Notwithstanding the widely held perspective that American efforts to tackle financial wrongdoing significantly overshadow efforts in Canada, many observers have lamented the absence in the United States of a clearly worded, statutory prohibition on insider trading such as is found in Canadian securities legislation. Some observers say that the absence of such a prohibition has led to a more malleable legal regime arising from judge-made law, rather than one reflective of articulated legislative intent.
Efforts in the United States to more effectively combat insider trading took a step forward on May 18, 2021, when the United States House of Representatives passed the Insider Trading Prohibition Act (H.R. 2655, 117th Cong.) (the Bill). The Bill aims to bring uniformity and consistency to a prosecution framework that has largely been constructed by judge-made law, and which has led to interpretive difficulties for prosecutors, regulators and market participants across the United States.
The Bill is identical to another bill passed in December 2019, which died on the table before the Senate’s then-Republican majority. Now that the Senate is controlled by the Democrats, the dynamics have shifted and the Bill is expected to be passed. If passed and ultimately signed into law, the Bill will amend the Securities Exchange Act of 1934 (the Exchange Act) to expressly prohibit both the trading of securities while aware of Material Non-Public Information (MNPI), and the wrongful communication of MNPI.
These provisions would be the first specific statutory prohibitions of insider trading in United States law. To date, insider trading is addressed under the rubric of fraud. Securities Exchange Commission (SEC) Rule 10b-5, an anti-fraud rule codified pursuant to the SEC’s authority granted under Section 10(b) of the Exchange Act, is the primary basis for prosecuting insider trader. We have previously written in detail on the mechanics of the proposed legislation and the changes it will bring to the existing insider trading prosecution framework in the United States. Most fundamentally, the Bill would shift the insider trading analysis away from the concept of civil fraud and toward the more broadly defined concept of “wrongfully” obtained MNPI. The Bill’s prohibition on the use and/or communication of MNPI obtained “wrongfully” would, in effect, expand liability beyond situations where MNPI was obtained in breach of a duty of trust or confidence, to include theft, bribery, misrepresentation, espionage, violations of federal statutes protecting computer data, conversion, misappropriation, or deceptive taking of MNPI.
While the Bill will bring a measure of consistency and certainty for regulators, prosecutors, and market participants alike, in order to get the Bill passed, it was amended to include a potentially significant limitation. The Bill requires that, in order to convict a tipper who holds MNPI in the capacity of a fiduciary or pursuant to a confidentiality or other contractual arrangement, the tipper must have received some form of “personal benefit” by communicating the MNPI (which is defined in the Bill to include “pecuniary gain, reputational benefit, or a gift of confidential information to a trading relative or friend”). The “personal benefit” requirement originally made its way into the 2019 predecessor to the Bill as an eleventh-hour concession by House Democrats in order to get certain key Republicans onside and remains in the Bill that has now passed in the House.
The “personal benefit” requirement imposes an additional hurdle that does not exist in Ontario’s enforcement regime. Although the Bill defines “personal benefit” broadly, it would appear to make it more difficult to address the paradigmatic tipping situations where corporate directors or executives gratuitously disclose MNPI (imprudently or by design) among friends, in an informal setting such as on the golf course, in exchange for no valuable consideration. It is interesting to consider what the result would have been, under the framework proposed in the Bill, in a case like Finkelstein v. Ontario Securities Commission, 2018 ONCA 61 (Finkelstein). In Finkelstein, a lawyer tipped his close friend that a private equity firm would soon be acquiring all of a certain public company’s issued and outstanding shares. This in turn set off a chain of tipping that resulted in a series of trades which netted the tippees profits of about $2 million collectively. A panel of the Ontario Securities Commission found that Finkelstein had engaged in tipping under the provisions of Ontario’s securities legislation in spite of the absence of proof that he had derived a personal benefit from his conduct.
As Finkelstein shows, the fact that there is no readily identifiable quid pro quo or benefit which accrues to the tipper does not preclude an insider trading conviction under Ontario securities law. In contrast, it is at best unclear how the disclosure of MNPI in a case like Finkelstein would be treated under the Bill’s enforcement regime. It may be that a “personal benefit” in Finkelstein-type cases will be found in the guise of a “reputational benefit, or a gift of confidential information to a trading relative or friend”, but it remains unknown how flexibly these concepts will be treated by courts and regulators in the United States. One wonders whether the inclusion of the “personal benefit” requirement will ultimately render the new insider trading legislation less effective in some of the most common tipping fact situations. The policy reasons behind the “personal benefit” requirement are unclear, given how critically important it is that those in a position of trust within a corporation safeguard the confidential information to which they are privy.
Notwithstanding the above, the framework proposed in the Bill will undoubtedly bring a measure of certainty to the insider trading enforcement regime in the United States. To that extent, the Bill should assist firms and other market participants seeking to manage compliance and other risks that arise with respect to the use and communication of MNPI.