Litigators Fear Congressional Fixes To Newman

Law360, New York (March 31, 2015, 1:28 PM ET) -- The latest of three proposed insider trading bills may be more comprehensive than the first two, but securities litigators fear a congressional answer to the Second Circuit’s landmark Newman decision may be a bad idea no matter what.

The first bill, known as the “Ban Insider Trading Act of 2015," was introduced by Rep. Stephen F. Lynch, D-Mass., on Feb. 27, just a month after Manhattan U.S. Attorney Preet Bharara asked the Second Circuit to reconsider its December ruling to overturn the insider trading convictions of two hedge fund managers and significantly narrow the scope of what makes insider trading a crime.

In a statement announcing his legislative proposal, Lynch called on Congress to enact a “robust” statute to protect the markets in the wake of the appellate court’s “ill-advised” decision. His bill would amend Section 10 of the Securities Exchange Act to make it a federal crime to purchase or sell any security based on any information an individual knows or should know is material inside information.

“It is obvious from the Newman case that we need clarity in this area in order to create a bright-line distinction between what is permissible and prohibited,” Lynch said.

But many securities litigators, including Ian Roffman, chairman of the litigation department at Nutter McClennen & Fish LLP, believe that clarity may not be that easy — or practical — to achieve.

“The more simple and straightforward the statute, the less confusion there is likely to be but the more likely the statute is going to make illegal trading that shouldn’t be,” said Roffman, former senior trial counsel in the SEC’s Boston regional office.

Insider trading is not currently considered a specific crime under federal law. Rather, insider trading prosecutions have been based on over 50 years of court rulings and SEC rules that have developed on top of generic anti-fraud provisions of federal securities laws, including Section 10b of the Securities Exchange Act of 1934. 

Under the Newman standard, the government must prove that an insider was entrusted with a fiduciary duty, that the insider breached that duty by disclosing confidential information in exchange for a personal benefit, and that the tippee knew that the information was confidential and disclosed for a benefit. The tippee must then use that information to trade or for benefit.

“Insider trading law tries to balance between competing interests of, on the one hand, facilitating more information in the market, and on the other hand, restricting sources of information that are somehow deemed to be inappropriate,” said Roffman, who added that all three of the proposed bills “move the needle” toward restricting information, in direct response to the Newman decision.

Lynch’s bill seeks primarily to address the question of what information would be considered “material” in an insider trading case. The two bills that have been proposed since then both address the question of how the information is allowed to be obtained or used.

Those are the “Stop Illegal Insider Trading Act," proposed by Sens. Jack Reed, D-R.I., and Bob Menendez, D-N.J., on March 11, and the “Insider Trading Prohibition Act," introduced by Rep. Jim Himes, D-Conn., on March 25.

The senators’ bill, which is the shortest by far, would amend Section 10 to make it illegal for a person to trade securities based on material information that he or she knew or had reason to know was not publicly available — regardless of whether the individual knew that the source of the tip had a fiduciary duty or received a personal benefit.

Himes’ bill would make changes to Section 16 of the Exchange Act and define more explicitly what would constitute “wrongfully obtaining” information, among other provisions.   

But Jacob Frenkel of Shulman Rogers Gandal Pordy & Ecker PA said that while the Himes bill is the most “workable,” “comprehensive” and “thoughtful,” all of the bills still fall short.

“Assuming there is an insider trading prohibition enacted into law, would the [U.S. Securities Exchange Commission] and [Department of Justice] then charge 10b and the new insider trading law as a violation?” he asked. “Or just the insider trading law? So the question is, is this going to be an addition or an instead of?”

Rather than create additional confusion, Congress should leave the issue of insider trading to the courts, Frenkel said.

“10b has worked for more than 50 years to cover insider trading,” said Frenkel. “There’s no reason it cannot continue to work.”

Day Pitney LLP Managing Partner Stan Twardy also said he feared additional complications should a bill be passed.

“Each of these is coming in and trying to define certain things,” he said. “The question is whether they will undermine their intent by creating something that is not how people prosecute these cases.”

It may also be too soon for any bill to get passed, Twardy added. The Second Circuit is still considering Bharara’s request for a rehearing en banc, and even if its previous decision is affirmed, the case could go up before the U.S. Supreme Court.

“You have Congress trying to step in here, but the courts haven’t really resolved this one way or another,” he said.