through investigations that lead to criminal referrals. The SEC's insider trading enforcement efforts in 2018 kept pace with its efforts in prior years.

For the past decade, our Insider Trading Annual Review has tracked sentencing trends in insider trading cases. In 2018, it was difficult to discern a pattern concerning the extent to which cooperators received significantly better treatment than did other convicted insider trading defendants. Until 2014, there was a clear pattern showing that cooperators in insider trading cases benefitted by receiving a sentence of probation or a far reduced prison sentence when compared to convicted defendants who had not cooperated. That calculus changed in 2014 when some defendants started to prevail against the DOJ and SEC in contested matters and the groundbreaking Newman decision led to the reversal of many prior government victories. In 2018, while the data is not as stark as in prior years, the earlier trend of significant credit for cooperation appears to be re-emerging.


"Insider trading" is an ambiguous and overinclusive term. Trading by insiders can be legal or illegal. The legal version occurs when certain corporate insiders, including officers, directors, and employees, buy or sell the stock of their own company without taking advantage of knowledge of material nonpublic information ("MNPI"). Illegal insider trading occurs when a person buys or sells a security while in possession of MNPI that was obtained in violation of a breach of fiduciary duty or similar duty of trust and confidence.

For as long as the crime has existed, it has been plagued by ambiguity. Insider trading is not expressly prohibited by the securities laws. Rather, the prohibition on trading on the basis of MNPI has been crafted by courts through interpretation of the antifraud provisions of the Securities Exchange Act of 1934, including Section 10(b) and Rule 10b-5, and the Securities Act of 1933, including Section 17(a). As a result of the piecemeal judicial crafting of the crime, the standards for determining what constitutes insider trading have not always evolved in a way that establishes bright-line tests.

Since insider trading was first recognized as a violation of the securities laws in 1961, two primary theories have emerged. Under the "classical theory" of insider trading, a corporate insider commits insider trading when he trades on MNPI obtained from his company, in violation of a fiduciary duty to the company and its shareholders to refrain from using corporate information for personal gain. Under the "misappropriation theory," a person who is not a corporate insider commits insider trading when she trades on MNPI that she has misappropriated from a party to whom she owes a fiduciary duty, such as the duty owed by a lawyer to a client.

Under either theory, the law imposes liability for insider trading on any person who obtains MNPI and then trades while in possession of such information in violation of a fiduciary duty or other duty of trust and confidence. Also under either theory, both the "tippers" and the "tippees"—that is, individuals sharing information and those with whom information is shared, respectively—may also be liable for insider trading under certain circumstances.

The circumstances under which tippees can be held liable for insider trading have narrowed and shifted over time. Until 2012, tippees could be liable for insider trading so long as they knew that the information on which they were trading had been obtained in breach of a duty. In 2012, a decision by the United States Court of Appeals for the Second Circuit in SEC v. Obus arguably expanded tipper/tippee liability—at least in SEC civil enforcement actions—to encompass cases where neither the tipper nor tippee had actual knowledge that the inside information was disclosed in breach of a duty. Rather, a tipper's liability could flow from recklessly disregarding the nature of the confidential or nonpublic information, and a tippee's liability could arise in cases where the sophisticated investor tippee should have known that the information was likely disclosed in violation of a duty of confidentiality.

The Obus holding was narrowed in 2014 by the Second Circuit's controversial opinion in United States v. Newman, a landmark case that resulted in numerous insider trading convictions being overturned. In Newman, the Second Circuit held that downstream tippees in insider trading cases brought under Section 10(b) and Rule 10b-5 could be convicted of insider trading only if (1) the tippee knew that the insider or misappropriator had received a personal benefit in exchange for his or her disclosure of the information, and (2) this personal benefit was "objective" and "consequential." To the extent that the government sought to establish a personal benefit to the tipper based on a relationship between the tipper and tippee, Newman held that such an inference can be made only in cases of "meaningfully close personal relationship[s]." The Newman decision not only significantly narrowed the scope of tippee liability, but also left open questions, including what exactly would constitute a personal benefit to the insider or misappropriator.

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Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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