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Is a Federal Insider Trading Law Coming?
To many this will come as a complete surprise, but there is no federal law that explicitly outlaws insider trading. Rather, for decades the SEC and the Department of Justice, with the endorsement of federal judges, have used the general securities fraud statutes to patch together a complex and problematic insider trading common law. After years of criticism, however, that could now be changing. On May 18, the U.S. House of Representatives passed legislation, which, for the first time in history, would explicitly outlaw insider trading in the United States. It is unclear whether the Senate will act to pass this law, which would require bipartisan support. But if so, it would represent a dramatic change for how the government prosecutes insider trading — and a likely increase in enforcement.
Current Legal Landscape of Insider Trading
Congress has never outlawed insider trading. Prosecutors have instead relied on Rule 10b-5 of the Securities and Exchange Act of 1934 to pursue insider trading cases. As a result, insider trading law is largely made by judges.
Section 10(b) of the 1934 Act, and Rule 10b-5 thereunder, generally proscribes fraudulent and deceitful practices in the purchase or sale of securities. Courts have relied primarily on Rule 10b-5 in holding that insider trading is an impermissible fraudulent practice. Starting in the 1960s, courts began to develop the "classical" theory of insider trading. The classical theory is generally used to prosecute a corporate insider who, as a result of that position, has access to the corporation's material, nonpublic information to trade the corporation's securities. The theory relies on the "special relationship" and fiduciary duty between the corporate insider and the corporation's shareholders. In choosing to trade on the material, nonpublic information, the corporate insider violates a duty not to disclose the confidential information. A second theory of insider trading developed later — the "misappropriation" theory — has been used to prosecute outsiders such as lawyers and accountants, who, through a position of trust with a corporation, gain access to material information and breach that duty of trust to trade. Each theory is premised on the idea that the corporate insider or outsider breaches a duty and engages in a fraud when they trade and fail to disclose this breach.
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