24 Aug H.R. 2534 is the Most Significant Expansion and Clarification of Insider Trading Law in Decades
Most people would be shocked to learn that Insider trading law has never been statutorily defined. Instead, it’s a hodge-podge of Judge made law that has been criticized due to the ambiguous requirements to prove insider trading laid out in the case law over time. As we’ve seen in the past few years, different circuits and different Judges don’t always agree on the prevailing law. This makes it difficult for everyone from juries to defendants, and agencies like the SEC or DOJ to pinpoint with clarity whether insider trading has occurred.
On May 7, 2019, Representative Jim Himes (D-Conn) introduced proposed legislation that would amend the Securities Exchange Act of 1934, 15 U.S.C § 78a et seq. (the “Act”). The aptly named “Insider Trading Prohibition Act” (H.R. 2534) would amend the Act by explicitly defining and broadening the elements of criminal insider trading.
Subsequently, it would significantly expand the potential scope of criminal liability for insider trading in several ways. First, it would eliminate the existing “personal benefit” requirement. Second, it would lessen the scienter requirement from ‘willful’ to the more relaxed ‘reckless’ use of “wrongfully obtained” MNPI. Finally, it would expand the definition of “wrongfully obtained” information to include stolen, hacked, and fraudulently obtained information.
The current insider trading law places the burden on the government to prove that a defendant breached a duty of trust and confidence, by using or tipping material non-public information (MNPI) for personal gain. The SEC has had difficulties at times to find a relationship relevant enough to show that a defendant breached a duty by trading on confidential information.
The new legislation would make it easier to establish a violation of insider trading laws. The bill would make it a violation to trade while in possession of material, nonpublic information “if such person knows, or recklessly disregards, that such information has been obtained wrongfully, or that such purchase or sale would constitute a wrongful use of such information.”
That would make it easier to use circumstantial evidence to show that a defendant knew, or at least was aware and chose to ignore, the source of the information. The Insider Trading Prohibition Act also makes it unlawful for a person who wrongfully obtains material nonpublic information to communicate the tip to another person when it is ‘reasonably foreseeable’ that the person is likely to trade based on that information. This makes “reckless” behavior punishable as well.
Instead of a breach of a duty, the bill uses a “wrongfully obtained” standard. “[W]rongfully obtained” is defined to include MNPI obtained by: (i) “theft, bribery, misrepresentation, or espionage (through electronic or other means);” (ii) “a violation of any Federal law protecting computer data or the intellectual property or privacy of computer users;” (iii) “conversion, misappropriation, or unauthorized and deceptive taking of such information;” or (iv) “a breach of any fiduciary duty, a breach of a confidentiality agreement, a breach of contract, or a breach of any other personal or other relationship of trust and confidence.” Id. at § 16A(c)(1).
One notable difference between the new bill and current insider trading legislation is the addition of information obtained through hacking before its release to the public. Normally, hackers do not owe a duty of trust per current insider trading laws. Under the proposed legislation, hackers’ efforts to obtain confidential information by breaching data security measures would make them subject to the insider trading violation.
Furthermore, current law requires that prosecutors show that a benefit flowed from the tippee to the tipper, a difficult burden of proof in some cases. The new act would eliminate that requirement altogether.
The bill provides that it is not necessary for the investigators to demonstrate whether a personal benefit was paid, so long as the person trading was in possession of information and was aware that the information was wrongfully obtained. Thus, simply knowing that information was wrongfully obtained, or consciously ignoring that fact, would be enough to prove a violation regardless of any personal relationship with the source.
While the new legislation still has quite a bit to go until passed into law, the fact that the House Financial Services Committee unanimously approved does increase its odds of seeing a full vote in the House and Senate. If the proposal eventually passes, it will represent quite a significant expansion and clarification of the current U.S. insider trading laws.