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Federal Securities Law: Insider Trading

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Federal Securities Law: Insider Trading

March 1, 2016April 12, 2017 (RS21127)
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Summary

Insider trading in securities may occur when a person in possession of material nonpublic information about a company trades in the company's securities and makes a profit or avoids a loss. Certain federal statutes have provisions whichthat have been used to prosecute insider trading violations. For example, Section 16 of the Securities Exchange Act of 1934 requires the disgorgement of short-swing profits by named insiders—directors, officers, and 10% shareholders. The 1934 Act's general antifraud provision, Section 10(b), is frequently used in the prosecution of insider traders. Although the statute does not specifically mention insider trading but, instead, forbids the use of "manipulative or deceptive" means in buying or selling securities, case law has made clearclarified that insider trading is the type of fraud that is prohibited by Section 10(b). Securities and Exchange Commission (SEC) rules issued to implement Section 10(b), particularly Rule 10b-5, have also been frequently invoked in insider trading prosecutions. InWith the Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988, Congress enacted legislation imposingthat imposed up to treble damages (and in some cases the greater of $1 million or up to treble damages) on a personpersons found guilty of insider trading. More recently, the Stop Trading on Congressional Knowledge (STOCK) Act of 2012 (P.L. 112-105) explicitly stated that there is no exemption from the insider trading prohibitions for Members of Congress, congressional employees, or any federal officials. As statednoted above, SEC Rule 10b-5 is the most frequently used SEC rule in lawsuits that charge violations of insider trading prohibitions. However, other SEC rules, some of which specifically target insider trading, are also important. There are numerous cases that have usedin which Section 10(b) and Rule 10b-5 have been used to prosecute insider trading violations. The most recent case of note is the Supreme Court's decision in Salman v. United States. On December 6, 2016, the Court unanimously upheld the conviction of Bassam Yacoub Salman for insider trading on tips that he had received from his brother-in-law. The Court agreed with federal prosecutors that a trader can be guilty of violating insider trading prohibitions even if the insider did not receive a tangible benefit, such as money or property, for passing the tip so long as the trader and insider are friends or relatives.

No bill concerning insider trading appears to have been introduced in the 115th Congress to date. However, several bills, including H.R. 1173, H.R. 1625, and S. 702, were introduced in the 114th Congress before the Supreme Court's Salman decision. The Salman decision appears not to go as far as these bills would have in prohibiting the acts of trading in securities with inside information and disclosing inside information.

Federal Securities Law: Insider Trading

Introduction

Insider trading in securities may occur when a person in possession of material nonpublic information about a company trades in the company's securities and makes a profit or avoids a loss. Federal statutes have provisions that either specifically forbid insider trading or have been interpreted by courts to prohibit insider trading. This report discusses some of the key statutes as well as regulations issued by the Securities and Exchange Commission (SEC or Commission) to implement the statutes. The report also discusses some of the most pertinent court decisions on insider trading.

Overview of Federal Statutes Related to Insider Trading Securities Act of 1933

The Securities Act of 19331 (1933 Act) makes it illegal to offer or sell securities2 to the public unless the securities have been registered with the SEC.3 A registration statement becomes effective 20 days after it is filed with the Commission, unless it is delayed or suspended.4 Registration under the 1933 Act covers only the securities actually being offered and only for the purposes of the offering in the registration statement. The registration statement consists of two parts: the prospectus, provided to every purchaser of the securities, and Part II, containing information and exhibits that do not have to be provided to purchasers but are available for inspection. Section 7 of the 1933 Act, referring to Schedule A,5 sets forth the information that must be contained in the registration statement.6 This schedule requires a great deal of information, such as the underwriters, the specific type of business, significant shareholders, debt and assets of the company, and opinions as to the legality of the stock issue. Section 10(a) of the 1933 Act specifies the information which the prospectus must contain.7 There are also numerous regulations issued by the Commission which provide additional details about the registration process under the 1933 Act.8

Certain transactions and securities are exempted from the registration process. The exempted transactions include private placements, intrastate offerings, and small offerings.9 Among the exempted securities are government securities, bank securities, and short-term commercial paper; all securities for which it is believed that other, adequate means of government regulation exist.10

Securities Exchange Act of 1934

The Securities Exchange Act of 193411 (1934 Act) is concerned with several different topics, one of which is the ongoing process of required disclosure by covered publicly traded companies to the investing public through the filing of periodic and updated reports with the Commission.12 Any issuer13 that has a class of securities traded on a national securities exchange or, in certain circumstances, has total assets exceeding $10 million and a class of equity securities held of record14 by 2,000 shareholders or 500 shareholders who are not accredited investors15 must register with the SEC under the 1934 Act.16 Every issuer required to register under the 1934 Act must also file periodic and other reports with the SEC.17 Section 12 of the 1934 Act requires the filing of a detailed statement about the company when the company first registers.18 Section 13, in turn, requires a registered company to file annual and quarterly reports with the SEC.19 These reports must contain essentially all material information, financial and otherwise, about the company—information that the investing public would need in making an informed decision about whether to invest in the company. Section 14 contains requirements about proxy solicitation.20 Some exemptions from these reporting requirements are provided.21 The Commission has issued extensive regulations to specify information that these reports must provide.22

Failure to disclose material information is actionable. For example, Section 18(a) of the Securities Exchange Act grants an express private right of action to investors who have been injured by reliance upon material misstatements or omissions of facts in reports that have been filed with the SEC.23 Section 10(b) of the 1934 Act,24 the general antifraud provision, and Rule 10b-5,25 issued by the SEC to carry out the statutory fraud prohibition, provide for a cause of action for injuries caused by omissions, misrepresentations, or manipulations of material facts in statements filed with the SEC, as well as in statements other than those filed with the SEC.26

One provision in the 1934 Act27to prosecute insider trading violations.

The decision by the U.S. Court of Appeals for the Second Circuit (Second Circuit) in United States v. Newman has brought increased attention to the issue of insider trading. In its December 10, 2014, decision, the Second Circuit overturned two high-profile convictions for insider trading. The court did not simply vacate the convictions; it remanded for the district court to "dismiss the indictment with prejudice," thereby forbidding the government from refiling the case. The Second Circuit held that the evidence against two stock fund analysts could not sustain a guilty verdict because the government did not adequately show that the alleged insiders received personal benefits for providing information to the stock fund analysts and that the government did not present evidence that the defendants knew that they were trading on inside information obtained from insiders who were violating their fiduciary duties. The U.S. Attorney for the Southern District of New York asked the Second Circuit to reconsider the ruling, but on April 3, 2015, the Second Circuit denied the U.S. Attorney's request. On July 30, 2015, the U.S. Department of Justice asked the Supreme Court to review the Second Circuit decision. On October 5, 2015, the U.S. Supreme Court declined to hear the Newman insider trading appeal.

On July 6, 2015, a case decided by the U.S. Court of Appeals for the Ninth Circuit may have further complicated insider trading law. The case, Salman v. United States, affirmed a lower court decision finding a breach of fiduciary duty and creation of a personal benefit in a family insider trading situation, holding that the "gift" of inside information was sufficient to create liability for insider trading. On January 19, 2016, the U.S. Supreme Court granted certiorari in the Salman case.

Several bills, including H.R. 1173, H.R. 1625, and S. 702, have been introduced in the 114th Congress to attempt to prevent the type of securities trading allowed by the Newman decision. This report will be updated as warranted.


Federal Securities Law: Insider Trading

Overview of Federal Statutes Related to Insider Trading

Insider trading in securities may occur when a person in possession of material nonpublic information about a company trades in the company's securities and makes a profit or avoids a loss. Federal statutes have provisions which either specifically forbid insider trading or have been interpreted by courts to prohibit insider trading.

Securities Exchange Act of 1934

One provision in the Securities Exchange Act of 19341 is specifically designed to discourage insiders in the corporation from taking advantage of their inside information in the trading of the corporation's securities. Section 16 of the 1934 Act228 places sanctions on insiders who use inside information in making short-swing profits.29 For purposes of this provision, an insider is defined as any "person who is directly or indirectly the beneficial owner of more than 10 percent of any class of any equity security .. . . which is registered .. . . or who is a director or an officer of the issuer...." Every person meeting the insider . . . ."30 Every person who qualifies as an insider under this definition must file a report with the Securities and Exchange Commission (SEC)SEC at the time of the registration of the securitysecurity's registration on a national securities exchange or by the effective date of a filed registration statement or within 10 days after he becomes a beneficial owner, director, or officer.31 If there has been a change in the ownership of the security or if there has been a purchase or sale of a security-based swap agreement involving the equity security, the insider must file the report before the end of the second business day following the day on which the transaction has been executed.3

32

To prevent the unfair use of inside information, Section 16(b) permits the company or any security holder suingto sue on behalf of the company to recover any profit whichthat the person realizes from any purchase and sale or sale and purchase of any equity security of the company within a period of less than six months.

33

Section 10(b)4 of the 1934 Act and SEC and Rule 10b-55 are used in most cases of insider trading violations, as well as in other kinds of alleged securities fraud. Section 10(b) is the 1934 Act's general antifraud provision. Although it(Some of the major cases are discussed below.) Although Section 10(b) does not refer to specific types of fraud or to specific types of insiders, one of its most frequent applications over the years has been to insider trading. The statute states,

in relevant part:

It shall be unlawful for any person, directly or indirectly by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange:

(a)...

. . .

(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

(c)...

. . .34

Rule 10b-5, mentioned later along with other SEC regulations whichthat focus more specifically on insider trading, is the general SEC rule which is used in all kinds ofused in many securities fraud cases. The rule states,

:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

35

Insider Trading Sanctions Act of 1984

TheAccording to the House report on the bill, the Insider Trading Sanctions Act of 1984636 was enacted because of the belief that

[i]nsider: Insider trading threatens .. . . markets by undermining the public's expectations of honest and fair securities markets where all participants play by the same rules. This legislation provides increased sanctions against insider trading in order to increase deterrence of violations.

"Insider trading" is the term used to refer to trading in the securities markets while in possession of "material" information (generally, information that would be important to an investor in making a decision to buy or sell a security) that is not available to the general public.7

37

The act1984 Act provides that, if the commissionCommission believes that any person has bought or sold a security while in possession of material, nonpublic information, the commissionCommission may bring an action in U.S.federal district court to seekseeking a civil penalty. The penalty may be up to three times the profit gained or loss avoided.8

38

Insider Trading and Securities Fraud Enforcement Act of 1988

After a number of hearings and considerable debate in the 100th Congress, the President Reagan signed the Insider Trading and Securities Fraud Enforcement Act of 1988.939 This act expanded the scope of civil penalties to control personsthat may be imposed against officers and directors who fail to take adequate steps to prevent insider trading.10 The act, among other things,40 Among other things, the 1988 Act also established a private right of action against the inside trader for buyers or sellers of securities against the inside trader if theywho traded contemporaneously with the insider.11

41

Stop Trading on Congressional Knowledge (STOCK) Act of 2012

The STOCK Act,1242 signed into law on April 4, 2012, makes clearaffirms that insider trading prohibitions apply to Members of Congress, congressional staff, and other federal officials. According to Section 3 of the STOCK Act,

[A] Member of Congress and an employee of Congress may not use nonpublic information derived from such person's position as a Member of Congress or employee of Congress or gained from the performance of such person's official responsibilities as a means for making a private profit.

Section 9 of the STOCK Act places this prohibition on other federal officials and also affirms the non-exemption from insider trading prohibitions for these officials:

Executive branch employees, judicial officers, and judicial employees are not exempt from the insider trading prohibitions arising under the securities laws, including section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

43

The STOCK Act also has provisions concerning financial disclosure reporting requirements for legislative and executive branch officials.13

44

Examples of Penalties for Insider Trading

There are both civil and criminal penalties1445 for insider trading, and the penalties can vary depending on what statutes a trader is found guilty of violating. For example, 15 U.S.C. Section 78u-1The 1934 Act sets out the civil penalties for engaging in securities transactions while in possession of material nonpublic information.46 As mentioned above, the penalty can be up to three times the profit gained or loss avoided. However, willful violations of other provisions, such as Section 10(b), the general antifraud securities statuteprovision, may result in other significant penalties. These penalties for each willful violation of a securities statute by an individual include, including fines up to $5 million and/or imprisonment for up to 20 years; a business may be fined for individuals and fines up to $25 million for businesses.47.15

Selected Regulations

As stated above, SEC Rule 10b-5, which implements Section 10(b) of the Securities Exchange Act, is apparently the most frequently used SEC rule in lawsuits that charge violations of insider trading prohibitions. However, other SEC rules, some of which specifically target insider trading, are also important.

Rule 10b5-116 prohibits trading "on the basis of" material nonpublic information.48 This rule states that one of the proscribed activities under Section 10(b) and Rule 10b-5 is securities trading "on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed" to the issuer of the security, shareholders of the issuer, or another who is the source of the inside information.49 The regulation defines "on the basis of" as havingto have a kind of knowledge requirement:

[A] purchase or sale of a security of an issuer is "on the basis of" material nonpublic information about that security or issuer if the person making the purchase or sale was aware of the material nonpublic information when the person made the purchase or sale.

50

Various affirmative defenses are allowed to avoid prosecution under the rule, such as the alleged violator's demonstrating that, before becoming aware of the material nonpublic information, he had entered into a binding contract to buy or sell the security, had instructed another person to buy or sell the security for his account, or had adopted a written plan for trading securities.

before becoming aware of the material nonpublic information.51

Rule 10b5-217 sets out duties of trust or confidence in misappropriation insider trading cases. based on the misappropriation of inside information.52 The misappropriation theory of insider trading is a fairly recent development in securities law. Under the classical theory of insider trading, a corporate insider is prohibited from trading that corporation's securities if the trade is based on inside information and if the trader has a duty of trust and confidencefiduciary duty to the corporation's shareholders. In contrast to classical insider trading, the misappropriation theory findsmay hold liable a person who is not actually a corporate insider but who has instead been provided inside information in confidence and who breaches a fiduciary duty to the source of the information in order to gain profit or avoid loss in the securities market. Rule 10b5-2 sets out examples of what is meant by "duties of trust or confidence." TheySuch duties include a person's agreement to maintain the disclosed information in confidence; a person's history with the discloser of the inside information indicating an expectation that the recipient of the information will keep the information in confidence; and a person's receiving information from a spouse or close relative, unless the recipient can show that he neither knew nor should have reasonably known or agreed that he would keep the information confidential.

53

Regulation FD18 is another SEC rule which may concern a prohibition onthat could prohibit insider trading.54 Regulation FD addresses selective disclosure. It provides that, when an issuer or any person acting on behalf of thean issuer discloses material nonpublic information to certain enumerated persons (typically, securities market professionals and holders of the securities), it must disclose that information to the public. The disclosure of the material nonpublicthat issuer or person acting on behalf of the issuer must disclose the information to the public. This disclosure must be made simultaneously with the intentional disclosure to the enumerated persons or as promptly as possible to the publicafter the disclosure, in the case of a non-intentional disclosure to the enumerated persons.

55

Selected Decisions That Have UsedIllustrating the Use of Section 10(b) and Rule 10b-5 to Prosecute Insider Trading Violations

There are numerous cases that have usedand administrative proceedings in which Section 10(b) and Rule 10b-5 have been used to prosecute insider trading violations. What followsThe following is a brief discussion of a fewsome of the most importantnotable of these cases.

and proceedings. Strong v. Repide

Although it was decided 25 years before the enactment of the Securities Exchange Act, Strong v. Repide1956 illustrates that the common law rule of fiduciary duty, which is arguably the idea driving the case law imposing penalties for insider trading, prohibits a company insider from profiting from knowledge that he alone knowshas about the company. According to the Court, a corporate director may not generally have an obligation of a fiduciary nature to disclose to a shareholder the director's knowledge affecting the value of the shares.57 However, the Court believed that such a duty can exist in special cases and did, in fact, exist in this case because the fraudulent concealment of the identity of a stock purchaser would have affected the value of the stock in question. To wit, the Court stated: "Concealing his identity when procuring the purchase of the stock, by his agent, was in itself strong evidence of fraud on the part of the defendant."58 The Court went on to state: "The case before us seems a plain one for holding that, under the circumstances detailed, there was a legal obligation on the part of the defendant to make these disclosures."59 In the Matter of Cady Roberts & Co. In an administrative disciplinary proceeding, In the Matter of Cady Roberts & Co.,60 about the company. The Court stated,

A director upon whose action the value of the shares depends cannot avail of his knowledge of what his own action will be to acquire shares from those whom he intentionally keeps in ignorance of his expected action and the resulting value of the shares.

This is a rule of common law....

Even though a director may not be under the obligation of a fiduciary nature to disclose to a shareholder his knowledge affecting the value of the shares, that duty may exist in special cases, and did exist upon the facts in this case.

In an administrative broker-dealer disciplinary proceeding, In re Cady Roberts & Co.,20 the SEC held that Section 10(b) and Rule 10b-5 prohibited insider trading by a person, in this case a broker-dealer, who may not actually be within the corporation whose stock has been traded, but who has received privileged information about the corporation from someone within the corporation.

The case concerned a partner in a brokerage firm who, after receiving a message from a director of the Curtiss-Wright corporation stating that the board of directors had voted to cut the dividend, placed orders to sell some of theCurtiss-Wright stock before news of the dividend cut was disseminated to the public.61 The broker was not a corporate insider (i.e., he was not an officer, director, or significant shareholder). However, the SEC foundheld that the broker's conduct violated at least clause (3) of the above-quoted SEC Rule 10b-5 in that itthe conduct operated as a fraud or deceit on the purchasers and that, thus, there was no need to decide the scope of clauses (1) and (2).62 In determining that there was a violation of clause (3), the SEC appears to have found fraud committed on both the company and on persons on the other side of the market, noting:

Analytically, the obligation [not to trade on inside information] rests on two principal elements: first, the existence of a relationship giving access, directly or indirectly, to information intended to be available only for a corporate purpose and not for the personal benefit of anyone, and second, the inherent unfairness involved where a party takes advantage of such information knowing it is unavailable to those with whom he is dealing. In considering these elements under the broad language of the anti-fraud provisions we are not to be circumscribed by fine distinctions and rigid classifications. Thus, it is our task here to identify those persons who are in a special relationship with a company and privy to its internal affairs, and thereby suffer correlative duties in trading in its securities. Intimacy demands restraint lest the uninformed be exploited.

63

The SEC rejected the broker's argument that the obligation to disclose material information exists only in a situationsituations involving face-to-face dealings:

It on the grounds that: [i]t would be anomalous indeed if the protection afforded by the anti-fraud provisions were withdrawn from transactions effected on exchanges, primary markets for securities transactions. If purchasers on an exchange had available material information known by a selling insider, we may assume that their investment judgment would be affected and their decision whether to buy might accordingly be modified. Consequently, any sales by the insider must await disclosure of the information.

64

Thus, it appears that this case established that Section 10(b) and Rule 10b-5 extend beyond officers, directors, and major stockholders to others who receive information from a corporate source(in this case, a broker-dealer) who receive information from a corporate source. Later cases, discussed below, appear to support this view.

Securities and Exchange Commission v. Texas Gulf Sulphur Securities and Exchange Commission v. Texas Gulf Sulphur,65,21 a 1968 decision by the U.S. Court of Appeals for the Second Circuit (Second Circuit), effectively supported the SEC's ruling in Cady Roberts by suggesting that anyone in possession of inside information must either publicly disclose the information or not trade the particular stock until the information becomes public.

According to the Second Circuit:

[A]nyone in possession of material inside information must either disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence, or if he chooses not to do so, must abstain from trading in or recommending the securities concerned while such inside information remains undisclosed.66

Chiarella v. United States

The U.S. Supreme Court appears, however, in 1980 to have somewhat modified the rule of Texas Gulf Sulphur by indicating that, for there to be a fraud a fraud to be actionable under Rule 10b-5, there must be a duty to disclose arising from a relationship of trust and confidence between parties to the transaction.67 Chiarella v. United States22 alleged aStates involved an alleged violation of Rule 10b-5 by an employee of a financial printer.68 The employee, who was involved in printing materials related to corporate takeover bids, deduced the names of the target companies from information contained in documents delivered to the printer by the acquiring companies.69 Without disclosing his knowledge, the employee purchased stock in the target companies and sold the shares immediately after the information was made public, realizing a profit of $30,000. The lower courts found70 The Second Circuit held that a violation of Rule 10b-5 had occurred and convicted the employee of the print company for willfully failing to inform the sellers of the target company securities that he knew of an imminent takeover bid that would increase the value of their stock.

71

The Supreme Court reversed.72 According to the Court, thean employee in this situation did not have a duty to disclose the information.73 He was not a corporate insider, and he received no confidential information.74 In addition, no duty arose from the relationship between the printing company employee and the sellers of the target companies' securities.75 The Court held that a duty to disclose under Section 10(b) and Rule 10b-5 does not arise from the mere possession of nonpublic market information.23

76

Dirks v. Securities and Exchange Commission24 went perhaps a little further than Chiarella in the direction of indicating that noncorporate persons with Dirks v. Securities and Exchange Commission77 could be seen to have gone a little further than Chiarella by indicating that persons not within a corporation who possess inside information are not always liable when trading on insidethis information. ThisThe case involved an officer of a broker-dealer who specialized in providing investment analysis of insurance company securities to institutional investors.78 He received information that the assets of an insurance company were greatly overstated because of fraudulent corporate practices and that regulatory agencies had not acted on these charges made by company employees.79 Although the officer of the broker-dealer did not himself trade the stock, some of his customers did, based on information that they received from him.80 The price of the stock fell, and the SEC began investigations, eventually finding that the officer had violated Rule 10b-5 by repeating the allegations of fraud to investors who later sold their stock in the insurance company.81 However, because of his role in uncovering the fraud, he received only a censure from the SEC.

The82 On appeal, the Supreme Court foundheld that no violation of Section 10(b) had occurred. in this case.83 In order to find a violation of Section 10(b) by a corporate insider, two elements are necessary, according to the Court: (1) the existence of a relationship affording access to inside information intended to be available only for a corporate purpose, and (2) the unfairness of allowing a corporate insider to take advantage of that information by trading without disclosure.84 However, the duty arises from a fiduciary relationship; in , in the Court's view.85 In addition, there must be manipulation or deception to bring about a breach of the fiduciary duty.86 Here, according to the Court, the insider did not trade on the inside information, nor did he make secret profits.87 For the officer of the broker-dealer to have thea duty to disclose inside information or to abstain from trading, the officer must have a fiduciary duty and must have breached thatbreached his fiduciary duty. Since he88 The officer in this case had no duty to abstain from using inside information, because he had no pre-existing fiduciary duty to the insurance company's shareholders and, therefore,.89 Therefore, he did not violate Section 10(b) or ruleRule 10b-5.90 Carpenter v. United States 10b-5.

Seven years after Dirks, the Supreme Court decided another landmark securities case, Carpenter v. United States.25 Although the case91 In this case, although the Court did not find the defendants guilty under the misappropriation theory of securities fraud, it did discuss the issue. In the Carpenter case,92 The case arose when R. Foster Winans, a former writer for the Wall Street Journal's "Heard on the Street" column, and others were charged with violations of Section 10(b) and Rule 10b-5.93 They were also charged with violating the federal mail and wire fraud statutes2694 and with conspiracy.2795 In researching information to be used in his column, Winans interviewed corporate executives, but none of the information that he obtained containedwas said to have involved corporate inside information.96 Because of its perceived quality and integrity, the column had the potential for affecting the prices of the stocks that it discussed.

97

The Wall Street Journal's official policy was that, before publication, the contents of the column were its confidential information. Despite98 However, despite being familiar with thethis rule, Winans agreed to give Peter Brant and Kenneth Felis, both employees of Kidder Peabody, advance information about the columns.99 Brant, Felis, and another conspiratorperson, David Clark, bought and sold stocks based on the probable impacteffects of the information that would later appear in Winans's columns.100 The profits from these trades over a four-month period amounted to $690,000.101 Kidder Peabody's compliance department eventually noticed correlations between the Winans columns and the Clark and Felis accounts.102 The SEC began an investigation; Winans and his roommate, David Carpenter, revealed the scheme;, and the indictments followed.

103

The lower courts foundSecond Circuit held that Winans had knowingly breached a duty of confidentiality by misappropriating prepublication information. They104 It found that this misappropriation had violated Section 10(b) and Rule 10b-5 because theWinans's deliberate breach by Winans of his duty of confidentiality was a fraud and deceit on the newspaper. The lower courts105 The Second Circuit also held that Winans had fraudulently misappropriated property within the meaning of the mail and wire fraud statutes. The parties found guilty filed for certiorari to challenge the lower courts' conclusions.

The106 In reviewing the Second Circuit's decision, the Supreme Court was evenly divided28 concerning thethese convictions under the securities laws and therefore affirmed the lower courts' judgment., by a vote of four to four, the Second Circuit's opinion.107 The Court did not elaborate on the issue of whether Winans's activities violated the securities laws. The CourtIt also affirmed the lower courts'Second Circuit's judgment with respect to the mail and wire fraud convictions.

without elaboration.108 United States v. O'Hagan

Ten years later, in United States v. O'Hagan, the Supreme Court legitimated the misappropriation theory of securities fraud by finding James O'Hagan guilty of violating Section 10(b) and Rule 10b-5 violations..109 O'Hagan was a partner in a Minneapolis law firm, which that represented Grand Met, a large diversified law firmMetropolitan PLC (Grand Met), a company based in London. Grand Met was interested in acquiring Pillsbury. Company (Pillsbury).110 O'Hagan purchased call options for and stock in Pillsbury after he learned of Grand Met's interest.111 After the tender offer was publicly announced, Pillsbury stock immediately rose.112 O'Hagan exercised his options and liquidated his stock, realizing a profit of over $4 million.

113

The SEC indicted O'Hagan on 57 counts, including securities fraud under Section 10(b) and Rule 10b-5.114 A jury convicted him on all of the counts,115 but the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit) reversed,29 holding, among other things, that the misappropriation theory is inconsistent with Section 10(b).116 The Supreme Court subsequently reversed the Eighth Circuit.30

117

In its decision with respect to the misappropriation theory, the Court found that O'Hagan's fiduciary status and his willful intent to violate that status were sufficient to find him guilty of misappropriating confidential information.

:

[T]he fiduciary's fraud is consummated, not when the fiduciary gains the confidential information, but when, without disclosure to his principal, he uses the information to purchase or sell securities. The securities transaction and the breach of duty thus coincide. This is so even though the person or entity defrauded is not the other party to the trade, but is, instead, the source of the nonpublic information... . . . . A misappropriator who trades on the basis of material, nonpublic information, in short, gains his advantageous market position through deception; he derivesdeceives the source of the information and simultaneously harms members of the investing public....31

118

United States v. Newman

A decision late in 2014 by the U.S. Court of Appeals for the Second Circuit hasrecently brought increased attention to the issue of insider trading. Some commenters have gone so far as to indicate that the decision has "upended the government's campaign" against insider trading, referring to successes that the U.S. Attorney for the Southern District of New York has had in prosecutions over the past few years.32

In itsIn this decision, United States v. Newman,33 the Second Circuit overturned two high-profile convictions for insider trading. The court did not simply vacate the convictions; it remanded for the district court to "dismiss the indictment with prejudice," thereby forbidding the government from refiling the case. In March 2015 the U.S. Attorney for the Southern District of New York asked the Second Circuit to reconsider its ruling, but in April 2015 the Second Circuit denied the U.S. Attorney's request.34

The Office of the U.S. Attorney for the Southern District of New York brought charges against various hedge fund and investment fund analysts, including Newman and Chiasson, charging them with insider trading for allegedly obtaining material nonpublic information from employees of publicly traded technology companies and then passing that information to the portfolio managers at their companies. Defendants-appellants Newman and Chiasson appealed their May 2013 convictions from the lower court (U.S. District Court for the Southern District of New York) on two general bases—insufficiency of evidence and failure to instruct the jury that to convict the defendants it had to find that a tippee (one who receives inside information) knew that the insider disclosed financial information in exchange for a personal benefit.

The Second Circuit held that the evidence could not sustain a guilty verdict because the government did not adequately show that the alleged insiders the Second Circuit overturned two high-profile convictions for insider trading.119 The Second Circuit held that the evidence against Todd Newman and Anthony Chiasson, who were analysts for hedge funds and investment funds, could not sustain a guilty verdict.120 According to the Second Circuit, the government had not adequately shown that the alleged insiders, who were employees of publicly traded technology companies, received personal benefits for providing information to Newman and Chiasson.121 In addition, according to the court, the government did not presenthad not presented evidence that the defendants knew that they were trading on inside information obtained from insiders who were violating their fiduciary duties.

The Second Circuit's decision in the Newman case turned on a close examination of the Supreme Court's Dirks decision. As mentioned above, Dirks held that, in order to find a tipper (one who provides inside information to others) liable for violating federal securities laws, the insider must have a fiduciary duty to the company whose information he discloses and he must have received a personal benefit from the disclosure. The tippee's duty to abstain from trading derives from the insider's fiduciary duty and benefit. If the insider did not commit a breach of fiduciary duty resulting in a personal benefit from the disclosure, then the tippee, according to the Supreme Court, cannot be found liable because liability occurs only when the insider has breached a fiduciary duty and the tippee knows or should know that there has been a breach of a fiduciary duty.

In its analysis of the law concerning insider trading, the Second Circuit found that the lower court's instructions to the jury were erroneous. According to the Second Circuit, to sustain an insider trading conviction against a tippee, the government must prove the following elements beyond a reasonable doubt: (1) the corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached his fiduciary duty by disclosing confidential information to a tippee in exchange for a personal benefit; (3) the tippee knew that the information was confidential and that it was disclosed for personal benefit; and (4) the tippee nevertheless used that information to trade in a security or to tip another for personal benefit. In contrast, the lower court instructed the jury that the government had to prove (1) the insiders had a fiduciary or other relationship of trust and confidence with their corporations; (2) the insiders breached that duty by disclosing material nonpublic information; (3) the insiders personally benefited from the disclosure; (4) the defendant knew that the information he had received had been disclosed in violation of a duty; and (5) the defendant used the information to buy a security.

The Second Circuit found that, in adhering to the lower court's jury instructions, a reasonable juror might conclude that a defendant could be found guilty of insider trading just because the defendant knew that the insider had disclosed information that was required to be confidential. This is not an accurate reading of the decision in Dirks, the Second Circuit indicated.

But a breach of the duty of confidentiality is not fraudulent unless the tipper acts for personal benefit, that is to say, there is no breach unless the tipper "is in effect selling the information to its recipient for cash, reciprocal information, or other thing of value for himself.... " Dirks, 463 U.S. at 664 (quotation omitted). Thus, the district court was required to instruct the jury that the Government had to prove beyond a reasonable doubt [emphasis added] that Newman and Chiasson knew that the tippers received a personal benefit for their disclosure.35

In addition to its conclusion that the district court provided inaccurate instructions to the jury, the Second Circuit found that the government, though it was entitled to prove its case through circumstantial evidence, could not "demonstrate" each element of the charged offense beyond a reasonable doubt. The Second Circuit's language concerning the government's not meeting this mark is somewhat strong.

[I]f the evidence [presented] "is nonexistent or so meager," ... such that it "gives equal or nearly equal circumstantial support to a theory of guilt and a theory of innocence, then a reasonable jury must necessarily entertain a reasonable doubt.... " Because few events in the life of an individual are more important than a criminal conviction, we continue to consider the "beyond a reasonable doubt" requirement with utmost seriousness.... Here, we find that the Government's evidence failed to reach that threshold, even when viewed in the light most favorable to it.36

The circumstantial evidence in this case was simply too thin to warrant the inference that the corporate insiders received any personal benefit in exchange for their tips.

Based on its analysis of the Dirks decision, the Second Circuit's reasoning in Newman may not be especially surprising. However, the decision has resulted in a great deal of discussion. On the one hand, there appears to be concern that the decision is a blow to prosecutors and will make it more difficult for the government to obtain convictions against persons charged with insider trading. On the other hand, there is praise that needless government prosecutions may have been curtailed. One article states:

Two camps [have] formed: Prosecutors who complained that the ruling will tie their hands in pursuing Wall Street crime, and defense lawyers who expressed delight after years of lamenting what they saw as government overreach. From both sides, a consensus emerged that the ruling would have a chilling effect on insider trading prosecutions.37

On July 30, 2015, the U.S. Department of Justice asked the Supreme Court to review the Second Circuit decision.38 On October 5, 2015, the U.S. Supreme Court declined to hear the Newman insider trading appeal.39

United States v. Salman

On July 6, 2015, the U.S. Court of Appeals for the Ninth Circuit (Ninth Circuit) decided a case that may further complicate the law of insider trading. In United States v. Salman (Salman),40 defendant Bassam Yacoub Salman appealed his conviction by jury trial for conspiracy and insider trading. He argued that the evidence against him was insufficient to sustain his conviction according to the Second Circuit's standard set out in Newman, and he urged the Ninth Circuit to adopt the Newman standard.

The case involved insider trading in Salman's extended family. In 2002, Salman's future brother-in-law Maher Kara began working with Citigroup's investment banking group focused on health care. Maher discussed his work with his older brother Michael, who traded on information that Maher provided him. Maher continued to provide inside information to Michael, including information about upcoming mergers. Salman became close to Michael and traded on inside information that Michael provided him. Salman also shared the information with other family members, and they split the profits. The government presented evidence showing that Salman knew that he was receiving inside information. Maher testified that he gave his brother Michael inside information to benefit him. The government also showed that Salman knew how close Michael and Maher were. Salman, charged with securities fraud and conspiracy to commit securities fraud, defended on appeal that the government's evidence was insufficient under the standard announced in Newman; that is, that there was insufficient evidence to find that Maher disclosed information to Michael in exchange for a personal benefit or that, if he did, Salman knew of the benefit.

The Ninth Circuit in its analysis41 looked to the Dirks case, particularly the Dirks discussion of the "personal benefit" requirement for tippee liability. In examining what the Dirks case had to say about what "personal benefit" means, the Ninth Circuit focused on the Court's statement that "the elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend."42 The Ninth Circuit went on to state concerning the Dirks quote:

The last-quoted holding of Dirks governs this case. Maher's disclosure of confidential information to Michael, knowing that he intended to trade on it, was precisely the "gift of confidential information to a trading relative" that Dirks envisioned. Indeed, Maher himself testified that, by providing Michael with inside information, he intended to 'benefit" his brother and to "fulfill [] whatever needs he had."

Salman argued that the Second Circuit in Newman interpreted Dirks to require that more than mere evidence of a friendship or family relationship between tipper and tippee is sufficient to find that a personal benefit was received in exchange for inside information. Salman particularly focused on the Newman language indicating that, for there to be liability for the exchange of inside information, there must be "at least a potential gain of a pecuniary or similarly valuable nature." The Ninth Circuit disagreed and stated some possible opposition to the Newman decision:

To the extent Newman can be read to go so far, we decline to follow it. Doing so would require us to depart from the clear holding of Dirks that the element of breach of fiduciary duty is met where an "insider makes a gift of confidential information to a trading relative or friend." Dirks, 463 U.S. at 664. Indeed, Newman itself recognized that the "'personal benefit is broadly defined to include not only pecuniary gain, but also, inter alia,...the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend.'"43

The Ninth Circuit found that the evidence presented by the government was more than enough for a "jury to find both that the inside information was disclosed in breach of a fiduciary duty, and that Salman knew of that breach at the time he traded on it"44 and affirmed the lower court's decision convicting Salman of securities fraud and conspiracy to commit securities fraud.

The Ninth Circuit Salman decision and the Second Circuit Newman decision appear to have different views of what is necessary for finding insider trading violations. Some commenters have wondered whether the Newman decision is compatible with the Supreme Court's treatment of tippee liability in Dirks. Judge Rakoff, the author of the Salman decision, appears to be one of these questioners. For example, in an April 2015 U.S. District Court for the Southern District of New York decision, Securities and Exchange Commission v. Payton,45 Judge Rakoff discussed a possible incompatibility between the two cases, keeping in mind that Dirks is a civil case and Newman is a criminal case:

In Dirks, a civil case, the Supreme Court defined a personal benefit as

"a pecuniary gain or a reputational benefit that will translate into future earnings.... For example, there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient. The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend."

Dirks, 463 U.S. at 663-64 (emphasis supplied). It is arguably unclear whether the italicized sentence modifies the prior reference to "pecuniary gain or...future earnings," or is an independent stand-alone possibility. However, in Newman, a criminal case, the Second Circuit held that, to the extent Dirks suggests that a benefit may be inferred from a personal relationship, "such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly viable nature." 773 F.3d at 452. Whether this is the required reading of Dirks may not be obvious, [footnote omitted] and it may not be so easy for a lower court, which is bound to follow both decisions, to reconcile the two [emphasis added].46

The possible incompatibility between Newman and Salman, coupled with the Supreme Court's rejection of the Newman appeal, arguably creates something of a split in the federal circuit courts.47 This may lead to some confusion in prosecuting insider trading cases. On January 19, 2016, the U.S. Supreme Court granted certiorari48 in the Salman case. A decision may clarify what is required to find a person guilty of insider trading.

Congressional Interest in the Newman Decision

At least three bills have been introduced in the 114th Congress in an attempt to prevent the type of securities trading allowed by the Newman decision. Two of the bills would amend Section 10, the general antifraud provision of the Securities Exchange Act, and one of the bills would add a new provision, Section 16A, to the Securities Exchange Act.

H.R. 1173, referred to the House Committee on Financial Services, would add subsection (d) to Section 10. It would hold a person liable for violating the insider trading prohibition laid out in Section 2(a) of the bill if the person intentionally discloses "without a legitimate business purpose" information that he knows or should know is material information and inside information. The bill lists factors defining "should know" as including the person's financial sophistication, knowledge of and experience in financial matters, position in the company, and assets under management.

H.R. 1625, referred to the House Committee on Financial Services, would add new Section 16A to the Securities Exchange Act. The section would prohibit the trading of securities if a person has material nonpublic information about the securities or knows or recklessly disregards that the information has been wrongfully obtained or that the securities transaction would be a wrongful use of the information. The section would also prohibit a person from communicating material nonpublic information about securities to others if others engage in securities transactions based on the communication and the securities transactions were reasonably foreseeable. The standard for wrongfulness of a communication is based on information that has been obtained by such activities as theft, violation of a federal law protecting computer data, or breach of a fiduciary duty. Specific knowledge of how the information was obtained is not necessary for a violation so long as the person trading was aware that or recklessly disregarded that the information was wrongfully obtained or communicated. The SEC may by rule provide for exemptions from the prohibitions if the exemptions are not inconsistent with the purposes of the section.

S. 702, referred to the Senate Committee on Banking, Housing, and Urban Affairs, would add subsection (d) to Section 10 of the Securities Exchange Act. It would prohibit securities transactions on the basis of material information that a person knows or has reason to know is not publicly available. It would also prohibit knowingly or recklessly communicating information that is not publicly available if it is reasonably foreseeable that the communication is likely to result in a securities transaction. "Not publicly available" does not include information that a person has independently developed from publicly available sources. The SEC may provide for exemptions if it determines that they are necessary or appropriate in the public interest and consistent with the protection of investors.

Author Contact Information

[author name scrubbed], Legislative Attorney ([email address scrubbed], [phone number scrubbed])

Footnotes

15 U.S.C. § 78u-1(a)(3) imposes on a person controlling the violator a penalty of the greater of $1 million or three times the profit gained or loss avoided. Limitations on the liability of controlling persons may be found at 15 U.S.C. § 78u-1(b). For more information on the STOCK Act, see. Id. § 78ff.

Id. § 240.10b5-2.

65243.103.

67. Id. at 235-37. Concurring and dissenting opinions in Chiarella suggest that, if the misappropriation theory of securities fraud had been presented, the employee. Id. at 650.

Id. at 652.

92. 484 U.S. at 19, 22-23.

124. Id. at 428-29.
1.

15 U.S.C. §§78a et seq.

2.

15 U.S.C. §78p.

3.

15 U.S.C. §78p(a).

4.

15 U.S.C. §78j(b).

5.

17 C.F.R.§240.10b-5.

6.

P.L. 98-376, codified in a number of provisions of 15 U.S.C. §§78a et seq.

7.

H.Rept. 98-355, at 2 (1984).

8.

15 U.S.C. §78u-1(a)(2).

9.

P.L. 100-704, codified in a number of provisions of the federal securities laws.

10.

15 U.S.C. §78u-1(a)(3) imposed on a person controlling the violator a penalty of the greater of $1,000,000 or three times the profit gained or loss avoided. Limitations on the liability of controlling persons may be found at 15 U.S.C. §78u-1(b).

11.

15 U.S.C. §78t-1.

12.

P.L. 112-105, codified in provisions and notes of several titles of the U.S. Code, particularly in Titles 5 and 15.

13122 According to some commenters, this decision "upended the government's campaign" against insider trading because it held that the government must show that the insiders, who in this case allegedly passed on inside information, received personal benefits, presumably of a tangible nature, in order to obtain conviction.123 Although the federal government sought review of the Second Circuit's decision in Newman from the Supreme Court,124 the High Court declined to hear the case.125 Salman v. United States

As mentioned above, the Second Circuit's Newman decision required proof of a tangible benefit. However, in its 2015 decision in United States v. Salman, the Ninth Circuit found that it is enough to show that the insider and the tippee (the one who receives inside information) share a close family relationship.126 The Ninth Circuit took specific note of the Supreme Court's statement in Dirks v. Securities and Exchange Commission, discussed above, that "[t]he elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend."127 Salman appealed the Ninth Circuit's decision to the Supreme Court, which granted review.

On December 6, 2016, the U.S. Supreme Court in Salman v. United States sided with the Ninth Circuit, unanimously upholding the conviction of Bassam Yacoub Salman for insider trading on tips that he had received from his brother-in-law.128 The Court agreed with federal prosecutors that a trader can be guilty of violating insider trading prohibitions even if the insider did not receive a tangible benefit, such as money or property, for passing the tip so long as the trader and insider are friends or relatives. In so doing, the Court resolved a difference of opinion between the U.S. Courts of Appeals for the Second and Ninth Circuits concerning what the government must prove in prosecuting insider trading cases.

In its Salman decision, the Supreme Court held that the Ninth Circuit had properly applied Dirks in affirming Salman's conviction.129 The Court first looked to the trial court evidence that had established there were close family and friendship relationships among Salman and others involved in the case.130 With these close relationships in mind, the Court found that Dirks easily resolved the issue at hand, reiterating the Dirks Court's statement that "a jury can infer a personal benefit—and thus a breach of the tipper's duty—where the tipper receives something of value in exchange for the tip or 'makes a gift of confidential information to a trading relative or friend.'"131

According to the Court in Salman, when an individual disclosed confidential information to his brother with the expectation that his brother would trade on it, that individual breached his fiduciary duty to his employer, Citigroup, and its clients.132 Then, when Salman, as a tippee, traded on this information, knowing that it had been improperly disclosed, he too breached a duty of trust and confidence to Citigroup and its clients.133 According to the Court, it is not necessary that the tipper receive something of a tangible nature; rather, the breach of the fiduciary duty to a trading relative or friend suffices to meet the standard laid out in Dirks.134

Congressional Interest in Insider Trading

No bills concerning insider trading appear to have been introduced, to date, in the 115th Congress. However, before the Supreme Court's Salman decision, at least three bills were introduced in the 114th Congress in an attempt to prevent the type of securities trading that would appear to have been allowed under the Newman decision.

Two of the bills would have amended Section 10, the general antifraud provision of the Securities Exchange Act, and one of the bills would have added a new provision, Section 16A, to the Securities Exchange Act.

H.R. 1173, 114th Congress, referred to the House Committee on Financial Services, would have added a new subsection (d) to Section 10. This new subsection would have held a person liable for violating the insider trading prohibition laid out in Section 2(a) of the bill if the person intentionally disclosed "without a legitimate business purpose" information he knew or should have known is material information and inside information. The bill would have defined "should know" to include various factors, such as the person's financial sophistication, knowledge of and experience in financial matters, position in the company, and assets under management.

H.R. 1625, 114th Congress, also referred to the House Committee on Financial Services, would have added a new Section 16A to the Securities Exchange Act. This section would have prohibited the trading of securities if a person had material nonpublic information about the securities or knew or recklessly disregarded that the information was wrongfully obtained or that the securities transaction would involve a wrongful use of the information. The section would also have prohibited a person from communicating material nonpublic information about securities to others if: (1) others engaged in securities transactions based on the communication and (2) the securities transactions were reasonably foreseeable. The standard for the wrongfulness of a communication is based on information that has been obtained by activities such as theft, breach of a fiduciary duty, or violation of a federal law protecting computer data. Specific knowledge of how the information was obtained is not necessary for a violation so long as the person trading was aware or recklessly disregarded that the information was wrongfully obtained or communicated. The bill would also have authorized the SEC to provide exemptions from these prohibitions by rule if the exemptions were not inconsistent with the purposes of the section.

S. 702, 114th Congress, referred to the Senate Committee on Banking, Housing, and Urban Affairs, would have added a new subsection (d) to Section 10 of the Securities Exchange Act. This new subsection would have prohibited securities transactions on the basis of material information that a person knew or had reason to know was not publicly available. It also would have prohibited knowingly or recklessly communicating information that was not publicly available if it was reasonably foreseeable that the communication was likely to result in a securities transaction. "Not publicly available" would have been defined in such a way that it would not have included information that a person had independently developed from publicly available sources. The SEC would also have been authorized to provide for exemptions by regulations if it determined that such regulations were necessary or appropriate in the public interest and consistent with the protection of investors.

The Supreme Court's decision in Salman may accomplish at least part of the goals of the legislation proposed in the 114th Congress. However, the Salman decision does not appear to go as far as the bills in prohibiting the act of trading in securities with inside information and disclosing inside information. Salman addressed the issue of whether it is necessary for a tipper to receive something of a tangible nature when providing inside information to a trading relative or friend. However, the bills are not limited to relatives and friends; instead, they appear to prohibit in a broad way the trading of securities by any person who knows or should know that he possesses inside information.

Author Contact Information

[author name scrubbed], Legislative Attorney ([email address scrubbed], [phone number scrubbed])

Footnotes

1.

15 U.S.C. §§ 77a-77aa.

2.

The term "security" is defined very broadly in 15 U.S.C. § 77b(1) as:

any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a "security", or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.

3.

15 U.S.C. § 77e.

4.

Id. § 77h(a).

5.

Id. § 77aa.

6.

Id. § 77g.

7.

Id. § 77j(a).

8.

See, e.g., 17 C.F.R. Parts 230, 231, and 239.

9.

15 U.S.C. § 77d.

10.

Id. § 77c.

11.

Id. §§ 78a-oo.

12.

Id. § 78m.

13.

For purposes of this report, an "issuer" is a legal entity that issues publicly traded securities to fund its operations and is required to file material information through annual and other reports with the SEC.

14.

The phrase "held of record" refers to the entity that a company lists in its records as the registered holder of a security.

15.

In general, an "accredited investor" is an institutional investor or an individual with significant financial means and sophisticated investment knowledge. See 17 C.F.R. § 230.501.

16.

15 U.S.C. § 78l. As stated earlier, the 1933 Act requires the registration of a particular offering of securities. The 1934 Act requires the registration of a class of securities.

17.

15 U.S.C. §§ 78l, 78m, and 78n.

18.

Id. § 78l.

19.

Id. § 78m.

20.

Id. § 78n.

21.

Id. § 78l.

22.

See, e.g., 17 C.F.R. Parts 240, 241, and 249.

23.

15 U.S.C. § 78r(a).

24.

Id. § 78j(b).

25.

17 C.F.R. § 240.10b-5.

26.

See, e.g., State Teachers Ret. Bd. v. Fluor Corp., 654 F.2d 843 (2d Cir. 1981);Goldberg v. Meridor, 567 F.2d 209 (2d Cir. 1977).

27.

15 U.S.C. §§ 78a et seq.

28.

Id. § 78p.

29.

"Short-swing profits" are profits from the purchase and sale of a security within six months.

30.

Id. § 78p(a)(1).

31.

Id. § 78p(a)(2).

32.

Id. § 78p(a)(2)(C).

33.

Id. § 78p(b).

34.

Id. § 78j(b).

35.

17 C.F.R. § 240.10b-5.

36.

P.L. 98-376, 98 Stat. 1264 (Aug. 10, 1984) (codified, as amended, in 15 U.S.C. §§ 78a et seq.)

37.

H. Rept. 98-355, at 2 (1984).

38.

15 U.S.C. § 78u-1(a)(2).

39.

P.L. 100-704, 102 Stat. 4677 (Nov. 19, 1988) (codified, as amended, in a number of provisions of the federal securities laws).

40.
41.

15 U.S.C. § 78t-1.

42.

P.L. 112-105, 126 Stat. 291 (Dec. 3, 2012) (codified in provisions and notes of several titles of the U.S. Code, particularly in Titles 5 and 15).

43.

See 15 U.S.C. § 78u-1(g) for duty of Members and employees of Congress and 15 U.S.C. § 78u-1(h) for duty of other federal officials.

44.

For more information on the STOCK Act, see CRS Report R42495, The STOCK Act, Insider Trading, and Public Financial Reporting by Federal Officials, coordinated by [author name scrubbed].

1445.

The SEC typically seeks the civil penalties, and the Department of Justice typically seeks the criminal penalties.

1546.

See, e.g., 15 U.S. C. §C. § 78u-1.

47.
1648.

17 C.F.R. § 240.10b5-1.

1749.

17 C.F.R. §Id. § 240.10b5-1(a).

50.

Id. § 240.10b5-1(b).

51.

Id. § 240.10b5-1(c).

52.
1853.

17 C.F.R. §243.100–Id. § 240.10b5-2(b).

54.

Id. §§ 243.100-243.103.

55.

Id. § 243.100(a).

56.

213 U.S. 419 (1909).

57.

Id. at 431.

58.

Id. at 432-33.

59.

Id. at 434.

60.

40 SEC 907 (1961).

61.

Id. at 908-09.

62.

Id. at 913.

63.

Id. at 912.

64.

Id. at 914.

19.

213 U.S. 419 (1909).

20.

40 SEC 907 (1961).

21.

401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969).

2266.

Id. at 848.

445 U.S. 222 (1980).

2368.

Id.

69.

Id. at 224.

70.

Id.

71.

See United States v. Chiarella, 588 F.2d 1358 (2d Cir. 1978).

72.

445 U.S. 222 (1980).

73.

Id. at 235.

74.

Id. at 236.

75.

Id.

76.

Concurring and dissenting opinions in Chiarella suggest that, if the misappropriation theory of securities fraud had been presented, Chiarella, a financial printer employee who deduced information from the printing materials related to takeover bids and then traded based on the information, might have been found guilty under it. Chief Justice Burger believedopined that the employee's conviction should have been affirmed because the "evidence shows beyond all doubt that Chiarella, working literally in the shadows of the warning signs [stating the employer's confidentiality policy] in the printshop misappropriated—stole, to put it bluntly—nonpublic information entrusted to him in the utmost confidence." Chiarella, 445 U.SId. at 245 (Burger, C.J., dissenting). Although Justice Brennan disagreed with the Chief Justice's view of the evidence, he agreed that a "person violates section 10(b) whenever he improperly obtains or converts to his own benefit nonpublic information which he then uses in connection with the purchase or sale of securities." Id. at 239 (Brennan, J., concurring). Justice Blackmun, with whom Justice Marshall joined, wrote that, even without resting Chiarella's conviction on a misappropriation theory, he should have been convicted because he had "purloined" information (Blackmun, J., dissenting, id. at 246-252. Id. at 246-52 (Blackmun, J., dissenting). Justice Stevens, who concurred in the opinion of the Court, wrote separately, emphasizing the "fact that we have not necessarily placed any stamp of approval on what this petitioner did, nor have we held that similar actions must be considered lawful in the future." Id. at 238 (Stevens, J., concurring, id. at 238).

2477.

463 U.S. 646 (1983).

2578.

484 U.S. 19 (1987).

Id. at 648.
2679.

18 U.S.C. §§1341 and 1343Id. at 649.

80.
2781.

18 U.S.C. §371Id. at 651.

82.
2883.

Because of Justice Powell's retirement, there were only eight members of the Court at the time of the decision.

29.

92 F.3d 612 (8th Cir. 1996).

30.

521 U.S. 642 (1997).

31Id. at 667.
84.

Id. at 660.

85.

Id. at 664.

86.

Id. at 663.

87.

Id. at 665.

88.

Id. at 666.

89.

Id.

90.

Id.

91.

484 U.S. 19 (1987).

Id.. at 65623-24.

3293.

http://dealbook.nytimes.com/2014/12/10/appeals-court-overturns-2-insider-trading-convictions/?_r=0.

Id. at 93.
3394.

773 F.3d 438 (2d Cir. 2014)18 U.S.C. §§ 1341. 1343.

3495.

No. 13-1837 (L) (2d Cir. April 3, 2015)Id. § 371.

96.
3597.

773 F.3d at 450Id. at 22.

3698.

773 F.3d at 451Id. at 23.

3799.

Id.

100.

Id.

101.

Id.

102.

Id.

103.

Id. at 22-24.

104.

United States v. Carpenter, 791 F.2d 1024 (2d Cir. 1986).

105.

Id. at 1031.

106.

Id. at 1034-35.

107.

Because of Justice Powell's retirement, there were only eight Justices on the Court at the time of the decision.

108.

484 U.S. at 25-26.

109.

521 U.S. 642 (1997).

110.

Id. at 647.

111.

Id. at 647-48.

112.

Id. at 647.

113.

Id. at 648.

114.

Id. at 648-49.

115.

Id. at 649.

116.

92 F.3d 612 (8th Cir. 1996).

117.

521 U.S. 642 (1997).

118.

Id. at 656.

119.

773 F.3d 438 (2d Cir. 2014).

120.

Id. at 442.

121.

Id. at 449-52.

122.

Id. at 451-53.

123.

Ben Protess & Matthew Goldstein, Appeals Court Deals Setback to Crackdown on Insider Trading, Dealbook (Dec. 10, 2014), https://dealbook.nytimes.com/2014/12/10/appeals-court-overturns-2-insider-trading-convictions.

B. Protess and M. Goldstein, Appeals Court Deals Setback to Crackdown on Insider Trading, New York Times (December 10, 2014), located at http://dealbook.nytimes.com/2014/12/10/appeals-court-overturns-2-insider-trading-convictions/?_r=1.

It is possible that the Newman decision may affect only criminal insider trading cases brought by the government and may not have the same kind of impact on the proof needed to convict a person for civil violations related to insider trading. On April 6, 2015, a judge in the U.S. District Court for the Southern District of New York allowed the SEC to pursue a civil enforcement action in Securities and Exchange Commission v. Payton after the SEC had dropped the criminal insider trading charges in the wake of the Newman decision. See Kleinberg Kaplan, Civil Insider Trading Case Survives Newman, located at http://kkwc.com/publications/civil-insider-trading-case-survives-newman/.

38.

http. Alexandra Stevenson & Matthew Goldstein, U.S. Asks Supreme Court to Review Insider Trade Ruling, N.Y. Times (July 30, 2015), https://www.nytimes.com/2015/07/31/business/dealbook/us-asks-supreme-court-to-review-insider-trading-ruling.html?_r=01.

39125.

http://www.law360.com/articles/708238/breaking-supreme-court-rejects-newman-insider-trading-appeal136 S. Ct. 242 (2015).

40126.

792 F.3d 1087 (9th Cir. 2015).

41.

Judge Jed S. Rakoff, who is Senior Judge of the U.S. District Court for the Southern District Court of New York, wrote this Ninth Circuit decision. Judge Rakoff sits on a few Ninth Circuit panels each year and was assigned by lot to the Salman appeal127. Id. at 1093 (quoting Dirks v. SEC, 463 U.S. 646, 664 (1983) (emphasis added)).

42128.

792 F.3d at 1092, quoting from Dirks, 463 U.S. at 664—U.S.—, 137 S. Ct. 420 (2016).

43129.

Id. at 1093-94.

.
44130.

Id. at 1094.

. at 423-25.
45131.

Id. at 428.

132.

Id. at 428-29.

133.

Id. at 429.

134.

No. 14 Civ. 4644 (S.D.N.Y. April 6, 2015). On February 29, 2016, a jury in SEC v. Payton (No. 14 Civ. 4644 (S.D.N.Y. trial 2/29/16)) found the defendants guilty of insider trading. The SEC, seeking to comply with the dictates in the Newman decision, argued that the source of the inside information had received such benefits as rent reduction and legal assistance. The jury, in finding the defendants guilty, determined that these benefits complied with the requirements of Newman that personal benefits go beyond mere friendship and that traders further down the tipping chain knew or should have known about the benefits.

46.

Id., slip op. at 10-11.

47.

For more information on the possible federal circuit split, see CRS Legal Sidebar WSLG1353, Circuit Split on Insider Trading Law, by [author name scrubbed].

48.

United States v. Salman, cert. granted, 577 U.S. ___ (Jan. 19, 2016) (No. 15-628).