'Insider Trading' Is in the Eye of the Judicial Beholder

The contemporary state of what passes for insider trading "law" is enough to perplex even lawyers and law professors.

Did Rep. Christopher Collins (R-N.Y) commit the federal crime of securities fraud when he spoke to his son, Cameron, on the phone shortly after he found out bad news about an Australian biotechnology company that they both held shares in?

The answer may depend in part on which one of the 12 regional federal appellate circuits hear the appeal of the case. It may depend on which three appellate judges on such a circuit happen to be chosen to hear such an appeal. Even the same three appellate judges may significantly revise their view of the matter, applied to the same facts, over the course of less than a year, so the answer may depend in part on when Collins happens to catch the judges.

Such is the contemporary state of what passes for insider trading "law." It's enough to perplex even lawyers and law professors. "'It's Complicated': The Evolving Case Law on How Relationships Impact Insider Trading Liability," is how two lawyers at the firm Orrick headlined a blog post about the issue. A former federal prosecutor who is now a professor at Brooklyn Law School, Miriam Baer, last year published an article in the Yale Law Journal highlighting what she said was "the extent to which insider trading law falls short of criminal law's legality principle."

Baer explained that this "legality principle" includes "two distinct but related concepts. First, criminal prohibitions should be set forth with sufficient clarity to inform citizens in advance of what is prohibited; second, and of more importance in this context, crime creation is reserved solely for the legislature. Judges do not make crimes; legislatures do."

A timeline of recent developments on this legal front is a reminder of just how complicated, evolving, unclear, and judge-written this area of the law is. The particular area of interest in the Collins case isn't trading by an actual insider—the congressman, Christopher Collins, who was a member of the biotech company's board, didn't sell any of his own shares—but by someone, such as the congressman's son Cameron, who was allegedly tipped off by the insider.

In 1983, the Supreme Court ruled in Dirks v. Securities and Exhange Commission (SEC) that "the elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient."

In 2012, Judge Jed Rakoff, in United States v. Whitman, observed, "the prohibition of insider trading in the United States has developed in a somewhat ad hoc manner, leaving many unanswered questions." Rakoff noted Congress had never passed a general law outlawing insider trading, "partly because the SEC has generally opposed such proposals on the ground that that any statutory definition of illegal insider trading would inevitably create 'loopholes.'" Rakoff noted, however, that "the judge-made law of insider trading, however flexible, can create potential gaps in coverage that are the functional equivalent of legislative loopholes."

On November 10, 2014, Justices Scalia and Thomas issued an unusual statement indicating that they'd "be receptive" to hearing a case challenging the SEC's power to define insider trading. The justices contended that allowing the SEC to do so collides with "the norm that legislatures, not executive officers, define crimes." Said Scalia, joined by Thomas: "When King James I tried to create new crimes by royal command, the judges responded that, 'the King cannot create any offence by his prohibition or proclamation, which was not an offence before.'"

On December 10, 2014, a three-judge panel of the U.S. Court of Appeals for the Second Circuit issued a ruling in United States v. Newman that raised the bar for the government to prove these cases. "The corporate insider has committed no breach of fiduciary duty unless he receives a personal benefit in exchange for the disclosure…even in the presence of a tipper's breach, a tippee is liable only if he knows or should have known of the breach," the Second Circuit judges Barrington Parker, Ralph Winter, and Peter Hall contended, acknowledging yet dismissing Judge Rakoff's accusation that the appellate court had been "somewhat Delphic" in discussing "what is required to demonstrate tippee liability."

On December 6, 2016, the Supreme Court ruled unanimously in Salman v. SEC, and in weirdly hypothetical language, somewhat overrules the Second Circuit's Newman ruling: "To the extent the Second Circuit held that the tipper must also receive something of a 'pecuniary or similarly valuable nature' in exchange for a gift to family or friends, we agree with the Ninth Circuit that this requirement is inconsistent with Dirks."

On August 23, 2017, Judges Robert Katzmann and Denny Chin of the Second Circuit ruled in United States v. Martoma, which addresses the same issues. On June 25, 2018, they issued a different, "amended," decision in the same case. Judge Rosemary Pooler dissented from both the original decision and the amended one. Commenting on the second decision—"Martoma II"—a former SEC official now working for a law firm, Kevin Hamisch, wrote, "Future litigation will undoubtedly be necessary to bring clarity to the question of what constitutes a meaningfully close relationship for purposes of tipper and tippee liability."

Such "future litigation" will undoubtedly provide plenty of paid work for the lawyers involved, but it's not much consolation to any market participants who might, with some reason, prefer clarity to the current confusing and complex series of improvisations.

The Collins criminal case was brought by prosecutors in the Southern District of New York, which is in the Second Circuit, and involves trades made in June of 2017.

There are other charges in the indictment beyond securities fraud, including conspiracy, wire fraud, and making a false statement to a federal official. Those are topics for another day, as is how our drug approval system manages to generate so many insider trading cases.

Rep. Collins, a Republican from New York, has pleaded not guilty. His best hope may be that he draws Judges Pooler, Parker, Hall or Winter on appeal rather than Chin or Katzmann, or that, if the case reaches the Supreme Court, it triggers the review invited by Scalia or Thomas.

Absent that, he may be left to experience a kind of poetic justice. As a congressman, Collins had and has the power to write law to prevent the SEC, judges, and prosecutors from inventing new crimes. Collins and his colleagues have so far neglected to do that. Now a lawmaker who failed to defend the legislature's sole prerogative to define crimes is getting a personal and close-up lesson in the consequences of that default.

Ira Stoll is editor of FutureOfCapitalism.com and author of JFK, Conservative.