Last week, a large, bipartisan majority of the US House of Representatives passed a bill that would explicitly codify a ban on insider trading, with 410 votes in favor of the bill and 13 against (12 Republicans and one independent). The bill, the Insider Trading Prohibition Act, was sponsored by Congressman Jim Himes (D-Conn.) and is one of several pieces of legislation that was initially proposed after the Second Circuit Court of Appeals' 2014 insider trading decision in United States v. Newman.1 The bill must be passed by the Senate and signed by the President before it could become law.
Insider trading is neither explicitly defined nor prohibited by any federal statute. Currently, the ban on insider trading is primarily based on Section 10(b) of the Securities Exchange Act2 and SEC Rule 10b-5.3 Section 10(b) broadly prohibits "any manipulative or deceptive device or contrivance" in connection with securities transactions,4 while Rule 10b-5 prohibits, among other things, "any device, scheme, or artifice to defraud" in connection with securities transactions.5 Courts have interpreted these provisions to prohibit trading on the basis of material, nonpublic information under certain conditions.6
The Insider Trading Prohibition Act, as passed by the House, largely adopts and incorporates concepts and theories of liability from prior insider trading caselaw. As currently drafted, the bill only covers transactions involving securities, security-based swaps, and security-based swap agreements.7 Section (a) of the bill prohibits buying or selling covered investments "while aware of material, nonpublic information relating to [a security], or any nonpublic information... that has, or would reasonably be expected to have, a material effect on the market price of [the security]."8 However, such trading is only prohibited if the trading person "knows, or recklessly disregards, that such information has been obtained wrongfully," or that the transaction "would constitute a wrongful use of such information."9
Section (b) then prohibits "wrongful communication" of material, nonpublic information to another person, commonly referred to as "tipping."10 If a person is prohibited from trading under Section (a), then Section (b) prohibits that person (a "tipper") from communicating material, nonpublic information to another person (a "tippee") if it is "reasonably foreseeable" that the tippee will engage in a securities transaction based on the information.11 Similarly, tipping is also prohibited if the first tippee provides the information to a second tippee who trades, as long as that trading was reasonably foreseeable.12
For the purposes of the prohibition under Section (a), the key question is whether information has been "obtained wrongfully" or whether the use of information would be "wrongful."13 The bill explains that the use or communication of information is "wrongful" only if it would constitute:
(A) theft, bribery, misrepresentation, or espionage (through electronic or other means);
(B) a violation of any Federal law protecting computer data or the intellectual property or privacy of computer users;
(C) conversion, misappropriation, or other unauthorized and deceptive taking of such information; or
(D) a breach of any fiduciary duty, a breach of a confidentiality agreement, a breach of contract, a breach of any code of conduct or ethics policy, or a breach of any other personal or other relationship of trust and confidence for a direct or indirect personal benefit (including pecuniary gain, reputational benefit, or a gift of confidential information to a trading relative or friend).14
Finally, under the bill a person may be liable as long as the person engaging in trading "was aware, consciously avoided being aware, or recklessly disregarded that [the] information was wrongfully obtained, improperly used, or wrongfully communicated," even if the trading person was not aware of the specific details.15 The bill further provides for some exceptions and affirmative defenses to liability.16 The bill provides that employers would not be liable merely for employing a person who violates the law, and that a person is not liable for trading at the direction and for the benefit of a person whose trading would not violate the law.17 The bill also gives the SEC the power to create exemptions to the bill's prohibitions, and provides that the law shall not apply to transactions permitted under Rule 10b-5-1.18
The bill received bipartisan support in the House after Congressman Patrick McHenry (R-N.C.), the Ranking Member of the House Financial Services Committee, inserted an amendment to the bill which, among other things, added language requiring evidence of a "personal benefit" to prove certain theories of liability under the bill.19 The exact requirements of the personal benefit test have been intensely litigated since the Second Circuit's decision in Newman, including more recently in the Supreme Court's decision in Salman v. United States20 and the Second Circuit's recent decision in United States v. Martoma.21 Though this amendment passed, the bill does not include another Republican priority: that any statute passed by Congress be "the exclusive insider trading law of the land."22
The bill cleared an important hurdle by passing the House, but might still change if the bill is considered by the Senate. The McHenry amendment inserting a personal benefit requirement suggests that there may be further debate about which aspects of existing insider trading caselaw should be codified by statute. The bill as passed by the House already incorporates principles from prior insider trading cases, but in some instances adopts standards and theories that are not settled under existing law. For example, the bill provides that a person can be liable for trading on stolen information, a point that courts have only partially accepted when the manner of theft was "deceptive."23 The bill further would prohibit trading or tipping if such action would violate a confidentiality agreement (even in the absence of an express agreement not to trade)—this theory of liability was a main point of contention in the SEC's 2008 case against Mark Cuban, which was rejected by a jury.
Any changes to the Insider Trading Prohibition Act could have implications for market actors and the scope of insider trading liability if the bill becomes law. As the Second Circuit's decision in Martoma demonstrates, even an ambiguously placed comma can have implications for whether conduct is unlawful insider trading.24 WilmerHale will keep up to date with the legislation, and provide information on important developments if the bill continues to move forward.
1. United States v. Newman, 773 F.3d 438 (2d Cir. 2014). In Newman, the Second Circuit overturned the conviction of two portfolio managers who were charged as part of a tipping ring. The Second Circuit vacated the defendants' convictions, holding that there must be proof that the tippee was aware of the personal benefit received by the tipper in exchange for divulging material, nonpublic information. Id. at 447-48. The court also provided further guidance about what constitutes a "personal benefit" in tipping cases. Id. at 452-53.
2. 15 USC. § 78j(b) (2018).
3. 17 C.F.R. § 240.10b-5 (2019).
4. 15 USC. § 78j(b).
5. 17 C.F.R. § 240.10b-5(a).
6. See generally, e.g., Chiarella v. United States, 445 US 222 (1980); United States v. O'Hagan, 521 US 642 (1997).
7. See Insider Trading Prohibition Act, H.R. 2534 116th Cong. §§ 16A(a)-(b) (2019). The bill does not address non-securities, such as commodities, which are primarily regulated by the Commodity Futures Trading Commission (CFTC). The Dodd-Frank Act gave the CFTC anti-fraud authority akin to Section 10(b) of the Securities Exchange Act, pursuant to which the CFTC adopted an anti-fraud rule similar to SEC Rule 10b-5. 17 C.F.R. § 180.1 (2019). The CFTC has invoked this rule to pursue insider-trading-type cases in certain contexts. In re Motazedi, CFTC Dkt. No. 16-02 (Dec. 2, 2015).
8. H.R. 2534 § 16A(a).
10. Id. § 16A(b).
11. Id. § 16A(b)(1)-(2).
13. Id. § 16A(a).
14. Id. § 16A(c)(1).
15. Id. § 16A(c)(2).
16. Id. §§ 16A(d)-(e).
18. Id. § 16A(e).
19. Press Release, Financial Services Committee Republicans, McHenry Amendment Accepted to Improve Insider Trading Bill, Protect Good Faith Traders (Dec. 5, 2019).
20. Salman v. United States, 137 S. Ct. 420 (2016).
21. United States v. Martoma, 894 F.3d 64 (2d Cir. 2017).
22. Press Release, Financial Services Committee Republicans, McHenry Amendment Accepted to Improve Insider Trading Bill, Protect Good Faith Traders (Dec. 5, 2019). In recent years, in order to circumvent unfavorable caselaw imposing stricter requirements for Section 10(b) and Rule 10b-5 liability, some prosecutors have begun charging insider trading cases under 18 USC. § 1348 (2018). For a discussion of this growing trend and an analysis of the different elements of Section 1348, see a prior WilmerHale client alert: Mark D. Cahn, Elizabeth L. Mitchell & Brett T. Atanasio, Better The Devil You Know? Tipping Liability, Martoma and the Rise of 18 USC. § 1348, WilmerHale (May 14, 2019).
23. SEC v. Dorozhko, 574 F.3d 42, 51 (2d Cir. 2009).
24. Martoma, 894 F.3d at 74.
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