House Passes Proposed Legislation Defining Insider Trading
Since the Second Circuit’s 2014 decision in United States v. Newman triggered a debate about the personal benefit requirement, several bills have been introduced in Congress to define insider trading. The most recent effort is H.R. 2534, the Insider Trading Prohibition Act, which the House of Representatives passed overwhelmingly last week. The bill would codify certain aspects of the judicially created body of insider trading law. Although we understand that the Senate is unlikely to consider this legislation at least in the near term, the bill’s provisions – if ever enacted – could make it easier for the government to prove insider trading cases, at least against individuals.
H.R. 2534 would prohibit the purchase or sale of securities while the trader is aware of material nonpublic information (“MNPI”) if the purchaser or seller “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.” Trading would be considered wrongful if the information was obtained (i) through theft, bribery, misrepresentation, or espionage, (ii) in violation of any federal law “protecting computer data or the intellectual property or privacy of computer users,” (iii) through “conversion, misappropriation, or other unauthorized and deceptive taking of such information,” or (iv) in breach of any fiduciary duty, confidentiality, contract, code of conduct or ethics policy, “or any other personal or other relationship of trust and confidence.”
H.R. 2534 thus would appear to codify aspects of insider-trading law as we know it. For example, the prohibition on trading while “aware” of information reflects the “knowing possession” standard used in the Second Circuit as well as the standard set out in SEC Rule 10b5-1(b) (a trade is “on the basis of” MNPI if the person “was aware of” the MNPI at the time of the trade). Note that the House debated but ultimately rejected a proposed amendment to change the “aware of” MNPI standard to a “while using” standard.
However, unlike current insider trading law, the bill would appear to eliminate the personal benefit requirement. It prohibits wrongfully tipping information where later trading is “reasonably foreseeable”, but does not require that a tipper or tippee be aware that a tipper had received a personal benefit in exchange for providing information in breach of a duty. To the contrary, the bill makes clear that the government is not required to show the trader knew “the specific means by which the information was obtained or communicated, or whether any personal benefit was paid or promised by or to any person in the chain of communication” as long as “the person trading while aware of such information . . . was aware, consciously avoided being aware, or recklessly disregarded that such information was wrongfully obtained, improperly used, or wrongfully communicated.”
The bill further states that, except as provided under Exchange Act § 20(a)’s control-person liability provision, no person shall be liable “solely by reason of the fact that such person controls or employs a person who has violated this section, if such controlling person or employer did not participate in, or directly or indirectly induce the acts constituting the violation of this section.” This provision could provide protection to a fund manager whose employee has gone rogue, as long as the employer itself did not participate in or induce the alleged misconduct.
The final version of H.R. 2534 deleted an initial proposal providing an interim exemption for “automatic trading transactions” and requiring the SEC to determine whether “automatic trading transactions” should be exempted. Instead, the bill provides that its prohibitions would not apply to transactions that satisfy the requirements of Rule 10b5-1, and would require the SEC to review and make any appropriate modifications to Rule 10b5-1 in accordance with the proposed act.
Earlier this year, Congress considered additional efforts to amend the insider-trading laws, although no further action appears to have been taken so far on these bills. In January 2019, the full House passed a separate, bipartisan bill (115H6320) calling for the SEC to study whether Rule 10b5-1 should be amended in certain aspects. In September 2019, parallel bills were proposed in the House (H.R. 4335) and the Senate (S. 2488) to plug the so-called “8-K trading gap.” Those bills would require the SEC, within one year after the proposed legislation’s enactment, to issue rules requiring issuers to establish policies, controls, and procedures to prevent officers and directors from trading the issuers’ securities between (i) either the date a reportable event occurs or the date the issuer determines to report that event and (ii) the date the issuer files a Form 8-K or furnishes it to the SEC.