The U.S. insider trading framework is a mess. Principles apply that are inconsistent with one another and that treat similarly situated persons in a disparate manner. In my 2021 book and a forthcoming book chapter, I argue that, rather than piecemeal changes, the U.S. insider trading regimen should be revised to comport with concepts of fairness and to align with the framework of other developed markets.
The key undoing of the U.S. insider trading framework has been the Supreme Court’s rejection of the parity of information and access approaches embraced by lower federal courts, as exemplified by the Second Circuit’s decision in Texas Gulf Sulphur.1 These approaches are implemented today by developed securities markets outside of this country.2
In defining the contours of illegal insider trading under Section 10(b) of the Securities Exchange Act, the Supreme Court has opted for an approach premised on a fiduciary relationship or a relationship of trust and confidence.3 This foundation leads, for example, to the following troubling results: First, an individual is liable only if he or she tips material nonpublic information with the motivation to financially benefit or provide a gift to the recipient. Consequently, if the requisite motivation is lacking, even reckless tippers incur no liability under Section 10(b).4 Second, because the tippee’s liability under Supreme Court jurisprudence is derivative of the tipper’s misconduct, a tippee who receives material nonpublic information from a careless tipper can legally trade under Section 10(b) – even when such tippee knows that the information is material and nonpublic as well as from a reputable inside source.5 Third, one who misappropriates material nonpublic information in breach of a duty to the source of the information avoids Section 10(b) liability by timely and adequately disclosing to such source that he or she intends to trade the subject securities.6
Faced with this insider trading framework, the SEC has sought to provide a more rigorous approach but has created even more inconsistencies and inequitable consequences. First, displeased with the Supreme Court’s restrictive approach in Chiarella, the SEC promulgated Rule 14e-3, which adheres to a broad parity of information approach. Applying solely to tender offers, the consequence is that one’s entitlement to keep trading profits legally or be sent to the slammer may hinge on whether a corporate transaction takes the form of a merger or a tender offer. And, not surprisingly, when engaging in these trades, the subject trader may be utterly unaware of whether the material nonpublic information that is the basis for such trades relates to a prospective merger, tender offer, or other form of acquisition. To treat similarly situated actors in such a disparate manner is illogical and contrary to fundamental notions of fairness.
Second, faced with insiders tipping financial analysts and other market professionals, the SEC sought to rein in this conduct by alleging that such tipping was proscribed under Section 10(b) pursuant to the Dirks decision.7 Meeting with minimal success, the SEC abandoned this approach when it adopted Regulation FD, which generally prohibits selective disclosure by media spokespersons and other specified persons to financial analysts, market professionals, and shareholders. Thus, the SEC, in part, sought to overrule the effect of a Supreme Court decision. However, Regulation FD has gaps in coverage, is not an antifraud provision, and does not provide aggrieved investors with a private remedy.8
Third, the SEC has extended the reach of the misappropriation theory by adopting Rule 10b5-2, which, among other provisions, provides that an oral or written nondisclosure agreement triggers Section 10(b) liability if one trades in breach of such an agreement. Clearly, in a business setting, parties dealing at arm’s length execute NDAs because they don’t trust one another. To equate a contractual breach with that of a relationship of trust and confidence defies reality. Yet, to the SEC’s credit, a number of courts have applied this provision in government enforcement actions.9 This approach expands the clear intent and scope of NDAs under custom and practice.
Fourth, in the criminal setting, a number of courts have held that the Title !8 U.S.C. criminal fraud statutes, including the securities fraud statute, are broader than the Title 15 U.S.C. securities statutes, including Section 10(b). Therefore, these courts reason that the Dirks personal benefit test does not apply to criminal prosecutions brought under the Title 18 U.S.C. statutes.10 The consequence is that it is easier for a U.S. attorney to procure a criminal conviction in the tipper-tippee setting than it is for the SEC or private claimants to bring a meritorious action. This absurdity provides another key illustration — namely, that a criminal conviction is more easily procured than a civil enforcement or private judgment.
To rectify these deficiencies, I suggest several measures. First, the fiduciary duty rationale should be rejected and replaced by the access approach. The access approach encompasses persons who have unequal access to material nonpublic information because of their position or relationship, have obtained access to such information by means of illegal or dishonest conduct, or have been tipped material nonpublic information knowing that this information was conveyed by an access person. As framed above, the access approach responds to a concern raised by the Supreme Court in Dirks — that financial analysts would be impaired in their information discovery function because of the risk of violating the insider trading laws.11 Under the recommended approach, financial analysts and other market professionals may engage in their investigations so long as they are not unlawfully tipped material nonpublic information.
Second, other developed markets mandate that, absent a sufficient business justification, a publicly held company must promptly disclose all material information to the investing public.12 That is not the law in this country: Indeed, if a company is silent on the subject and no SEC rule or regulation calls for disclosure, there is no obligation to disclose even material information.13 Adoption of a mandate requiring prompt disclosure of all material information would have two key benefits: First, the market price of a subject company’s security would more likely reflect all material information regarding that company; and second, because of the much shorter time that inside information would be embargoed, the frequency of illegal insider trading should decrease.
Third, the Form 8-K filing period should be reduced from four business days to one business day. There is no justifiable explanation why the securities markets should wait so long for disclosure of such important information. Indeed, when the SEC adopted Regulation FD prior to its adoption of the Form 8-K amendments, the commission required that the subject company make disclosure “as soon as reasonably practicable (but in no event after the later of 24 hours or the commencement of the next day’s trading on the New York Stock Exchange) … after [a] senior official knows, or is reckless in not knowing, [that the information that was selectively disclosed] is both material and nonpublic.”14 The SEC should promptly amend Form 8-K, adopting this one business day requirement. By doing so, opportunities for illegal insider trading would be significantly reduced.
Fourth, the SEC should require insiders to file a Form 4 prior to their trades rather than two days after their transactions. Even if we assume that officers and directors are not trading on material nonpublic information, it is clear that they know far more about their company’s financial condition and prospects than do outsiders. As fiduciaries, these individuals should avoid the appearance (and, with some frequency, the actuality) of unfair financial advantage. Under this approach, insiders may trade the next business day after they file the requisite Form 4 with the SEC.
The current U.S. insider-trading framework is unacceptable and should be significantly revamped. The recommendations offered in this post would go a long way towards improving that framework.
1 SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968) (en banc).
2 See, e.g., Regulation (EU) No. 596/2014 of the European Parliament and the Council of 16 April 2014 on Market Abuse Regulation, art. 8.
3 See, e.g., Chiarella v. United States, 445 U.S. 222 (1980).
5 See, e.g., SEC v. Switzer, 590 F. Supp. 756 (W.D. Okla. 1984).
6 See United States v. O’Hagan, 521 U.S. 642 (1997).
7 See SEC v. Stevens, SEC Litigation Release No. 12813 (1991).
8 See Securities Exchange Act Release No. 43154 (2000) (adopting Release).
9 See, e.g., United States v. Chow, 993 F.3d 125 (2d Cir. 2021).
10 See United States v. Blaszczak, 947 F.3d 19 (2d Cir. 2019), vacated and remanded, 141 S. Ct. 1040 (2021), dismissal granted on other grounds, 2022 WL 17926047 (2d Cir. 2022); United States v. Ramsey, 565 F. Supp. 3d 641 (E.D. Pa. 2021).
11 See Dirks, 463 U.S. 646 (1983).
12 See, e.g., Regulation (EU) No. 596/2014 of the European Parliament and the Council of 16 April 2014 on Market Abuse Regulation, art. 17.
13 See, e.g., J & R Marketing SEP v. General Motors Corp., 549 F.3d 484, 496 (6th Cir. 2008) (“There is no general duty on the part of a company to provide the public with all material information.”).
14 Rule 101(d) of Regulation FD, 17 C.F.R. § 230.101(d).
This post comes to us from Marc I. Steinberg, the Radford Chair in Law and Professor of Law, SMU Dedman School of Law. It is based on his book, “Rethinking Securities Law,” published in 2021 by Oxford University Press (named Best Law Book of 2021 by American Book Fest), and his forthcoming book chapter, “U.S. Insider Trading Law: Its Unacceptable Framework and a Proposed Solution,” in the second edition of the Research Handboook on Insider Trading.