The Regulation Of Insider Trading Outline

The Regulation of Insider Trading

1. In General

   1. Insider trading occurs when a person or entity trades in a security on the basis of material non-public information which has been obtained in breach of a duty of trust or confidence.

      1. Rule 10b5-1 defines trading "on the basis of" material nonpublic information simply in terms of whether the trader was "aware" of the information at the time of the trade.

         • The Rule provides for an affirmative defense if the trader can show that the rule was executed pursuant to a binding contract, specific instructions, or a written trading plan that was entered into before the trader became aware of the information.

           • A "Rule 10b5-1 Plan" must: (1) specify the amount of the securities to be traded and the price and date of the transaction; (2) include a written formula for determining amount, price, and date; or (3) not permit the insider to exercise any subsequent influence over how, when, or whether to effect the purchase or sales, so long as the broker or other who is granted that discretion is not aware of any material nonpublic information when making those decisions.

   2. "Insider" is not defined by securities laws but is construed by courts to be a person or entity that by virtue of a fiduciary relationship with an issuer has knowledge of, or access to, material nonpublic information.

   3. How is the prohibition against insider trading enforced?

      1. By the SEC under § 10(b) of the '34 Act and Rule 10b-5 or § 14(e) of the '34 Act.

         • § 14(e) proscribed trading after a "substantial step" has been taken towards a tender offer.

           • Scienter is required

      2. By the Department of Justice for "knowing or willful" violation

      3. Private right of action in favor of contemporaneous traders, or against corporation in a derivative action.

   4. The basic premise of early insider trading cases was a finding of fraud based upon the unfairness of allowing insiders to profit from their special access to sensitive information. See Cady, Roberts & Co.; SEC v. Texas Gulf Sulphur Co. (pg. 880)

      1. The court in SEC v. Texas Gulf Sulphur Co. noted that such unfairness frustrates "the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information." (pg. 880)

   5. Insider Trading is now applicable to members of congress. See The STOCK ACT

2. Duty to Abstain or Disclose - Traditional Theory

   1. "Abstain or disclose" means that the corporate insider must either abstain from personal trading (or "tipping" others) or ensure that the information is fully disclosed to the market before trading.

   2. "[N]ot every instance of financial unfairness constitutes fraudulent activity under § 10(b)." Chiarella v. United States (pg. 881)

   3. "[T]he element required to make silence fraudulent [is] a duty to disclose . . . ." Chiarella v. United States (pg. 882)

   4. "[T]he established doctrine [is] that duty arises from a specific relationship between two parties . . . ." Chiarella v. United States (pg. 882)

   5. "Section 10(b) is aptly described as a catchall provision, but what is catches must be fraud. When an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak." Chiarella v. United States (pg. 882)

      1. The Court held in Chiarella that "a duty to disclose under § 10(b) does not arise from the mere possession of nonpublic market information." Chiarella v. United States (pg. 882)

      2. The Court in this case did not address the misappropriation theory as it was not properly presented to the jury. See Chiarella v. United States (pg. 883)

   6. Duty to Disclose - What does this mean?

      1. SPLIT

         • Public Access Approach

           • The Commission has indicated that information must be disclosed "in a manner calculated to reach the securities marketplace in general through recognized channels of distribution, and public investors must be afforded a reasonable waiting period to react to the information." Fabergo, Inc. (pg. 885)

         • In contrast, the Second Circuit has suggested that a better approach is simply to ask whether the information has yet been fully impounded in the market price. United States v. Libera (pg. 885)

   7. Chiarella stands for the proposition that a corporate insider in possession of material nonpublic information has a duty to either make sure that the inside information is fully disclosed and disseminated to the market before trading on the basis of such information (or "tipping" others) or to abstain from trading altogether. See Chiarella

   8. TRADITIONAL THEORY

      1. "Under the 'traditional' or 'classical theory' of insider trading liability, §10(b) and Rule 10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information. Trading on such information qualifies as a 'deceptive device' under §10(b) . . . because 'a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation.'" United States v. O'Hagan (quoting Chiarella v. United States)

         • Thus, if there is a relationship of trust and confidence between a person and a corporation, that person has a duty to either disclose the material nonpublic information before trading on the basis of that information or to abstain from trading of the basis of that information altogether. See id.

   9. Rule 10b5-1 defines trading "on the basis of" material nonpublic information simply in terms of whether the trader was "aware" of the information at the time of the trade.

      1. The Rule provides for an affirmative defense if the trader can show that the rule was executed pursuant to a binding contract, specific instructions, or a written trading plan that was entered into before the trader became aware of the information.

         • A "Rule 10b5-1 Plan" must: (1) specify the amount of the securities to be traded and the price and date of the transaction; (2) include a written...

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