In the past, there has been no law in the US establishing what makes up insider trading. However, that all may change as the House Financial Services Committee recently passed a bill that would define what is required to prove insider trading, and potentially expand current insider trading liability established by case law.
HR 2534, the Insider Trading Prohibition Act
Earlier this month, the Financial Services Committee unanimously passed HR 2534, the Insider Trading Prohibition Act, a bill sponsored by Congressman Jim Himes’s (CT-04). The bill would make it a federal crime to trade a security based on material, nonpublic information that was wrongfully obtained. The Insider Trading Prohibition Act:
- Makes it unlawful for a person to trade on material nonpublic information when the information was wrongfully obtained, or when the use of such information to make a trade would be deemed wrongful;
- Makes it unlawful for a person who wrongfully obtains material nonpublic information to communicate that “tip” to another person when it is reasonably foreseeable that the person is likely to trade on that information;
- The bill defines “wrongful” as information that has been obtained through “theft, bribery, misrepresentation or espionage, a violation of any federal law protecting computer data or the intellectual property or privacy of computer users, conversion, misappropriation or other unauthorized and deceptive taking of such information, or a breach of any fiduciary duty or any other personal or other relationship of trust and confidence.”
- Removes the requirement outlined in Newman that a person who receives a “tip” (a “tippee”) and trades on that information have any knowledge that the “tipper” received a personal benefit, so long as the tippee was aware, or recklessly disregarded, that the information was wrongfully obtained or communicated.
- Authorizes the SEC to exempt any person or transaction from liability under this bill at the Commission’s discretion.
Congressman Jim Himes commented on the rationale for bringing this bill forward, “It is unfair to Americans and harmful to the markets when individuals trade on material, non-public information. But, inexplicably, to this point there has not been legislation codifying the law in this area. Today we took a big step forward to solving that problem.”
If passed by the House and Senate, HR 2534 will broadly expand insider trading liability in a few ways. Instead of focusing on the “breach of a duty” to keep information confidential, the new bill focuses on the “wrongful” collection and communication of material nonpublic information by the tipper, or trading on information that was “wrongfully” obtained by the tippee.
The bill defines “wrongful” as information that has been obtained through “theft, bribery, misrepresentation or espionage, a violation of any federal law protecting computer data or the intellectual property or privacy of computer users, conversion, misappropriation or other unauthorized and deceptive taking of such information, or a breach of any fiduciary duty or any other personal or other relationship of trust and confidence.” This definition is quite broad, enabling the government to more easily prove insider trading violations, as well as giving it the flexibility to take on cases it couldn’t prove in the past.
One difference between HR 2534 and current insider trading prohibitions is the addition of information obtained through computer hacking before its release to the public. Normally, hackers do not owe a duty of trust and confidence as the current insider trading law requires. Under the new legislation, hackers’ efforts to obtain confidential information by breaching computer security measures would be subject to the insider trading prohibition.
Another key difference between existing law and the definition of insider trading presented by HR 2534 is the current requirement established under Newman that a person who receives a “tip” and trades on that information have knowledge that the “tipper” received a personal benefit for providing the material nonpublic information. HR 2534 removes this requirement. All that is needed to prove insider trading is that the tippee was aware, or recklessly disregarded, that the information was wrongfully obtained or communicated, and still traded on it.
HR 2534 is a long way from becoming law as it still must be passed by the full House, Senate and then signed by President Trump. However, it is noteworthy that the Financial Services Committee chose to address this issue, and that it passed the Insider Trading Prohibition Act unanimously. Clearly, we will keep watch on this bill’s progress as the new definition of what comprises insider trading established by the bill will have a substantial impact on the type of insider trading cases brought by the SEC and DOJ if it is passed.