Expanding Insider Trading? House of Representatives Passes the "Insider Trading Prohibition Act" With Bi-partisan Approval
On December 5, 2019, by an overwhelming 410-13 majority, the U.S. House of Representatives passed the "Insider Trading Prohibition Act" (the "ITPA" or the “Act”). While still subject to Senate approval, the passage of the ITPA in the House is significant because it shows wide, bi-partisan approval for codifying – and potentially broadening – the prohibitions against insider trading. The ITPA would bring clarity to certain aspects of insider trading law, but it would also expand the current prohibitions on insider trading, and potentially broaden the circumstances in which DOJ and the SEC may prosecute insider trading.
Since the 1960s, the U.S. Securities and Exchange Commission (“SEC”) and federal prosecutors have used Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 to bring insider trading cases.1 While these provisions generally prohibit fraud and deception in connection with the purchase or sale of a security, they do not explicitly prohibit (or even define) insider trading. Instead, over the last 50 years, a complex body of case law has developed concerning when and how trading while in possession of material, non-public information (“MNPI”) becomes fraudulent. For example, in 2014, in United States v. Newman,2 the U.S. Court of Appeals for the Second Circuit narrowed the circumstances in which a “tippee” – one who receives MNPI from another person and then trades on it – could be criminally liable, resulting in the vacatur of multiple insider-trading convictions. But two years later, in 2016, in Salman v. United States, the Supreme Court rejected Newman in part.3 And in 2017 and 2018, the Second Circuit then issued two opinions – in the same case – attempting to reconcile Newman and Salman.4
The ITPA attempts to clarify the law, and potentially broadens the circumstances in which DOJ and the SEC may prosecute insider trading.
As discussed below, the Act prohibits both the (i) buying and selling of securities while in possession of MNPI and (ii) the “wrongful communicat[ion]” of MNPI.
First, the Act makes it unlawful to buy or sell a security (to include certain swaps and swap agreements) “while aware of material non-public information . . . if such person knows, or recklessly disregards, that such information has been obtained wrongfully, or that such purchase or sale would constitute a wrongful use of such information.”
Second, the Act makes it unlawful to “wrongfully . . . communicate material non-public information relating to [a] security . . . to any other person” where it is “reasonably foreseeable” that the “other person” will either purchase or sell a security based on the information or will “communicate the information to another person” who trades “while aware of such information.”
The linchpin of both prohibitions is the term “wrongful.” A purchase or sale is prohibited only where the person knows the MNPI “has been obtained wrongfully” or that the purchase or sale would be a “wrongful use” of MNPI. And only a “wrongful communicat[ion]” of MNPI is prohibited.
Helpfully, the ITPA enumerates that a purchase or sale, or a communication of information, is “wrongful” when “the information has been obtained by,”
“theft, bribery, or misrepresentation, or espionage (through electronic or other means);”
“a violation of any Federal law protecting computer data or the intellectual property or privacy of computer users;”
“conversion, misappropriation, or other unauthorized or deceptive taking of such information;” or
“breach of any fiduciary duty, a breach of a confidentiality agreement, a breach of a 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).”
A few aspects of the ITPA are worth noting.
First, the ITPA’s focus on the “wrongful” obtaining and communication of information potentially broadens the types of conduct that may result in insider trading charges. Currently, the insider trading jurisprudence under Section 10(b) is predicated upon a breach of a duty, either to the shareholders of the corporation5 or to the source of the information,6 or deception. The last bullet point above essentially codifies this case law. The Act, however, makes clear that information can also be “wrongfully” obtained by simple “theft,” “bribery,” “espionage,” or violations of intellectual property or computer hacking laws, regardless of whether that conduct involved deception or the breach of a duty. Cf. SEC v. Dorozhko, 574 F.3d 42, 50-51 (2d Cir. 2009) (indicating that Section 10(b) would not prohibit trading in MNPI obtained by “mere theft”).
Second, the ITPA also arguably expands liability for “tippers” of inside information, making it unlawful to communicate MNPI when it is “reasonably foreseeable” to the tipper that the tippee will trade on it. This too arguably expands the scope of tipper liability; currently, tippers are liable only if they disclose information “intending” or with the “expectation” that the recipient would trade on it.7
While there is no timetable for the Senate to review the ITPA, the proposed statute had strong bi-partisan support in the House, despite the currently highly partisan political climate. The ITPA would bring clarity to certain aspects of insider trading law, but it would also expand the current prohibitions on insider trading. Our team of former prosecutors and SEC officials has wide experience in insider trading matters and is available to discuss the ITPA or any other insider trading issues that may arise.
1 See, e.g., SEC v. Texas Gulf Sulphur, 401 F.2d 833 (2d Cir. 1968).
2 773 F.3d 438 (2d Cir. 2014).
3 137 S. Ct. 420, 428 (2016).
4 United States v. Martoma, 894 F.3d 64 (2d Cir. 2018) (amending and superseding United States v. Martoma, 869 F.3d 58 (2d Cir. 2017)).
5 See Chiarella v. United States, 445 U.S. 222, 228 (1980).
6 See United States v. O’Hagan, 521 U.S. 642, 653 (1997).
7 See, e.g., United States v. Klein, 913 F.3d 73, 78 (2d Cir. 2019) (explaining, in Section 10(b) insider trading case, that “[t]he critical question regards the tipper's purpose: did the tipper share the material non-public information with the tippee intending that the tippee use the information to improperly trade in securities?” (emphasis added)).
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