On May 18, the U.S. House of Representatives passed H.R.2655, the Insider Trading Prohibition Act. If passed by the Senate, the legislation would be the first dedicated legislation to combat insider trading. For decades, the Department of Justice and Securities and Exchange Commission have enforced insider trading prohibitions under § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. However, this was never a perfect marriage as § 10(b) is, at its core, an anti-fraud statute, and not all insider trading cases present the elements of fraud necessary to bring enforcement actions under § 10(b) and Rule 10b-5. As the government stretched the language of the statute and rule to curtail problematic conduct, the conduct being investigated drifted further and further from the purpose and language of § 10(b). Enforcement attorneys and academics have long argued that Congress needed to act to codify the prohibition on insider trading, and it looks like they may finally get their wish.
The bill passed by the House does not merely codify existing case law on insider trading, although some elected officials say that is all the statute does. The language of the bill outlaws trading that is clearly problematic but is just outside the language of § 10(b). For example, trading based on information that has been obtained from a hack of a company has sometimes been outside the reach of DOJ and SEC. That is because § 10(b) prohibits manipulation or deception, and Rule 10b-5 prohibits fraud, deceit, or false or misleading statements or omissions. Hacking occasionally employs deception, but sometimes simply exploits vulnerabilities in software or overwhelms the victim’s system. Those did not fall squarely within the language of the statute or the rule. The government also had difficulty proving the connection between the hacking and the trading. Under the bill passed by the house, trading is prohibited if done while aware of material non-public information and with the knowledge that the information was obtained in “violation of any Federal law protecting computer data or the intellectual property or privacy of computer users.” This language opens up a whole new frontier for insider trading enforcement.
The bill broadens the enforcement landscape for insider trading and brings new types of information under its purview. The bill also simplifies tipper-tippee liability by effectively eliminating the personal benefit requirement. It is enough that the trader knows that the information was wrongfully obtained, used, or communicated. Tipper liability does not require a breach of a fiduciary duty or a relationship of trust and confidence under the bill. It is enough that the information was provided in violation of a contract, confidentiality agreement, or code of conduct or ethics, and almost any benefit to the tipper will satisfy the requirements of the bill. If passed by the Senate, the bill would greatly expand the universe of potential targets of insider trading investigations and would likely precipitate an immediate uptick in DOJ and SEC enforcement.
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