New Bill to Bring Clarity to Insider Trading Law

August 12, 2019 / by Crypto.IQ

Insider trading law has had its share of criticism due to the vague requirements set forth to prove insider trading. This makes it difficult for agencies like the SEC and the Justice Department to pinpoint whether insider trading has occurred.

The House Financial Services Committee has drafted a bill to address this issue. The newly introduced bill would eliminate the ambiguity for the definition of insider trading.

Subsequently, it would significantly expand the potential scope of criminal liability for insider trading. The first change entails the elimination of the existing “personal benefit” requirement. Secondly, it extends the requirement from willful to reckless use of “wrongfully obtained” non-public information. And finally, it expands 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 confidential information for personal profit. 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.

Finally, the new rule change would include more categories of what constitutes “wrongful” transmission of confidential information. There would be four ways to show that the information had been obtained wrongfully: by theft, bribery or espionage; by violation of any federal law protecting computer data; by misappropriation or unauthorized and deceptive taking of information; and by breach of a fiduciary duty.

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, making it difficult to open investigations in some cases. The new act would eliminate that requirement.

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.

The Insider Trading Prohibition Act would also include some case-specific exceptions. The SEC has the power to exempt any person or transaction from liability at the Commission’s discretion. This places responsibility on the Commission to conduct thorough due diligence before applying exemptions.

The bill would also allow individuals to engage in automated trading, which means trades that occur under an established plan of sales. These trades are currently permissible for executives who sell shares on a regular basis without leveraging any current information about the company.

The new legislation has some way to go until it is passed into law, but it has a good chance for passage after the House Financial Services Committee unanimously approved it. The bill should garner support, as it would expand insider trading law in the U.S. and it will make it easier for the SEC to establish cases of violation.