Anticipating a Sea Change for Insider Trading Law: From Trading Plan Crisis to Rational Reform

Abstract

The Securities and Exchange Commission is poised to take action in the face of compelling evidence that corporate insiders are availing themselves of rule-sanctioned Trading Plans to beat the market. These Trading Plans allow insiders to trade while aware of material nonpublic information. Since the market advantage insiders have enjoyed from Plan trading can be traced to loopholes in the current regulatory scheme, increased enforcement of the existing rules cannot address the issue. But, simply tweaking the existing rule structure to close these loopholes would not work either. This is because the SEC adopted the current rule as a part of a delicate compromise with the courts in the “use versus possession” debate over the proper test of scienter for insider trading liability. The current rule reflects the SEC’s preferred test (mere “awareness”), but it provides for Trading Plans as an affirmative defense in order to pass judicial scrutiny. Thus, any attempt to simply close the loopholes in Trading Plans while maintaining the awareness test would upset this delicate compromise. Only a comprehensive change to the current insider trading enforcement regime can address the issue. The reform proposed here begins with the recognition that Plan trading is generally done with the firm’s awareness and consent. Such trading is therefore a form of issuer-licensed insider trading. Since there are strong arguments that there is no moral wrong or economic harm done by issuer-licensed insider trading, the regulatory regime should openly embrace it as a permissible form of compensation through firm-sanctioned Modified Trading Plans, so long as there is adequate disclosure. Though such liberalization would represent a radical departure from the current enforcement regime, it would be within the SEC’s rulemaking authority, and would be consistent with Supreme Court precedent. Most importantly, it would dramatically improve the current enforcement regime in terms of justice, clarity, efficiency, and coherence. It is sometimes said there is nothing like a good crisis for effecting much needed change. The current media attention and public scrutiny over corporate insiders’ exploitation of rule-sanctioned Trading Plans may be just the crisis to spur the SEC to adopt a more rational and just approach to insider trading enforcement. The outline for such reform is proposed here.