Insider Trading: Where is the Line?

Abstract

Following the contours of the Securities and Exchange Commission’s seminal Cady, Roberts opinion in 1961, the federal courts developed the law of insider trading in two reasonably clear and predictable molds. Corporate insiders will incur liability for trading on material nonpublic information in breach of the duty they owe their corporations and shareholders, and corporate outsiders will be liable if they misappropriate and trade on such information in breach of a duty they owe to the source of their information. Recent cases have blurred the lines of liability for insider trading. Courts now may impose liability on defendants in situations where it is unclear whether they assumed any duty to the corporation or other source of their information, where the information in question is vague or speculative in nature, and where it is unclear that they acted with the requisite mental state. Compounding this uncertainty, the SEC and the Justice Department have made insider trading a high prosecutorial priority and are expending substantial resources and using new tools to bring insider trading cases that would not have been pursued in earlier times. Faced with uncertain liability parameters and intense enforcement efforts, prudent traders may conclude that any trade based on significant nonpublic information is just too risky. A wrong guess on any duty, materiality, or scienter element­­––finally resolved years later on appeal––can lead to imprisonment, or at least heavy civil fines, and a ruined career. Yet such a determination not to trade on significant nonpublic information effectively pushes these prudent traders into a so-called “parity-of-information” regime, in which all significant information must be publicly disclosed before it can be used for trading. While Congress, the SEC, and the courts have consistently rejected parity of information as an explicit legal requirement, the European Union’s enforcement model specifically embraces parity. The SEC and DOJ commitment to insider trading enforcement is to be commended for promoting fair markets for both ordinary and sophisticated investors, and thus for encouraging capital formation and economic growth. But it is an enforcement program that can be enhanced­­––and a parity regime avoided––through clear definition of the elements of the offense, through good case selection, and through alternative disposition paths to fairly and efficiently resolve smaller and less clear cases.