Lawyers push to toughen new US insider trading law
A group of influential US lawyers has urged Congress to toughen insider trading laws by making insiders liable even when they do not benefit from giving non-public information to traders.
A task force led by Preet Bharara, the former Manhattan US attorney who led a crackdown on insider trading after the financial crisis, issued a report on Monday calling on legislators to eliminate the so-called “personal benefit” test in US insider trading law.
“If you have a broad personal benefit requirement, it lets off the hook a rich insider who steals information from his company and benefits a crony or a family member to the tunes of tens of millions of dollars,” Mr Bharara told the Financial Times. “That’s classic unfairness and it has to be clear that such a thing violates the law.”
The report from eight former enforcement officials, judges and professors comes after the House of Representatives last month passed a ban on insider trading with overwhelming bipartisan support. The bill has yet to pass the Senate but, if adopted, this would mark the first time the US has passed specific legislation criminalising insider trading.
While many countries have specific statutes that outlaw insider trading, in the US decades of law have been built upon a more general 1934 law regulating American markets. US courts have rejected the fairness standard used in European insider trading law, instead basing the crime on the idea that insiders owe a duty not to share insider information.
Republicans in the House backed the bill, called the Insider Trading Prohibition Act, after it was amended to retain the personal benefit requirement that has evolved over the years in the US courts. At the time, Patrick McHenry, the ranking Republican on the House financial services committee, said the test would help protect “good-faith traders”.
The test is founded on a 1983 decision by the Supreme Court in Dirks v SEC, where the justices cleared a securities analyst because he had not been motivated by a personal benefit when he discussed information obtained from a whistleblower with his clients. “Absent an improper purpose, there is no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach,” the court ruled.
As US attorney from 2009 to 2017, Mr Bharara embarked on an aggressive crackdown on insider trading including the high-profile prosecutions of Rajat Gupta, Raj Rajaratnam, and SAC Capital. The spree was derailed in 2014 when the 2nd Circuit Court of Appeals found in two other cases involving traders that the government had not proven a personal benefit received by the original insiders.
The Supreme Court declined to review that decision, but in a separate case later clarified that if insiders are giving tips to close friends and families, they personally benefit because the action is legally the same as trading on their own account, and gifting the profits instead. More recently, the 2nd Circuit last month said prosecutors using certain statutes did not have to prove a personal benefit.
“The personal benefit requirement [that] has grown up over time has been very confusing to people,” said Mr Bharara. “There are times when you can provide a very impressive material non-public tip to somebody and the question about whatever the benefit is is unclear.”
The group led by Mr Bharara included Joon Kim, a partner at Cleary Gottlieb Steen & Hamilton, who was the acting Manhattan US attorney after Mr Bharara, and Jed Rakoff, the Manhattan federal judge who pushed for tougher accountability against big banks after the 2008 crash.
The others members of “The Bharara Task Force on Insider Trading” were Katherine Goldstein, a partner at Millbank, Melinda Haag, a partner at Orrick, Joan McKown, a partner at Jones Day, John Coffee, the Columbia Law School professor, and Joseph Grundfest, the Stanford Law School professor.
The absence of a specific ban on insider trading has not necessarily hindered US prosecutors, who have led the way in charging even global insider trading rings. Most recently, prosecutors in the US attorney’s office for the Southern District of New York broke up a scheme involving a Switzerland-based trader and bankers in London.
“The insider trading laws in other parts of the world are actually specific to insider trading. In that way, US laws have fallen behind. It’s just the US is the only authority that actually enforces it in a meaningful way,” said Mr Kim.
The task force’s recommendations aligned in parts with the seven-page bill passed last year by the House, which largely codified existing practice while expanding the law to cover insider trading that involves hacking.
However, the group called for a clearer distinction between the standards for civil and criminal cases and pushed for the elimination of the personal benefit test.
“It has generated a disproportionate share of confusion and uncertainty,” the report said, arguing that questions about the closeness of a person’s relationship with the recipient of a tip had “the potential to produce inconsistent and arbitrary results”.
“One person’s best friend may be someone else’s distant acquaintance, and should that really matter for purposes of policing the integrity of the markets?” the report said.