Insider Trading’s Legality Problem

Last year, when the Supreme Court revisited the topic of insider trading in Salman v. United States, scholars rehearsed a familiar debate: Should Congress enact a statute that explicitly defines insider trading? Or should it stick with the status quo, wherein the Court periodically clarifies previous holdings in cases such as Dirks, Chiarella, and O’Hagan? Defenders of the status quo argue that a statutory definition would simply encourage traders to find—and leap through—legal loopholes. Critics respond just as robustly that statutory language provides notice and restrains prosecutorial overreach.

In Insider Trading’s Legality Problem, I explore an additional reason for favoring a statutory approach. Criminal statutes do more than prohibit wrongdoing; they also allow us to differentiate among the variations of given offenses.[1]

Insider trading isn’t merely a civil offense. As in the case of Salman, it often triggers criminal penalties. Criminal law derives its legitimacy in part from the “legality principle,” a set of related rules that demands that criminal laws be duly enacted in advance and in terms specific enough for the average person to understand what is forbidden.

When legislatively enacted statutes conform to the legality principle, they do more than provide adequate warning of what is and is not forbidden. Under the best circumstances, they can improve criminal law’s content, precisely because they permit the legislature to think about a family of crimes holistically and differentiate similar, yet morally distinct, conduct. Through differentiation, we become better at singling out the abstract factors that make some crimes worse than others.

Readers will recall that Salman itself involved the question of whether the government was required to show a pecuniary benefit when a tipper provided material nonpublic information to a trading friend or relative. The Supreme Court clarified in Salman that, at least in the friends and family context, no such benefit was needed. Gifting a friend or relative nonpublic information was conceptually no different from illegally trading on the information and gifting the proceeds.

Salman demonstrates two of the core drawbacks inherent in relying too heavily on the judiciary to articulate criminal prohibitions. First, lawmaking necessarily emerges in a piecemeal fashion. With every new insider trading case that comes before the Court (and the appellate and district courts below), jurists put at rest one set of questions while leaving other questions for another day.

Second, although a common law approach can effectively prohibit behavior, it does not easily differentiate among variations in behavior. A hallmark of the typical state criminal statute is its gradation. Those familiar with the Model Penal Code and state criminal codes know that state legislatures often subdivide crimes into first, second, and third degrees and more. Gradation thus enables a society to learn – through an iterative and democratic process – that some versions of a given offense are worse than others. Concededly, post-conviction sentencing also parses distinctions in offenses (and this is the approach favored by the federal criminal code), but sentencing does not and cannot perform the same function as a statute that subdivides an offense.

What might insider trading law look like were Congress to define and subdivide it? Insider Trading’s Legality Problem provides several suggestions. The core aim, I argue, should be the differentiation of insider trading according to degrees of harm and moral wrongfulness. Congress could tie lesser and more serious liability to an offender’s mens rea (knowledge versus purpose), to the qualitative or quantitative nature of harm caused (direct versus tertiary violations of duty), or to some combination of the two. For example, one could imagine a three-tiered statute that imposed the greatest punishment on serial traders or ringleaders of insider trading schemes (Aggravated Insider Trading); that treated as serious, but less condemnable, those cases that involved knowing or purposeful violations of fiduciary duty (Insider Trading); and that reserved for lesser punishment those remote tippee cases in which the trader ignored a substantial and unjustifiable risk that the information was obtained in violation of a fiduciary duty (Reckless Trading).

The distinctions I offer in the preceding paragraph are intended solely as examples. One can imagine other ways to subdivide insider trading. And one might rely on additional factors, such as the status of the tipper (whether she was a CEO or other high-level officer who exploited her corporation) or the status of the tippee. How one resolves these questions is less important than the process that would induce members of Congress to openly debate them.

It seems unlikely that Salman will be the Court’s final word on insider trading, particularly in regard to criminal prosecutions. If Congress does eventually decide to enact a specific insider trading statute, it should use its lawmaking power not simply to prohibit certain conduct, but also to articulate the factors that make some variants of that conduct worse than others. That is, after all, one of the potential benefits of having a statutory criminal code, and it would be one of the many benefits of addressing insider trading’s legality problem.


[1] I expand upon this argument in regard to fraud and other federal crimes in Sorting Out White-Collar Crime, 97 Tex. L. Rev. __ (forthcoming 2019).

This post comes to us from Professor Miriam H. Baer at Brooklyn Law School. It is based on her recent paper, “Insider Trading’s Legality Problem,” available here.