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1 1 (November 9, 2021)

handle is hein.crs/goveetz0001 and id is 1 raw text is: C o n gr e s o a e s a c S enI S November 9, 2021 Insider Trading Insider-trading law has been shaped by competing institutional forces and theoretical perspectives. While the Securities and Exchange Commission (SEC) and federal prosecutors have pushed for broad theories of liability rooted in the value of equal access to information, the courts have implemented a narrower framework predicated on fiduciary duty and fraud. Congress, however, has not weighed in on this back-and-forth. Despite the attention insider trading attracts, legislators have not enacted a statutory definition for the offense. Its elements are instead the product of judicial decisionmaking, with SEC rules supplementing the core prohibition. Nevertheless, recent Congresses have shown increasing interest in insider trading, featuring several bills that would codify the elements of the offense and fill perceived gaps in existing doctrine. This In Focus provides an overview of insider- trading law and recent efforts at legislative reform. The Evolution of Insider-Trading Law Origins The modern insider-trading prohibition is grounded in Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5. Those provisions impose broad prohibitions of fraud in connection with securities transactions, but do not explicitly mention insider trading. Nevertheless, the courts and regulators have constructed a complex legal regime on top of this modest textual foundation. The story begins in 1961, when the SEC first deployed Rule 10b-5 to tackle open-market trading on the basis of inside information. In that year, the Commission settled an administrative enforcement action against a brokerage-firm partner who sold shares of the Curtiss-Wright Corporation after learning of an impending dividend cut from one of the corporation's directors. The enforcement action-In re Cady, Roberts & Co.-marked the SEC's first articulation of what became known as the disclose or abstain rule, under which persons with special access to a corporation's material nonpublic information must either disclose such information or abstain from trading the corporation's securities. While Cady, Roberts represented a notable expansion of Rule 10b-5, the Second Circuit accepted the SEC's position seven years later in SEC v. Texas Gulf Sulphur Co. The case offers a common insider-trading fact pattern: after a mining company discovered promising mineral deposits- but before it announced the discovery-several insiders bought the company's shares and options to acquire its shares. The Second Circuit embraced the SEC's view that this conduct violated Rule 10b-5. In doing so, the court articulated a broad theory of insider-trading liability premised on the notion that all investors should have equal access to material information about the securities they trade. Although the defendants in Texas Gulf were insiders, the court's opinion did not limit the disclose or abstain rule to a corporation's officers, directors, and agents. Instead, the Second Circuit explained that the requirement applied to anyone in possession of material nonpublic information-regardless of their relationship to the securities issuer. The Supreme Court Alters the Approach The equal-access gloss on Rule 10b-5 did not last. In 1980, the Supreme Court rejected that theory in Chiarella v. United States. The case involved an employee of a financial printer that prepared tender-offer documents for acquirers. Based on information in these documents, the employee identified firms that were being targeted for acquisition and purchased their shares before the bids were announced. The employee thus clearly traded on the basis of material nonpublic information. Nevertheless, he was not an insider of the targeted firms, nor did his employer-which served the acquirers-have any special relationship with them. In Chiarella, the Court reversed the employee's insider- trading conviction based on the absence of such a relationship. According to the Court, a trader's failure to disclose a material fact is fraudulent-and therefore violates Rule lOb-5-only if the trader has a duty to disclose the fact. There is no such duty, however, absent a fiduciary or other similar relation of trust and confidence. While the Court acknowledged that corporate insiders owe fiduciary duties to buyers and sellers of their companies' shares, it concluded that the defendant in Chiarella had no such relationship with the shareholders of the targeted firms. The Court therefore reversed the defendant's conviction because the trial court's jury instructions improperly allowed for a conviction without a finding of the requisite relationship. In rejecting the equal-access model from Texas Gulf, Chiarella sets forth the basic contours of what has been called the classical theory of insider-trading liability, under which corporate insiders who trade on material nonpublic information violate Rule 10b-5 by breaching a duty to their counterparties (buyers or sellers). The decision explicitly declined to consider an alternative theory, under which persons who trade on material nonpublic information can violate Rule 10b-5 by breaching a duty to the source of the information (in Chiarella, the acquirers that had retained the defendant's printing firm). This misappropriation theory would remain in limbo until the Supreme Court embraced it in its 1997 decision in United States v. O'Hagan. In that case, a partner at a law firm representing an acquirer in a takeover bid purchased ittps://Crsreports.congress.gt

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