Introduction: Mapping the Future of Insider Trading Law: Of Boundaries, Gaps, and Strategies

Abstract

The current law on insider trading is remarkably unrationalized because it contains gaps and loopholes the size of the Washington Square Arch. For example, if a thief breaks into your office, opens your files, learns material nonpublic information, and trades on that information, he has not breached a fiduciary duty and is presumably exempt from insider trading liability. But drawing a line that can convict only the fiduciary and not the thief seems morally incoherent. Nor is it doctrinally necessary. The basic methodology handed down by the Supreme Court in SEC v. Dirks and United States v. O’Hagan dictates (i) that a violation of the insider trading prohibition requires conduct that is “deceptive” (the term used in Section 10(b) of the Securities Exchange Act of 1934), and (ii) that trading that amounts to an undisclosed breach of a fiduciary duty is “deceptive.” This formula illustrates, but does not exhaust, the types of duties whose undisclosed breach might also be deemed deceptive and in violation of Rule 10b-5. Many forms of theft or misappropriation of confidential business information could easily be deemed sufficiently deceptive to violate Rule 10b-5. More generally (and more controversially), the common law on finders of lost property (which generally treats a finder as a bailee for the true owner) might be used to justify a duty barring recipients from trading on information that has been inadvertently released or released to them without lawful authorization. Nonetheless, current law has stopped short of generally prohibiting the computer hacker and other misappropriators who make no false representation and do not compensate the tipper. This article surveys possible means by which to fashion a more coherent and consistent prohibition on insider trading. It assumes that legislation is unlikely (and might even aggravate the problem), but that the SEC has broad discretion to adopt rules (just as it did in 2000 in adopting Rule 10b5-1 and 10b5-2). Specific rules are proposed. At the same time, this article acknowledges that the goal of reform should not be to achieve parity of information, and that there are potentially high costs in attempting to extend the boundaries of insider trading to reach all instances of inadvertent release. Deception, it argues, should be the key, both for doctrinal and policy reasons.