What is "insider trading"? While the term conjures images of 1980s corporate raiders like Michael Milken, Ivan Boesky, and the fictional Gordon Gekko, it may surprise many to learn there is no actual law on the books defining what it is and when it is illegal.
Instead, for more than 100 years, the United States has used a patchwork tapestry of case law, regulatory guidance, and anti-fraud statutes to prohibit trading on material, non-public information. Courts, prosecutors and regulators essentially adopted a "we'll know it when we see it" test − an approach led to ad hoc and uneven enforcement. It also created confusion about: who was an insider, when was information material, when was information non-public, and when was it illegal to give someone else a tip about inside information if the tipper did not profit themselves?
Lawmakers made strides towards clarity on December 5, 2019, when the US House of Representatives, by an overwhelming and bipartisan margin, passed a bill to formally codify the offense of insider trading.1 The legislation, named the Insider Trading Prohibition Act (HR 2534), would explicitly bar corporate insiders from trading on material, non-public information, an offense that, until now, was defined in case law and prosecuted via other anti-fraud laws, such as securities fraud, mail fraud, and wire fraud.2 The legislation's goal is to codify the overarching principles on insider trading that already exist in case law, while also clarifying certain ambiguities that have created more controversial results.3 In the final analysis, the bill would expand liability for insider trading. It defines and prohibits insider trading and clarifies that a tipper can be guilty of the offense even without a payment or promised personal benefit from the trade.
A broad definition
The bill defines insider trading broadly to include trades made based on information where the person knows, or "recklessly disregards," that such information was "obtained wrongfully," such as through theft or bribery, violation of federal data protection laws, or a "breach of any fiduciary duty, a breach of a confidentiality agreement, a breach of contract, or a breach of any other personal or other relationship of trust and confidence."4 The bill prohibits insiders (commonly known as "tippers") from communicating such information if it is "reasonably foreseeable" that the recipient will trade on that information or forward it to those who will.5
Legislation would overturn Newman
The knowledge or culpable mental state requirement for recipients of insider information (commonly known as "tippees") is also eased under the bill to formally abrogate the ruling in United States v. Newman, where the Second Circuit held that a tippee must have actual knowledge that the tipper received a specific personal benefit from passing along the inside information.6 The Newman holding made it harder for the government to successfully prosecute insider trading cases.7 The Insider Trading Prohibition Act legislatively overturns Newman and states that a person need not "know the specific means by which the [nonpublic] information was obtained or communicated, or whether any personal benefit was paid or promised by or to any person in the chain of communication, so long as the person trading while in the possession of such information . . . was aware, consciously avoided being aware, or recklessly disregarded that that such information was wrongfully obtained or communicated."8 In other words, there is now a "bright line" rule that tippees cannot trade on material, non-public information if they believe or have reason to believe it was improperly obtained by the tipper.
If passed by the Senate before the 116th Congress concludes on January 3, 2021, and if signed by President Trump, the Insider Trading Prohibition Act will provide more clarity to courts and market participants in this area. It remains to be seen how regulators, prosecutors, and courts will adapt to the new "insider trading" landscape if this becomes law.
1 H. Rep. No. 116-219, at 3 (2019); see also "House Passes Financial Services Bill to Explicitly Ban Insider Trading," US House Committee on Financial Services press release, https://financialservices.house.gov/news/documentsingle.aspx?DocumentID=404893 (December 5, 2019).
2 For example, Rule 10b-5 prohibits the use, "in connection with the sale or purchase of any security," of "any device, scheme or artifice to defraud," or any "act, practice, or course of business which operates . . . as a fraud or deceit." 17 C.F.R. § 240.10b-5.
3 "Himes Bipartisan Insider Trading Bill Passes House," US Congressman Jim Himes press release, https://himes.house.gov/media-center/press-releases/himes-bipartisan-insider-trading-bill-passes-house (December 5, 2019).
4 H.R. 2534, 116th Cong. § 2 (2019).
6 See H. Rep. No. 116-219, at 3 (2019) (citing United States v. Newman, 773 F.3d 438 (2d Cir. 2014)).
8 H.R. 2534, 116th Cong. § 2 (2019).
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