A report from an eight-member task force on insider trading, led by former S.D.N.Y. prosecutor Preet Bharara, argues for an insider trading statute that defines terms and eliminates the personal benefit test.
The Bharara Task Force on Insider Trading released a report calling for legislative reform that simplifies, clarifies, and modernizes the law on insider trading. Former New York federal prosecutor Preet Bharara, current S.D.N.Y. judge Jed Rakoff, and the six other task force members unanimously agreed to the need for an insider trading statute that clearly defines terms, substitutes a broader "wrongfully obtained" standard for the current concepts of fraud and deception, and eliminates the requirement of Dirks v. SEC (U.S. 1983) that a tipper shared information in exchange for a personal benefit.
Bharara announced the formation of the task force in a 2018 New York Times op-ed, coauthored with SEC Commissioner Robert Jackson, that lamented the "haziness" of insider trading law. Jackson is not a member of the task force, which includes, in addition to Bharara and Rakoff, former prosecutors Joon H. Kim (vice-chair), Katherine R. Goldstein, and Melinda Haag; Columbia law professor John C. Coffee, Jr.; former SEC Commissioner Joseph A. Grundfest; and former chief counsel for the SEC Enforcement Division Joan E. McKown. Several of the former prosecutors and SEC officials now practice criminal defense or counsel corporate clients on regulatory compliance. The preponderance of New York-based officials and specifically those associated with the Southern District reflects that court’s specialty in insider trading cases, in turn a function of its jurisdiction over the country’s financial center.
The task force also received and considered input from FINRA, the National Association of Criminal Defense Lawyers, the U.S. Chamber Institute for Legal Reform, and several law professors. The report contains the task force’s unanimous conclusions.
Need for reform. The report summarizes the evolution of insider trading law from 1909 through the development in the 1980s of the classical and misappropriation theories and the Dirks decision, which introduced the personal benefit test. More recently, U.S. v. Newman (2d Cir. 2014), Salman v. U.S. (U.S. 2016), and U.S. v. Martoma (2d Cir. 2017) created an "open question" as to the relevant standard for insider trading liability. And last month the Second Circuit held that the Dirks test does not apply to insider trading prosecutions under the criminal code’s Title 18.
In the task force’s view, the House’s recent passage of the Insider Trading Prohibition Act by a vote of 410-13 reflects broad consensus around the need for reform. The report credits the bill with improving insider trading law in several respects, most importantly by extending the universe of actionable tipping and trading to information acquired "wrongfully" and not just by fraud or deception. However, the bill as passed reintroduced the personal benefit standard that is the source of much of the current ambiguity around insider trading liability, the task force writes. Any statute should eliminate that standard or prosecutors will elect alternative statutes that do not require such a showing, like Title 18.
After concluding that reform is not only needed but overdue, the task force determined that legislation would be preferable to SEC rulemaking. While the SEC would be bound by Supreme Court precedent, Congress would have a clean slate to write a new law from scratch—and that new law would carry "the imprimatur of democratic legitimacy."
Four principles. The report sets out four principles for a new insider trading statute. First, because in the task force’s view uncertainty and complexity are driving the need for reform, legislation should focus on clarity and simplicity. The law should have plain language and structure, define any terms that are open to interpretation, and keep cross-references to a minimum.
The second principle focuses on a wrongfulness standard rather than the current concepts of deception, fraud, and manipulation stemming from Exchange Act Section 10(b) and Rule 10b-5. Basing the new standard on information "wrongfully" obtained or communicated would eliminate the distinction between the classical and misappropriation theories of insider trading and would clearly delineate the separate culpability of the tipper and tippee. "Wrongfulness" should be defined to include deception and misrepresentation; breaches of duties and agreements to keep information confidential; and theft, misappropriation, and embezzlement. Recognizing the fact pattern in Dirks, the task force considered including an exception for those who disclose information for the purposes of reporting misconduct, but decided that modern whistleblower protections make this unnecessary.
Third, the task force calls for eliminating the Dirks personal benefit test. While the test originated to distinguish a self-serving use of information from a legitimate business use, it has since generated confusion and uncertainty. In the last five years, post-Newman, juries in different cases in the Second Circuit have been instructed differently about whether the personal benefit test requires showing a pecuniary gain. The personal benefit requirement also implies that it is permissible to make a pure gift of material information so that the tippee can trade on it. The task force acknowledges the existence of other fraud-based statutes that do not require a personal benefit. While the existence of these other statutes will still leave some uncertainty, the task force believes that the new insider trading statute would become the principle means of prosecuting insider trading, as Section 10(b) has been.
The last principle is that a new statute should clearly and explicitly define the state of mind required for criminal and civil insider trading (the task force recommends willfulness and recklessness, respectively). The report’s model language proposes a fine for criminal insider trading of up to $5 million for individuals and $25 million for entities. The law should also make clear that for criminal liability, a tippee should know and have at least recklessly disregarded the fact that the tipper obtained or communicated the information wrongfully.
What didn’t make it. The task force also considered and ultimately rejected several other ideas for reform. The group considered replacing the personal benefit test with a "personal advantage" or "personal purpose" test before deciding that such a standard would likely be unworkable. Members also discussed replacing the personal benefit requirement with a rebuttable presumption that any tip would result in a violation of Rule 10b-5. While this would fix the problem of criminalizing disclosures with a valid purpose, like whistleblowing, it would unfairly shift the burden to defendants, contravene general criminal law concepts, and generate new uncertainty as to what purposes would be permissible. Finally, the task force rejected a parity-of-information approach (i.e., a counterparty is entitled to all the information known by the insider) for being too likely to disincentivize market participants from pursuing valid, innovative strategies and research.
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