On Dec. 5, 2019, the U.S. House of Representatives passed the Insider Trading Prohibition Act (ITPA) by a vote of 410-13. If passed by the Senate and signed into law by the President, the bill will establish the first statutory prohibition on insider trading and codify insider trading principles historically developed by the courts. The bipartisan passage of the bill indicates a strong intent on both sides of the aisle to explicitly ban insider trading.
The ITPA amends the Securities and Exchange Act of 1934, 15 U.S. Code §§ 78a et seq., to include a new section that expressly defines the elements of insider trading. The bill would make it unlawful for a person to buy, sell, enter into, or cause the purchase or sale of a security (including security-based swaps) while aware of material, nonpublic information (MNPI) relating to the security or any nonpublic information, from whatever source, that has, or would reasonably be expected to have, a material effect on the market price of the security, if the person knows, or recklessly disregards, that the information was obtained wrongfully, or that the purchase or sale would be a wrongful use of the information.
Whereas the initial draft of the bill did not include the personal benefit requirement, a last-minute amendment added language that requires MNPI to be given “for a direct or indirect personal benefit (including pecuniary gain, reputational benefit, or a gift of confidential information to a trading relative or friend).” The ITPA codifies case law on the personal benefit aspect of insider trading that has generated significant confusion and does not appear to bring further clarity to the law.
The bill also prohibits the wrongful communication of MNPI where a person whose own purchase or sale of a security would violate the general ban on insider trading wrongfully communicates MNPI to another person who (1) buys or sells a security to which the communication relates, or (2) communicates the information to another person who makes or causes a purchase or sale of a security while aware of MNPI relating to the security, and in each case the purchase or sale while aware of MNPI relating to the security was reasonably foreseeable. The ITPA legislates the prohibition of tipping, which until now has been a creation of the case law, and employs a “reasonable foreseeable” standard, codifying the standard used in case law.
The bill provides that trading while aware of MNPI or communicating MNPI would be wrongful only if such act constitutes, directly or indirectly, (1) theft, bribery, misrepresentation or espionage; (2) a violation of any federal laws protecting computer data, intellectual property or computer privacy; (3) unauthorized and deceptive takings; or (4) breach of confidentiality obligations or relationships or fiduciary duties for a direct or indirect personal benefit (including pecuniary gain, reputational benefit or a gift of confidential information to a trading relative or friend).
The ITPA codifies the SEC’s position that insider trading arises from a breach of confidentiality (Rule 10b5-2), even without an agreement not to trade, but also adds breach of contract, although it is not clear what other types of breach are envisioned. The inclusion of a personal relationship or other relationships of trust and confidence reflects elements of Rule 10b5-2, under which the breach of duty of trust and confidence is the major heading, with minor headings that include breaches of duty of confidentiality and personal relationships. The bill codifies the Second Circuit decision in SEC v. Dorozhko (2d. Cir 2009) that insider trading can arise on the basis of hacking but also goes beyond Dorozhko by including theft and even absent deception.
The bill provides that it is not necessary that a person trading while aware of MNPI or communicating MNPI knows specifically how MNPI was obtained or communicated, or whether any personal benefit was paid or promised, provided that such person was aware, consciously avoided being aware, or recklessly disregarded that MNPI was wrongfully obtained or improperly used or communicated. The ITPA appears to reverse US v. Newman (2d Cir. 2014), which required that the tippee had to be aware of the misappropriation or other breach by the original tipper.
With respect to derivative liability, except as provided in Section 20(a) of the Exchange Act, which imposes vicarious liability for securities fraud on controlling persons for the conduct of controlled actors unless the controlling person acted in good faith and did not induce the controlled actors’ conduct, the bill provides that no controlling person or employer who did not participate in or induce acts that would violate the ban on insider trading will be liable solely because such person controls or employs a person who violated the insider trading ban. This statute does not appear to add much to Section 20(a) of the Exchange Act and it is unclear what issue or uncertainty this section was intended to address.
The bill further provides that the SEC may grant exemptions from the new insider trading ban and that the prohibitions do not apply to persons who enter into Exchange Act Rule 10b5-1 trading plans or any successor regulation. In addition, the bill requires the SEC to review and make conforming amendments to Rule 10b5-1 within six months after enactment of the Insider Trading Prohibition Act. With respect to directed trading, the bill does not apply to persons who act at the specific direction, and solely for the account, of another person whose securities trading or communication of MNPI relating to the security is lawful under the bill.
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