In response to accusations Friday of trading on non-public information about the coronavirus, Senator Richard Burr of North Carolina asserted independent and lawful grounds for unloading between $628,000 and $1.72 million worth of stock. “I relied solely on public news reports to guide my decision regarding the sale of stocks on February 13,” he said. “Specifically, I closely followed CNBC’s daily health and science reporting out of its Asia bureaus at that time.”[1]

While some people doubted the veracity of Burr’s purportedly lawful trading motives, others denied their significance. Journalist Kurt Eichenwald, for example tweeted:

If you sold after the briefing, this is irrelevant. You had access to inside information. You’re forbidden by law, even if public info could justify a sale, from making stock trades until public disclosure of non-public info. Only 1 fact matters: Did you sell after the briefing?[2]

Senator Burr believes that he can lawfully trade, despite access to non-public information, if he would have traded anyway. Eichenwald thinks Burr was required to abstain from trading, even if it curtailed otherwise lawful stock sales. Who is right?

Scholars of insider trading will immediately recognize this as a recapitulation of a 30-year old debate known as the “mental causation” debate, the “use/possession” debate, or the “use/awareness debate.” It involves the issue of whether a trader with both lawful and unlawful reasons for trading violates the law. Should the law consider just the lawful trading rationales and not the unlawful ones or focus instead on the trader’s having proscribed information despite honest and independent reasons for trading?

This debate emerged alongside a three-way split among U.S. appeals courts in the 1990s. Broadly speaking, the Second Circuit endorsed Burr’s preferred legal theory,[3] the Ninth Circuit endorsed Eichenwald’s,[4] and the Eleventh Circuit came out in between.[5] Dozens of law review articles have debated these different approaches, but none has proven fully persuasive. The SEC purported to have decided the matter through rulemaking in 2000,[6] but courts continued to apply the three conflicting approaches.[7]

One reason that no legal standard has gained universal acceptance is that each advances a worthy policy consideration – while ignoring another. The Second Circuit recognized that positions of trust, whether CEO or senator, create responsibilities; going to confidential board meetings or intelligence briefings means that you can’t just do whatever you want afterward. But the Second Circuit ignored any concern for the trader-defendant’s legitimate reasons for trading. Sometimes an executive desperately needs cash, and corporate stock is all she has; sometimes a hedge fund undertakes months of lawful planning and research, and barring them from trading because they acquire a sliver of proscribed information seems unjustified. The Ninth Circuit, meanwhile, tolerates trading on inside information that is utterly incidental, but the court is insufficiently concerned with pretextual justifications and imposes no special responsibility on insiders in positions of trust.

These two approaches clash because one aims to protect otherwise lawful trades (despite inside information), and the other is designed to prohibit insider trading (despite lawful reasons to trade). The optimal rule would incorporate and balance both goals.

In a recent article, I propose such a rule and show how it does as well or better than each existing legal standard in achieving the various policy goals inherent in insider trading law. I also relate this debate to the broader jurisprudence of mixed-motives.

Senator Burr’s fate is currently uncertain in part because we don’t know which court’s law would govern the matter. If he were charged with insider trading, he might be in peril in the Second Circuit but not in the Ninth Circuit.[8]  His fate would also be uncertain under my proposed standard, but for what I believe are more valid reasons. The outcome would depend on all the relevant facts – such as how compelling  the non-public information he received was and how it compared in magnitude with the public information. An advantage of my test is that it  incorporates information about both purported trading motives, rather than just one. That makes the test more likely to produce the correct and legitimate  result – which matters because of how much turns on this question.[9]

Rule 10b-5 has been interpreted as barring insider trading,[10] with criminal penalties of up to 20 years imprisonment.[11] It is common for defendants in insider trading cases to argue that their trades were motivated at least in part by lawful trading objectives. The 2012 STOCK Act clarified that insider trading law applies to senators and other government officials, who may also lose their office if found to have violated ethical standards.[12] The current controversy is significant not only for how high it reaches in the federal government, but also for how many people it involves – so far. In addition to Senator Burr, at least four senators are accused of selling their shares based on non-public government information about COVID-19. At a time of acute national anxiety, the stakes are high indeed.

ENDNOTES

[1] https://twitter.com/SenatorBurr/status/1241008837479542786

[2] https://twitter.com/kurteichenwald/status/1241022844823355392

[3]  United States v. Teicher, 987 F.2d 112 (2d Cir. 1993).

[4]  United States v. Smith, 155 F.3d 1051 (9th Cir. 1998).

[5]  SEC v. Adler, 137 F.3d 1325 (11th Cir. 1998).

[6]  Securities Act Release No. 33-7881, Exchange Act Release No. 34-43154, Fed. Sec. L. Rep. (CCH) 86,319 (2000). The SEC’s rule is distinct, but can be construed as endorsing the Second Circuit’s approach.

[7] E.g., United States v. Anderson, 533 F.3d 623 (8th Cir. 2008)(applying Smith); United States v. Royer, F.3d 886, 889 n. 12 (2d Cir. 2008) (applying Teicher);  U.S. v. Naccio, 2006 WL 8439745 (D. Co. 2006) (applying Teicher); United States v. Causey, 2005 WL 3560632 at pp. *4–*5 (S.D.Tex. 2005) (applying Adler); United States v. Jun Ying, No. 1:18-CR-74-AT, 2018 WL 6322308, at *5 (N.D. Ga. Dec. 4, 2018) (applying Adler).

[8] In the Ninth Circuit, Burr would prevail unless a factfinder concluded his CNBC story was a mere pretext. In the Second Circuit, Burr could be convicted even if the factfinder believed his CNBC story.

[9] For the record, I predict that my test would convict Senator Burr, given the events that have been widely reported; the confidential information he learned in government briefings likely dwarfed in importance anything he learned from CNBC and other public sources; Burr’s statements to attendees of a luncheon imply that he took his government-derived information quite seriously. https://www.propublica.org/article/senator-dumped-up-to-1-7-million-of-stock-after-reassuring-public-about-coronavirus-preparedness  But actually predicting the legal result would require knowing all the relevant facts, and the factfinder’s assessment of them.

[10] Salman v. United States, 137 S. Ct. 420, 427–28 (2016).

[11] 15 U.S.C. § 78ff(a)

[12] https://www.burr.senate.gov/imo/media/doc/Ethics%20Review%20Request%20March%2020%202020.pdf (Burr’s letter, requesting a Senate Ethics Committee investigation of himself).

This post comes to us from Professor Andrew Verstein at Wake Forest University Law School. It is based on his recent article, “Mixed Motives Insider Trading,” available here.