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S. HRG. 109–806

ILLEGAL INSIDER TRADING: HOW WIDESPREAD

IS THE PROBLEM AND IS THERE ADEQUATE

CRIMINAL ENFORCEMENT?

HEARING

BEFORE THE

COMMITTEE ON THE JUDICIARY 

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

SEPTEMBER 26, 2006

Serial No. J–109–117

Printed for the use of the Committee on the Judiciary

(

(II)

COMMITTEE ON THE JUDICIARY 

ARLEN SPECTER, Pennsylvania, Chairman 

ORRIN G. HATCH, Utah 

CHARLES E. GRASSLEY, Iowa 

JON KYL, Arizona 

MIKE DEWINE, Ohio 

JEFF SESSIONS, Alabama 

LINDSEY O. GRAHAM, South Carolina 

JOHN CORNYN, Texas 

SAM BROWNBACK, Kansas 

TOM COBURN, Oklahoma 

PATRICK J. LEAHY, Vermont 

EDWARD M. KENNEDY, Massachusetts 

JOSEPH R. BIDEN, JR., Delaware 

HERBERT KOHL, Wisconsin 

DIANNE FEINSTEIN, California 

RUSSELL D. FEINGOLD, Wisconsin 

CHARLES E. SCHUMER, New York 

RICHARD J. DURBIN, Illinois 

MICHAEL O’NEILL, Chief Counsel and Staff Director 

BRUCE A. COHEN, Democratic Chief Counsel and Staff Director 

(III)

C O N T E N T S 

STATEMENTS OF COMMITTEE MEMBERS 

Page

Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa, prepared 

statement .............................................................................................................. 88

Specter, Hon. Arlen, a U.S. Senator from the State of Pennsylvania ................. 1

WITNESSES 

Coffee, John C., Jr., Adolf A. Berle Professor of Law, Columbia University 

Law School, New York, New York ...................................................................... 15

Cox, James D., Brainerd Currie Professor of Law, Duke University School 

of Law, Durham, North Carolina ........................................................................ 17

Macey, Jonathan, Sam Harris Professor of Corporate Law, Yale University, 

New Haven, Connecticut ..................................................................................... 14

Marchman, Robert A., Executive Vice President, Division of Market Surveillance, NYSE Regulation, Inc., New York, New York ........................................ 10

Tenpas, Ronald J., Associate Deputy Attorney General, Department of Justice, Washington, D.C. ......................................................................................... 2

Thomas, Christopher K., President, Measuredmarkets, Inc., Toronto, Canada . 12

Thomsen, Linda, Director, Division of Enforcement, Securities and Exchange 

Commission, Washington, D.C. ........................................................................... 4

QUESTIONS AND ANSWERS 

Responses of Robert A. Marchman to questions submitted by Senator Specter 26

Responses of Ronald J. Tenpas to questions submitted by Senator Specter ...... 29

Responses of Linda Thomsen to questions submitted by Senator Specter ......... 48

SUBMISSIONS FOR THE RECORD 

Beny, of Laura N., Assistant Professor, University of Michigan Law School, 

statement .............................................................................................................. 53

Coffee, John C., Jr., Adolf A. Berle Professor of Law, Columbia University 

Law School, New York, New York, statement ................................................... 61

Cox, James D., Brainerd Currie Professor of Law, Duke University School 

of Law, Durham, North Carolina, statement ..................................................... 77

Kasowitz, Marc E., Kasowitz, Benson, Torres & Friedman LLP, New York, 

New York, statement ........................................................................................... 90

Macey, Jonathan, Sam Harris Professor of Corporate Law, Yale University, 

New Haven, Connecticut, statement .................................................................. 94

Marchman, Robert A., Executive Vice President, Division of Market Surveillance, NYSE Regulation, Inc., New York, New York, statement ..................... 99

Tenpas, Ronald J., Associate Deputy Attorney General, Department of Justice, Washington, D.C., statement ...................................................................... 113

Thomas, Christopher K., President, Measuredmarkets, Inc., Toronto, Canada, 

statement .............................................................................................................. 129

Thomsen, Linda, Director, Division of Enforcement, Securities and Exchange 

Commission, Washington, D.C., statement ........................................................ 137

(1)

ILLEGAL INSIDER TRADING: HOW WIDESPREAD IS THE PROBLEM AND IS THERE 

ADEQUATE CRIMINAL ENFORCEMENT? 

TUESDAY, SEPTEMBER 26, 2006 

U.S. SENATE, 

COMMITTEE ON THE JUDICIARY, 

Washington, D.C. 

The Committee met, pursuant to notice, at 9:34 a.m., in room 

SD–226, Dirksen Senate Office Building, Hon. Arlen Specter, 

Chairman of the Committee, presiding. 

Present: Senator Specter. 

OPENING STATEMENT OF HON. ARLEN SPECTER, A U.S. 

SENATOR FROM THE STATE OF PENNSYLVANIA 

Chairman SPECTER. Good morning, ladies and gentlemen. The 

Senate Judiciary Committee will now proceed with our hearing on 

oversight of the Department of Justice on the issue of the insider 

trading matters. 

We have noted a comprehensive study made by 

Measuredmarkets, Incorporated, which found that 41 percent of the 

companies receiving buyout bids exhibited abnormal and suspicious 

trading in the days and weeks before those deals became public. 

And Measuredmarkets concluded that these unusual activities 

most likely involved illegal insider trading. These transactions involved very substantial sums of money, into the billions of dollars. 

While the merger activity has increased in recent years, in the 

past 6 years the number of insider trading cases pursued by the 

SEC has remained steady. We have noted that the Department of 

Justice has had some problems in a couple of cases: U.S. v. 

Scrushy, where there was a motion to suppress prosecution testimony taken because the SEC civil investigation had been undertaken at the behest and with the instructions from the U.S. Attorney’s Office; and in the case of U.S. v. Stringer, there was a dismissal because of misconduct on a conflict between witnesses and 

the attorney involving the Department of Justice and the Securities 

and Exchange Commission. 

In wake of Sarbanes-Oxley, the Judiciary Committee authored a 

new Federal securities fraud statute in 18 U.S. Code, and we are 

pursuing this oversight hearing to make an evaluation as to what 

is being done to enforce that statute. 

The Committee has undertaken some inquiries into the hedge 

funds, but in our society it is absolutely indispensable that the integrity of the markets be maintained. Americans invest very heavVerDate 0ct 09 2002 15:33 Feb 23, 2007 Jkt 032154 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\31445.TXT SJUD1 PsN: CMORC
2

ily in the stock market, and that is really the backbone of our commercial system. And it is very, very important that the integrity be 

maintained. 

We have a distinguished array of witnesses here today, and we 

will begin with the Associate Deputy Attorney General Ronald 

Tenpas, whose responsibilities include coordinating the work of the 

President’s Corporate Fraud Task Force. 

Welcome, Mr. Tenpas, and we look forward to your testimony. 

Before you begin, let me note for the record that Mr. Tenpas has 

an outstanding record, having clerked for Chief Justice Rehnquist 

after clerking for U.S. District Judge Louis Pollak. He had served 

as U.S. Attorney for the Southern District of Illinois and an Assistant U.S. Attorney for the Middle District of Florida and the District 

of Maryland; a bachelor’s degree from Michigan State, a law degree 

from the University of Virginia, and a Rhodes scholar. 

That is quite a pedigree, Mr. Tenpas. I expect a lot of success 

from a man with your record. Please proceed. 

STATEMENT OF RONALD J. TENPAS, ASSOCIATE DEPUTY ATTORNEY GENERAL, DEPARTMENT OF JUSTICE, WASHINGTON, D.C. 

Mr. TENPAS. Thank you, Mr. Chairman. You have set the bar for 

me. 

Let me first begin by thanking you for inviting the Department 

of Justice to testify today concerning our efforts to prosecute insider trading, and at the outset let me assure you that the Department and the Corporate Fraud Task Force share your sentiment 

about the importance of ensuring that everyone can invest in our 

markets, trusting in their integrity and, in particular, without fear 

of being taken advantage of by insiders who improperly use information. 

To understand the Department’s approach and track record, it 

may be best to start with what we as prosecutors are concerned 

with proving when presented with allegations of insider trading. A 

criminal insider trading case requires us to prove multiple elements, including that there was, one, a willful and fraudulent buying or selling of a security; two, that the selling occurred in breach 

of a fiduciary duty or other relationship of trust and confidence; 

and, three, that the selling occurred while in possession of and in 

use of material nonpublic information about that security. 

Given these requirements, proving criminal insider trading activity requires more than just market surveillance and the discovery 

of spikes in trading. Market anomalies may be indicative of a problem, but they are not enough to prove criminal activity. 

Each of the elements I mentioned can present significant proof 

problems. Depending on their role in an inside scheme, potential 

defendants can suggest any number of defenses. For example, as 

I just mentioned, prosecutors must demonstrate that the defendant’s conduct was a willful violation of the law, meaning that it 

must be proven that the defendant was aware at the time of the 

insider trade that he or she was doing something in violation of the 

law. 

A tippee, therefore, may claim that he or she did not know that 

it was illegal to trade on the information he received, especially if 

3

the tippee worked outside the corporation. Similarly, prosecutors 

must prove that the inside information at issue in the case was 

both material, meaning likely to be of interest to the reasonable investor, and nonpublic. Those who trade may often deny having 

known of the material information or, alternatively, claim that the 

information was broadly known and, thus, public. 

Similarly, because we must show that the defendant used the information in making his or her trading decision, a defendant may 

claim that the reason for his trade was unrelated to the inside information and that the trade was prompted by a personal need for 

funds, the timing of options, tax considerations, a desire to lock in 

previous gains, or any number of other reasons. Still further, a corporate outsider, such as the tippee, can challenge the claim that he 

owed a fiduciary duty to others. Moreover, given the nature of 

these cases and what we have to prove, insider trading cases rarely 

have a smoking gun. 

So, in sum, these cases almost universally turn on circumstantial 

evidence with inside traders frequently proffering a number of alternative explanations for their conduct, each of which must be discredited for the case to be successful. 

The challenge of building a circumstantial case that discredits all 

plausible alternatives can be daunting, and, of course, we must do 

so beyond a reasonable doubt. Nevertheless, the Department of 

Justice is committed to bringing such prosecutions and has compiled a strong record in recent years. We typically use the antifraud provisions of the Securities and Exchange of 1934, which carries substantial penalties, including imprisonment of up to 20 years 

and fines of up to $5 million. 

Our typical case can begin in a variety of ways, but often we will 

start with a referral from the SEC or from public reporting that 

casts attention on a particular transaction or transactions. We will 

then work with our prosecutors and agents, usually from the FBI, 

and often involving the Postal Inspection Service, to work cooperatively with the SEC to seek access to information that the SEC has 

secured, with each agency then conducting a parallel investigation—the SEC focusing on civil violations and remedies, and the 

Department prosecutors considering whether to bring criminal 

charges. 

As outlined more fully in my written testimony, in recent years 

the Department has brought a wide variety of cases that have focused on the most egregious offenses that promise the greatest deterrence. We focus our efforts on those cases where the evidence is 

strongest and where the conduct is most serious, whether because 

the insider had an important leadership position or because the 

criminal ring was well organized or because it involved a sector of 

the market that is especially of concern. In doing so, we try to 

make our efforts part of an overall enforcement regime that includes the parallel and equally important role played by the SEC. 

In sum, we are determined to use all tools at our disposal to attack insider trading, and we appreciate the opportunity to appear 

before you this morning to discuss this in more detail. 

[The prepared statement of Mr. Tenpas appears as a submission 

for the record.] 

Chairman SPECTER. Thank you very much, Mr. Tenpas. 

4

We now turn to the Director of the Securities and Exchange 

Commission Division of Enforcement, Linda Thomsen, who has 

been with the SEC since 1995, was Assistant Director of the Department, then Associate Director, then Deputy Director—really 

right up the ladder, Ms. Thomsen. 

She had been an Assistant U.S. Attorney for the District of 

Maryland, bachelor’s degree from Smith, and a law degree from 

Harvard. 

We appreciate your being here, and the floor is yours. 

STATEMENT OF LINDA THOMSEN, DIRECTOR, DIVISION OF ENFORCEMENT, SECURITIES AND EXCHANGE COMMISSION, 

WASHINGTON, D.C. 

Ms. THOMSEN. Thank you, Chairman Specter, and I appreciate 

being here. Thank you for inviting me to testify today about insider 

trading. Our laws against insider trading play an essential role in 

protecting our securities markets and in promoting investor confidence in the integrity of those markets. I appreciate the opportunity to explain the Commission’s efforts to deal with insider trading and to answer any questions you may have. 

I am especially pleased to testify together with Ron Tenpas of the 

United States Department of Justice. The respective histories of 

the SEC and the Department of Justice demonstrate our commitment to working with each other to prosecute insider trading, civilly and criminally. 

Over the years, investigating and prosecuting insider trading violations has remained a steady component of the SEC’s enforcement 

mission. Since 2001, the SEC has brought 300 actions against over 

600 individuals and entities for insider trading violations and has 

frozen millions of dollars in illicit trading proceeds. Over that same 

period, insider trading cases have consistently made up about 7 to 

12 percent of our filed caseload. 

At the same time, our enforcement program is, by necessity, dynamic. Our priorities and resource allocations must change to meet 

trends in the market and developing misconduct. Even within the 

relatively narrow arena of insider trading, we must shift our resources to those areas where the greatest threats lie. Most recently, 

the focus of our insider trading investigations has been on 

globalization, merger activity, and hedge funds. 

We have had some remarkable successes. Over the past year, we 

have charged a total of 17 defendants in the Reebok case, whom 

we allege participated in an international insider trading ring that 

netted at least $6.8 million in illicit gains by, among other things, 

stealing information from Merrill Lynch, from Business Week, and 

from a sitting New Jersey grand jury. 

In recent years, the Commission has also brought several insider 

trading cases involving hedge funds or their managers. Over the 

past 2 years, the Commission has brought at least three cases involving insider trading by hedge funds and their managers in advance of more than two dozen stock offerings commonly referred to 

as PIPEs. The Commission has also recently brought cases against 

hedge funds or their managers involving insider trading ahead of 

mergers and acquisitions. 

5

The Commission is particularly concerned about insider trading 

by registered broker-dealers and investment advisers. Earlier this 

year, the Commission filed a civil injunctive action against a 

former Merrill Lynch broker and ten former A.B. Watley day traders and their managers for participating in a scheme that allegedly 

involved trading ahead of large institutional orders broadcast over 

Merrill’s in-house squawk boxes. 

A few months ago, we instituted a settled administrative proceeding against Morgan Stanley for failure to maintain and enforce 

adequate policies and procedures to prevent the misuse of material 

nonpublic information by the firm or persons associated with the 

firm. Morgan Stanley agreed to pay a $10 million civil penalty and 

to engage an independent consultant to review its policies and procedures. 

Let me step back for just a moment and make some general observations about our insider trading program. 

Our Office of Market Surveillance is in daily contact with its 

counterparts in the various self-regulatory organizations, or SROs. 

The SROs perform primary surveillance, monitoring the markets 

for unusual trading, sudden changes in a security’s price, or other 

unusual market activity. Our Office of Market Surveillance maintains an open line of communication with the SROs. 

Insider trading leads also come to us from other sources, including the news media, our own inspections and investigations, and 

tips. When circumstances warrant, we can and will act swiftly, 

using asset freezes to preserve any alleged ill-gotten gains. 

Identifying suspicious trading is an essential starting point, but 

it is only the first step in compiling a viable case. The challenge 

is not to establish facts that show suspicious trading. The surveillance records alone are often sufficient to establish that much. The 

real challenge is to establish that a particular individual was in 

possession of material nonpublic information and traded on it in 

breach of a duty and to establish those facts based on admissible 

evidence. 

Piecing together an insider trading case can be a complex and 

painstaking process. Because insider trading involves secret information and communications, it is rare, as Mr. Tenpas said, to find 

a smoking gun proving that a trader was tipped and by whom. Virtually all insider trading cases hinge on circumstantial evidence, 

inferences to be drawn from the trading records, the timing of 

trades, the movement of funds, and other facts and circumstances. 

Building an insider trading case based on circumstantial evidence 

can be frustrating, risky, and time-consuming. But our staff has 

persevered and built hundreds of solid credible cases. 

The Commission employs a broad range of remedies to address 

insider trading. The Commission generally seeks injunctive relief, 

disgorgement, and civil financial penalties, which may be up to 3 

times the illegal profits made or the losses avoided. 

In settling cases, we have typically sought and obtained an injunction, disgorgement, and a one-time penalty that is a penalty 

equal to the amount of the illegal profits realized or losses avoided. 

Chairman SPECTER. Ms. Thomsen, how much more time would 

you like? 

Ms. THOMSEN. I am happy to—I think about a minute. 

6

Chairman SPECTER. OK. 

Ms. THOMSEN. We believe that the remedies we have, along with 

the threat of incarceration in the event of criminal prosecution, 

give us an effective arsenal for enforcement and deterrence. 

Insider trading undermines the integrity and credibility of our 

markets. We appreciate the fact that the markets are dynamic, and 

we understand the power of technology, and we will use it all to 

our advantage. We will continue to work very hard to protect the 

world’s finest and fairest markets, and we would be happy to answer any of your questions. Thank you. 

[The prepared statement of Ms. Thomsen appears as a submission for the record.] 

Chairman SPECTER. Thank you very much, Ms. Thomsen. 

Mr. Tenpas, as a result of the work of this Committee following 

Sarbanes-Oxley, we passed Section 1348 relating to securities 

fraud. Has that been helpful to the Department of Justice? And to 

what extent has it been used? 

Mr. TENPAS. That has been very helpful to the Department. We 

have at this point successfully prosecuted somewhere slightly over 

50 defendants. 

Chairman SPECTER. Has anybody gone to jail under the prohibitions of 1348? 

Mr. TENPAS. I believe so. Off the top of my head, I do not know 

the exact sentencing— 

Chairman SPECTER. It is pretty important determinant as to how 

effective it is, wouldn’t you say? 

Mr. TENPAS. I believe it is, but as I say, I do not know the exact 

spread, but, yes, people have gone to jail. 

Chairman SPECTER. Would you provide the Committee with a list 

of the prosecutions and the penalties which were obtained? 

Ms. Thomsen, on that same subject, I note a $10 million fine that 

the SEC imposed in June of this year on Morgan Stanley for failing 

to conduct surveillance on hundreds of thousands of employees to 

determine insider trading. Is that really effective for a company the 

size of Morgan Stanley? Does $10 million really make much of an 

impact on a company like that? 

Ms. THOMSEN. Well, I think the proof will be in the pudding, but 

I believe it was the largest penalty for that type of violation to 

date, which is a violation— 

Chairman SPECTER. Well, that does not mean a whole lot, largest 

penalty and proof is in the pudding. The pudding has been made. 

Where is the proof? 

Ms. THOMSEN. Well, I believe that to the extent Morgan Stanley 

is improving its procedures, to the extent we have consistently 

brought cases against broker-dealers and others for violations of 

15(f), we do see better surveillance and better procedures. Our remedies are always civil, so our remedies are always limited to injunctive relief, to procedures relief, which we obtained in the Morgan 

Stanley case, as well as penalties. I think— 

Chairman SPECTER. Your testimony says that the SEC has experienced recent successes in enforcing insider trading activities by 

hedge funds. We are very much concerned about hedge funds. We 

have had some investigation already, and some of it is ongoing. 

And I note in press reports the city of Philadelphia lost a lot of 

7

money because of a hedge fund failure. And hedge funds, as we all 

know, are not regulated, and that is really the jurisdiction of another Committee. 

Ms. THOMSEN. Yes, sir. 

Chairman SPECTER. But this Committee has jurisdiction over 

criminal law enforcement. Have there been any criminal sanctions 

imposed on any of the hedge funds for violations? 

Ms. THOMSEN. Well, I think I would defer to Mr. Tenpas, but I 

did read in the paper this morning that a hedge fund manager was 

indicted for insider trading by the Southern District of New York, 

and that was announced yesterday. 

Chairman SPECTER. I am interested in indictments. I am even 

more interested in convictions and most interested in jail sentences. How about it? Any jail sentences? 

Ms. Thomsen, that is directed to you. 

Ms. THOMSEN. I am sorry. 

Chairman SPECTER. You were talking about recent successes. I 

would like to know how successful you have been? 

Ms. THOMSEN. Well, I am sorry, sir, but because we have no 

criminal jurisdiction, we do not prosecute criminally and we— 

Chairman SPECTER. How many times have you gone for treble 

damages? You have statutory authority for that. 

Ms. THOMSEN. We do have statutory authority for treble damages. We typically seek treble damages when we are litigating a 

matter. When we settle matters, as I mentioned, we typically seek 

a one-time— 

Chairman SPECTER. Typically seek them when you have litigated 

the matter. 

Ms. THOMSEN. Yes, sir. 

Chairman SPECTER. How frequently have you obtained treble 

damages in the last 2 years? 

Ms. THOMSEN. Infrequently. 

Chairman SPECTER. Infrequently? 

Ms. THOMSEN. Infrequently. Courts are— 

Chairman SPECTER. Any? 

Ms. THOMSEN. There is one case that I know of where we obtained treble damages, and I cannot remember— 

Chairman SPECTER. Only one case that you know of, and you are 

the Director. 

Ms. THOMSEN. Yes, sir. Courts are reluctant to impose up to 3 

times. 

Chairman SPECTER. Would you review those cases for the last 5 

years and tell us what the— 

Ms. THOMSEN. I believe it is one. 

Chairman SPECTER. What the experience has been. 

Ms. THOMSEN. Absolutely. 

Chairman SPECTER. Mr. Tenpas, the Scrushy case raised the 

problem of collaboration between the SEC and the Department of 

Justice, and that case states, ‘‘To be parallel, by definition the separate investigation should be like side-by-side tracks that never 

intersect.’’ 

Would you like to see the statute amended to allow you to intersect those tracks? 

8

Mr. TENPAS. Well, we certainly think it is important that we 

have the ability to intersect those tracks by consulting with one another— 

Chairman SPECTER. Is that a yes, Mr. Tenpas? 

Mr. TENPAS. We have not reached a judgment about whether the 

statute needs to be amended to allow us to accomplish that. In the 

Scrushy case, we were not able to take appeal. In the similar 

Stringer case, we have it under appeal. I think our feeling would 

be— 

Chairman SPECTER. What are the reasons why you should not be 

able to collaborate with the SEC? 

Mr. TENPAS. We do not think there are any reasons we should 

not be able to collaborate with them. 

Chairman SPECTER. Well, would you review that matter and talk 

to others in the Department who have higher rank? Certainly nobody has a better record in the Department of Justice than you do. 

How was it working for Judge Pollak? 

Mr. TENPAS. It was terrific. He is a great man, a great judge. I 

owe him a great deal. 

Chairman SPECTER. Would it be a fair question to ask you to 

compare working for Judge Pollak with Chief Justice Rehnquist? 

Mr. TENPAS. Obviously they have— 

Chairman SPECTER. I withdraw the question, unless you want to 

answer. 

[Laughter.] 

Mr. TENPAS. They were both great people to work for. 

Chairman SPECTER. Very diplomatically stated. Thank you very 

much for appearing. I appreciate the work you have done, and I 

would like you to take a closer look at the effectiveness of your 

work with respect to criminal sanctions or treble damages. My own 

sense is that fines do not do a whole lot, but jail sentences do. And 

I have had a little experience in the field. 

One of the ideas which this Committee is pursuing is to impose 

criminal liability on corporate officials who knowingly and maliciously put into interstate commerce instrumentalities which cause 

death or serious bodily injury. The Ford Firestone case is a good 

illustration where Congress did legislate to put criminal penalties 

into effect. But if you willfully and maliciously act in a way which 

results in someone’s death, that states malice and grounds for prosecution for murder in the second degree. And typically that carries 

a jail sentence of 20 years. 

And you have the Ford Pinto case, which is another good illustration. Internal corporate documents showed that they could save 

money by putting the gas tank in one spot as opposed to another 

spot, with an evaluation as to what they would have to pay by way 

of damages. And it seems to me that if it is knowing and willful—

and that is a tough standard for a prosecutor to maintain. You are 

both former prosecutors. That does state malice, and consumers 

and people ought to be protected. 

You are in a field where market integrity is really important for 

this country, and insider trading is insidious. And when you have 

this study as disclosed by the New York Times about 41 percent 

of the cases raise the probability of collusion and insider trading, 

it really ought not to be just up to the New York Times to conduct 

9

the investigations. But if you have the benefit of their investigation—have you taken a look at that, Mr. Tenpas, Ms. Thomsen, as 

to what the Times has shown as to whether you ought to pursue 

that line? 

Mr. TENPAS. We are aware of the study, Senator. We have looked 

at it, and we are addressing it in the way that we typically would, 

which is to work closely with the SEC and the SROs. They have— 

Chairman SPECTER. Do you think that there is a valid basis for 

the conclusion of that study conducted by that outfit? 

Mr. TENPAS. That is a little beyond my purview because it involves fairly sophisticated statistical analysis, and that is— 

Chairman SPECTER. Sophisticated statistical analysis? Is that 

tough for a Rhodes scholar? 

Mr. TENPAS. It is tough for me. I was not particularly in the 

math arena, and one of the— 

Chairman SPECTER. Have you got some sophisticated statistical 

analysts in the Department of Justice? If not, we will get you some. 

Mr. TENPAS. Well, we do, but we find that the SROs and the SEC 

have active enforcement entities that have those folks— 

Chairman SPECTER. Well, OK. Ms. Thomsen, then you have 

looked at the study and you have analyzed it and you are sophisticated. What have you done? 

Ms. THOMSEN. We have looked at it. We have not had an opportunity to study all the underlying data. We have also looked— 

Chairman SPECTER. You have not had an opportunity to study 

all the underlying data? Why not? 

Ms. THOMSEN. If I may explain, we also have the data that we 

are getting from the SROs, and I do not think anyone disagrees 

with the notion that there is an increase or there has been an increase in anomalous or suspicious trading in advance of merger or 

acquisition activity— 

Chairman SPECTER. We have to move on, but let me ask each of 

you to give a report to the Committee on what you have done to 

date with respect to that study. I would hope that when you see 

that kind of an analytical study as prominently displayed as it was 

in a Sunday New York Times, you would take a look at it. And 

then I would like you to tell me what you think about it. And then 

the third aspect of the question is: What are you going to do in the 

future to pursue it? 

Ms. THOMSEN. Sure. 

Chairman SPECTER. Thank you both very much. 

We will now turn to our second panel, and our first witness is 

Mr. Robert Marchman, Executive Vice President of the New York 

Stock Exchange Regulation, Inc., oversees the Market Surveillance 

Division, which investigates insider trading in securities listed on 

the New York Stock Exchange. 

Regrettably, I am going to have to excuse myself for a few minutes at 10 minutes after 10 because we are having a news conference on the immigration question, and the immigration bill came 

out of this Committee, and I am searching to see if we can find 

someone who can replace me for a bit while I absent myself for a 

very brief period of time. But if we cannot, I am going to have to 

ask you to wait. I am sure you will understand that a big part of 

this job is juggling a lot of different issues, and right now we are 

10

in very heavy duty as a result of being the last week we are in session before we break for October. And I do not like to ask anybody 

to wait, and especially as prominent, high-powered, and hourly 

rates as this prestigious group. But if I have to, I will have to. 

Mr. Marchman, thank you for joining us. The floor is yours. 

STATEMENT OF ROBERT A. MARCHMAN, EXECUTIVE VICE 

PRESIDENT, DIVISION OF MARKET SURVEILLANCE, NYSE 

REGULATION, INC., NEW YORK, NEW YORK 

Mr. MARCHMAN. Good morning, Chairman Specter. Thank you 

for this opportunity to share my thoughts on insider trading, which 

is an area of serious regulatory concern for the New York Stock Exchange Regulation group. 

The mission of NYSE Regulation is to protect the investing public and the integrity of our markets. We accomplish our mission by 

zealously monitoring trades in NYSE Group-listed securities by 

regular and ongoing onsite examinations of NYSE Group member 

firms and by proactive investigation and discipline of member firms 

and associated persons for violation of NYSE Regulation rules and 

applicable Federal securities laws. 

The history of the securities markets teaches us that insider 

trading is a serious regulatory concern, particularly today, where 

the volume, complexity of trades, and products, as well as crossborder transactions are redefining capital markets on almost a 

daily basis. 

The Division of Market Surveillance of NYSE Regulation continues to meet these challenges through the use of extensive and 

sophisticated surveillances, systems, and tools that allow us to 

timely review and aggressively investigate trading that may constitute illegal insider trading. 

On an ongoing basis, Market Surveillance analysts conduct reviews of alerts and investigations. Real-time and exception-based 

alerts are mostly generated by advanced electronic surveillance 

systems within our Stock Watch unit. We have numerous electronic 

surveillances that surveill for activity that may constitute insider 

trading. 

In a typical insider trading investigation, sophisticated systems 

complement analysts’ requests for trading-related information from 

member organizations, listed companies, and other markets. 

Where, as is frequently the case, an investigation indicates possible 

insider trading by individuals or entities outside the jurisdiction of 

NYSE Regulation, for example, hedge funds, employees of listed 

companies, or customers of a member organization, the activity is 

referred to the SEC with whom we enjoy a strong and constructive 

working relationship. 

In addition to our interaction with the SEC on specific insider 

trading investigations and referrals, we have ongoing discussions 

with the staff regarding practices and trends. In our view, in addition to our highly advanced technology and experienced and professional staff, a strong relationship with the SEC and other market 

regulators in the U.S. and internationally is critical to successful 

surveillance of activity that may constitute illegal insider trading. 

To that effect, we continue to strengthen our proactive engagement with other market regulators. By way of example, this AuVerDate 0ct 09 2002 15:33 Feb 23, 2007 Jkt 032154 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\31445.TXT SJUD1 PsN: CMORC
11

gust 18th there was a meeting convened amongst various regulators from the SEC, NYSE Regulation, NASD, and the Chicago 

Board of Options Exchange to talk about current developments and 

discuss investigative techniques in insider trading. 

The last 2 years have seen a significant increase in the number 

and complexity of our insider trading referrals to the SEC. Referrals to the SEC increased from 68 in 2004 to 111 in 2005, a 63-

percent increase. For 2006, at the current pace, we project 140 referrals to the SEC, an increase of 26 percent from 2005. 

We have also seen during this period an increase in the number 

of insider trading matters related to hedge fund activity that had 

been referred to the SEC. Penalties and disgorgement from Market 

Surveillance referrals to the SEC have also increased. In 2004, penalties were approximately $2.5 million. In 2005, penalties were 

about $3.9 million. And for the first half of this year, penalties exceeded $3.2 million, and we are on our way to surpassing 2005 levels. 

In conclusion, at NYSE Regulation we remain vigilant and cognizant of our responsibility to vigorously pursue the highest excellence in our regulation of the markets. We also remain committed 

to continue to work with the SEC and with our fellow regulators 

to improve and strengthen the system of self-regulation that has 

made the United States the financial center of the world. 

I thank you again for this opportunity to discuss the efforts of 

NYSE Regulation in this important area of insider trading and invite you and your staff to experience firsthand our efforts by visiting us in the near future. 

Thank you. 

[The prepared statement of Mr. Marchman appears as a submission for the record.] 

Chairman SPECTER. Thank you very much, Mr. Marchman. 

I am going to have to take a short recess at this point and just 

a word of explanation as to where we stand and why it is important to do this. 

The Senate has reported out an immigration bill, as you may 

know. The House has reported out an immigration bill. And we 

have been unable to go to conference. And they want border enforcement and employer verification. We do, too, but we want to 

handle guest workers and we want to handle the 11 million undocumented immigrants. And a good part of our work is informing 

the public as to what we are doing so they understand why the bill 

is not being finished and to try to induce the House Members to 

go to conference, which is going to have to be after we take the 

break. 

So I gave you that little explanation because it is not something 

which is incidental to our work to be at a news conference, but 

really very directly tied into getting the job done. And everybody 

is just very, very busy right now. We are struggling the Supreme 

Court ruling in Hamdan and whether we are going to have habeas 

corpus. And we are struggling with the electronic surveillance 

issues. We are struggling with the fence and another matter. So 

that everybody is moving like molecules at a high speed in a lot 

of different directions. 

12

So I hope you will pardon the brief recess, and I will return just 

as soon as I can. 

[Recess 10:08 a.m. to 10:33 a.m.] 

Chairman SPECTER. We will resume the Judiciary Committee 

hearing. 

Again, I regret the interruption. This may not assuage you much, 

but this may be the shortest recess in the history of the Judiciary 

Committee to change buildings and have three Senators speak and 

come back. 

We turn now to Mr. Christopher Thomas, President and Founder 

of Measuredmarkets Inc., an analytical research firm based in Toronto, Canada. Mr. Thomas had worked as an analyst, investment 

adviser, and broker prior to founding Measuredmarkets; bachelor’s 

degree in economics from McGill University; studied at Loyola and 

Marlborough College in Marlborough, England. 

Thank you for joining us here today, Mr. Thomas, and we are 

very interested in your study and look forward to your testimony. 

STATEMENT OF CHRISTOPHER K. THOMAS, PRESIDENT, 

MEASUREDMARKETS INC., TORONTO, CANADA 

Mr. THOMAS. Thank you, Senator. I am President of 

Measuredmarkets. The firm supplied the underlying data to the 

New York Times for its article of August the 27th on abnormal 

trading activity. 

The analysis we did for the newspaper showed that for more 

than 40 percent of the scrutinized mergers with a value of $1 billion or more that were announced in the 12-month period, deviant 

trading behavior was evident before the deals became public. 

Therefore, we believe that with the data displaying such aberrant 

activity, it is more than reasonable to ask: What prompted this activity? Could it be insider trading? 

The Financial Times of London recently reports: ‘‘Insider trading 

is endemic in the London stock market. The Financial Services Authority recently found that almost 30 percent of takeover announcements...were preceded by suspicious share price movements....’’ If 

30 percent is considered endemic, what would one consider labeling 

a number greater than 40 percent? 

Our company provides a service that statistically examines the 

trading behavior of individual stocks. We determine if today’s activity conforms to the particular stock’s historical patterns or deviates 

from them. When stocks do wander away from their usual pattern 

of behavior, our process issues alerts automatically. If there is no 

news publicly available that might explain this aberration, we 

deem such activity highly suspicious and irregular, going against 

historical norms. 

Our factual data and experience has shown that very often such 

deviations occur several days before substantial changes in the 

prices of the identified stocks. We have numerous examples of such 

identification of unusual behavior preceding the release of material 

news. Some of these are cited in the New York Times article; others are on our website. 

Amongst our clients are a governmental investigatory agency, 

news services, money managers, brokers, and individual investors. 

13

So how does Measuredmarkets use the data? What determined 

abnormal trading? And what is considered suspicious trading? 

We look at some 3,000 data points for each common stock each 

day on the four exchanges, and for some stocks as many as 5,000 

data points. We examine a stock’s history of trading using three 

measures: closing price, total volume, and the total trades or number of individual transactions. This last measure is distinct from 

volume, albeit related to it. A stock’s normal behavior pattern for 

each measure is then calculated, covering nine different time periods. We thus have what can be 3-D pictures, covering each of the 

nine time periods, to compare against any day’s activity. Each 

stock’s history mathematically determines what its normal pattern 

of behavior is, automatically adjusting should it change from volatile to stable or vice versa. 

Should a day’s activity exceed the normal patterns, then it can 

be considered as exhibiting mathematically deviant behavior. It is 

aberrant, having wandered significantly away from its well-established normal path. 

Each day, for the four markets that Measuredmarkets currently 

tracks, hundreds of stocks are flagged as showing newly deviant 

behavior. The majority of those so marked are actually reflecting 

news that is already in the public domain. The service our company 

provides becomes useful, important, and significant when stocks 

have deviated from their own norms and there is no news generally 

available that could explain the deviations. Such activity we suggest is suspicious. Referring to the New York Times articles: ‘‘The 

companies were not the subject of widely dispersed merger commentary during the periods of abnormal trading, nor did they make 

any announcements that would seem to explain the moves.’’ 

The Measuredmarkets service deals with real numbers from the 

real world—hard data that is in the public domain. From the immense amount of information that is generated by the stock markets, we sift the data so that ordinary investors and interested organizations gain valuable information. 

I started this company to level the playing field for investors. 

‘‘What is the use of living if it be not to strive for noble causes and 

to make this muddled world a better place for those who will live 

in it after we are gone?’’ That was Winston Churchill, and I have 

to point out that his mother was an American. 

Thank you, Senator. 

[The prepared statement of Mr. Thomas appears as a submission 

for the record.] 

Chairman SPECTER. Thank you, Mr. Thomas. 

Our next witness is Professor Jonathan Macey, Deputy Dean and 

Professor of Corporate Law, Corporate Finances and Security Law, 

at Yale University; was the Dupont Professor of Law at Cornell, 

and also served as an instructor at the University of Chicago, University of Tokyo, and University of Virginia; law clerk to Judge 

Friendly; bachelor’s degree cum laude from Harvard, and law degree from Yale; editor of the Yale Law Journal. 

A very distinguished record, Professor Macey. The floor is yours. 

14

STATEMENT OF JONATHAN MACEY, SAM HARRIS PROFESSOR 

OF CORPORATE LAW, YALE UNIVERSITY, NEW HAVEN, CONNECTICUT 

Mr. MACEY. Thank you very much, Mr. Chairman. It is a pleasure to be here, and thanks for inviting me. Insider trading has 

been a focus of my teaching and research. Illegal insider trading 

is the theft of valuable information about corporate plans that 

properly belongs to the corporation and its investors. Vigorous enforcement is important to protect intellectual property rights of investors and corporations. 

However, not all trading by insiders is illegal, and not all trading 

on the basis of informational advantages is illegal. Rather, insider 

trading is illegal when securities are traded in breach of a relationship of trust and confidence, known as a ‘‘fiduciary duty.’’ And it 

is also, of course, illegal to tip information in violation of a fiduciary duty or to misappropriate confidential information. 

It is not the case that insider trading is a victimless crime. Insider trading is a crime that has victims because insider trading 

deprives people of what is rightfully theirs—the ability to profit on 

material nonpublic information about their companies or to avoid 

losses associated with such information, and in doing so deprives 

people of returns and undermines legitimate societal trust and expectations about market functions. 

The problem with insider trading for personal benefits is that it 

reduces—another problem is that it reduces the incentives of legitimate market participants, like analysts, to allocate scarce resources to research. And the question that I want to turn to is: 

How much insider trading do we actually observe in the U.S., and 

can we and should we be doing more to stop it? And I want to 

make the following points. 

No. 1, the available empirical research indicates that the U.S. 

has, by far, the most vigorous insider trading enforcement program 

in the world, as well as the strictest laws against insider trading. 

The U.S. is the country in which insider traders’ profits are the 

lowest. 

In the U.S., unlike many other countries, there is a private right 

of action for violation of the laws against insider trading, and from 

a causal perspective, the private plaintiff’s bar generally 

piggybacks on the enforcement efforts of the Securities and Exchange Commission and also self-regulatory agencies. The evidence 

suggests that while coming up with a benchmark for what is vigorous enforcement is not an easy task, relative to any other countries the U.S. does a great deal more, and the SEC in particular. 

For example, over the last 5 years, the SEC has brought 260 insider trading enforcement actions. By contrast, in the U.K. there 

have only been 14 insider trading actions, and the largest fine, 

which was 25,000 pounds in the U.K., is lower than the average 

penalty in the U.S. 

The enforcement program of the SEC has targeted not only corporate officers and directors and their friends, business associates, 

tippees, printing firm employees are common targets, also employees of investment banking firms, law firms, and accounting firms. 

At the same time, I want to point out that trading that is not 

done on the basis of a violation of fiduciary duty and involves makVerDate 0ct 09 2002 15:33 Feb 23, 2007 Jkt 032154 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\31445.TXT SJUD1 PsN: CMORC
15

ing money from investments in legitimate research about corporate 

performance and governance is socially valuable and should be encouraged. 

With respect to studies that we have been talking about today, 

studies that show increases in trading volume or share prices in 

advance of merger and acquisition activities must, if they are to be 

useful, do a couple of things that studies that have been discussed 

do not do. No. 1, they do not distinguish between legitimate and 

illegitimate trading activity. For example, purchases by a hedge 

fund or an LBO fund or an arbitrageur may actually put a company in play, increasing the chances of an outside acquisition attempt, which in turn can explain sudden increases in trading volume and share prices of target companies, thus suggesting that we 

need to think carefully about the causation that we observe in 

studies such as that reported in Gretchen Morgenson’s August 27, 

2006, New York Times article. 

I also want to point out that, in terms of thinking about the allocation of resources in insider trading, there are other things on the 

SEC’s plate that one can credibly argue should be the focus of 

sharp attention, such as options back-dating and accounting fraud. 

Thus, one can draw the conclusion, as I have done, that the SEC 

in its enforcement program does an excellent job of balancing the 

policy goal of detecting and punishing insider trading with the goal 

of conducting insider trading investigations in a careful way so that 

we maintain the important deterrent effect that we have associated 

with the social stigma that is carried with the act of illegal insider 

trading in the U.S. that one does not see as a matter of norms and 

social deterrent in other countries. 

Thank you very much. 

[The prepared statement of Mr. Macey appears as a submission 

for the record.] 

Chairman SPECTER. Thank you, Professor Macey. 

We turn now to Professor John Coffee, Columbia Law School; 

holds the distinguished Adolf Berle Chair; taught at Georgetown 

University Law Center, and was in private practice for 6 years 

with Cravath, Swaine & Moore; been a member of the NASD’s 

Market Practices Committee and the Legal Advisory Committee of 

the New York Stock Exchange Board of Directors; bachelor’s degree 

from Amherst, Phi Beta Kappa; law degree from Yale; master in 

law from New York University. 

We may be overloaded with Yale law grads today— Professor 

Coffee, Professor Macey. 

STATEMENT OF JOHN C. COFFEE, JR., ADOLF A. BERLE PROFESSOR OF LAW, COLUMBIA UNIVERSITY LAW SCHOOL, NEW 

YORK, NEW YORK 

Mr. COFFEE. Thank you for inviting me, Senator. As a law professor, and uniquely for this panel, I teach both criminal law and 

securities law, so I look at insider trading from both sides, and I 

am going to focus my comments not on whether insider trading is 

bad—I assume we all agree on that—but on the criminal enforcement of it. And I am basically going to submit that criminal enforcement is the one force that will truly deter in this field. But 

16

there are problems with criminal enforcement, and there are new 

problems looming on the horizon. 

Now, I am going to ask a series of questions and give brief, incomplete answers. 

Has insider trading increased? There is no universally recognized 

proxy, but there is pretty probative evidence that there has been 

an increase. The New York Stock Exchange data in Mr. 

Marchman’s written submission shows that the number of referrals 

to their Market Surveillance Unit has made to the SEC over the 

last 2 years went up 60 percent in 2005 and 25 percent in 2006. 

That is consistent data because their computers are going to be objective and turn out the same criteria and the same warning bell 

each time. 

Now, what is driving this increase that I think exists? Usually, 

it is related to merger and acquisition activity, but that is not the 

story today. I think it is more the intense competition among hedge 

funds where there is tough competition for the investor’s dollar. 

They have to get very high rates of return to stay in business, and 

they may do anything to get material nonpublic information. 

Second, there are new classes of transactions— management 

buyouts, PIPE transactions—that are particularly vulnerable because large numbers of people know in advance about these transactions, and the risk of insider trading goes up exponentially. So 

we have reasons for why it is increasing and evidence it is increasing. Is the SEC at fault? I cannot say that. I cannot make a case 

that the SEC has been inattentive. They have prosecuted between 

7 and 12 percent of their enforcement cases, insider trading cases, 

for the last 10 years or so, and basically I cannot tell the SEC or 

this Committee that they should prosecute more insider trading 

and, thus, less accounting fraud or less market timing or less stock 

option back-dating. All of these things deserve the attention of the 

SEC. 

Therefore, I would suggest the focus has to be on making enforcement more efficient, and here I want to give one basic message. If 

we look worldwide at what makes enforcement efficient, it is effective criminal enforcement, and effective criminal enforcement of insider trading is very difficult. It is easy enough to find out who 

traded, but it is very difficult to identify whether that trading was 

based on material nonpublic information that was misappropriated. 

That requires evidence that is hard to obtain. 

Thus, many insider trading cases are actually prosecuted on 

other grounds. You will recall the Martha Stewart case where she 

was prosecuted for false statements and conspiracy and her co-conspirators for perjury, but none of them were prosecuted for insider 

trading. 

The point I am making is that there needs to be cooperation between civil and criminal enforcers because often the actual charges 

brought will not be securities fraud but something else. However, 

it does deter. 

Now, when we look worldwide at enforcement, I have to tell the 

Committee that in the legal systems closest to the United States, 

insider trading has not been successfully enforced through criminal 

law. In Great Britain and in Canada, there has been no success 

with criminal enforcement. I have just served on a Canadian comVerDate 0ct 09 2002 15:33 Feb 23, 2007 Jkt 032154 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\31445.TXT SJUD1 PsN: CMORC
17

mission that has tried to examine why there has been little success, and basically we find that there are legal barriers between cooperation between the civil enforcer and the criminal enforcer, and 

the cases cannot be made. 

Now, cooperation has never in the past been a problem in the 

United States, but within the last year, two Federal courts have 

dismissed criminal indictments brought by U.S. Attorneys because 

of cooperation between the SEC and the U.S. Attorney. The best 

known of these cases is the Scrushy case you referred to, the CEO 

of HealthSouth. In that case, the U.S. Attorney did call up the SEC 

attorney and suggest some questions they would like asked and 

some questions they would not like asked because it would tip off 

the deponent of the pending criminal investment. Also, the U.S. Attorney suggested they move the proceeding to Alabama from Atlanta so that they could indict the deponent if he committed perjury. Mr. Scrushy was indicted for perjury, and the case was dismissed by a court that says the Government had laid a perjury 

trap. 

I think that is a very fallacious logic. I do not accept the perjury 

trap argument. The defendant was not induced to lie. The defendant was merely induced to lie in Alabama rather than in Georgia, 

and the defendant has no right to avoid prosecution because he 

was not told in advance that the Government was hiding in the 

bushes waiting to indict him if he lied. All defendants should know 

that they can be indicted if they lie before the SEC. 

I suggest that Congress could fix this. This is not a constitutional 

problem. This is a simple problem of supervisory jurisdiction, and 

I think there is a quick fix that is possible. And I will leave it at 

that point. 

[The prepared statement of Mr. Coffee appears as a submission 

for the record.] 

Chairman SPECTER. Thank you very much, Professor Coffee. 

We turn now to Professor James Cox, Duke Law School; appointed to the Currie Chair in 2000; previously taught at Boston 

University and the University of California at Stanford; a member 

of the NASD’s Legal Advisory Committee and the ABA Committee 

on Criminal Law; bachelor’s degree with high distinction from Arizona State University, law degree from the University of California, and a master’s in law from Harvard. 

We appreciate your being here, Mr. Cox. 

STATEMENT OF JAMES D. COX, BRAINERD CURRIE PROFESSOR OF LAW, DUKE UNIVERSITY SCHOOL OF LAW, DURHAM, NORTH CAROLINA 

Mr. COX. Thank you, Senator, for inviting me. My testimony prepared on a blustery Saturday morning reports a lot of studies that 

document everything that you have heard here this morning: that 

insider trading in our capital markets is pervasive and insidious, 

surrounding almost every event. 

By way of illustration and replicating what Mr. Thomas found, 

you find that, on average, beginning about 12 days before takeovers 

or a merger, roughly 40 to 50 percent of the premium that is going 

to be ultimately paid in that unannounced event is already reflected in the stock’s price; that the deals, earnings reports, listVerDate 0ct 09 2002 15:33 Feb 23, 2007 Jkt 032154 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\31445.TXT SJUD1 PsN: CMORC
18

ings, delistings, bankruptcy, offering of new public securities are 

not well- kept secrets in our capital markets. So insider trading is 

a problem. 

As Jack pointed out, we do not know whether the right number 

of referrals are the 140 cases anticipated this year by the Stock 

Watch group. Maybe it should be 300 cases or 400 cases. It is very 

hard to get a handle on that. What we do know is that the evidence 

of insider trading, as I repeated and as captured in my statement, 

is pervasive. 

The suggestions I make are somewhat consistent with what both 

John and Jack have made, and that is that we need to think about 

enforcement. But enforcement really has two different components 

to it, and I focus in my testimony more on the first component, and 

that is, increasing the likelihood of detection. The other component 

of that is the sanction. In between there is the probability of successful prosecution. But let’s talk a little bit about detection. 

One of the relevant questions I have suggested in my written testimony would be an appropriate question for Mr. Marchman and 

his organization is whether they really believe that their data base 

has sufficient inputs as to who are the participants in the deal so 

that when you do find suspicious trading going on—and how do we 

know it is suspicious trading? Generally, a suspicious trade is determined just by the size of the trade. But maybe we ought to look 

at suspicious trading by who the trader is. Do they have in their 

data base sufficient knowledge about who the lawyers are, the investment bankers, the commercial bankers, the accountants that 

are likely involved with these transactions so that they are kicked 

out of the computers even though they may trade a very small 

amount? 

For close to 20 years now I have studied how the Stock Watch 

group operated and how their data base is constructed, what 

names were in it, the heuristics that were used for identifying abnormal volume changes and price changes. And the question is: 

Has that data base kept apace with market developments? How 

transparent is the trading to the Stock Watch group of who the 

traders are vis-a-vis the Stock Watch group, not necessarily to the 

market? As we all know, being able to conceal your identity in the 

marketplace is an important attribute of capital markets. We do 

not want to have it necessarily totally transparent to other investors who is trading, but that is quite a separate question from 

whether we have a system that allows the self-regulatory organizations, the first line of defense for the integrity of our capital markets with respect to insider trading, to know who is trading and 

whether those data bases are adequate and sufficient. 

I believe that we could have a method that would be designed 

to provide sufficient data bases in ways that are consistent with 

privacy notions and at the same time enhance greatly the surveillance of our capital markets, the detection of insider trading, and 

most likely the apprehension and successful prosecution of those 

who violate their trust by trading on material nonpublic information. 

Thank you, Senator. 

[The prepared statement of Mr. Cox appears as a submission for 

the record.] 

19

Chairman SPECTER. Thank you, Professor Cox. 

Well, there is certainly a broad divergence of views. That is an 

excellent panel from that perspective, and I compliment my staff 

on assembling them, more so than easel, if I might say. 

Professor Cox, you are beating around the bush by calling insider 

trading only pervasive and insidious. Would you disagree with that, 

Professor Macey? 

Mr. MACEY. Well, the available data suggests one of two things, 

Senator. One is we could say that insider trading is more pervasive 

in the U.S. than in other countries because the data that Jim Cox 

and Mr. Thomas are referring to suggests greater volume increases 

and bigger price spikes. But I do not think with a glancing familiarity with world capital markets would agree that insider trading 

is more pervasive. 

Obviously, with respect to the question how much illegal insider 

trading should be— 

Chairman SPECTER. He did not say it was more pervasive. He 

just said it was pervasive. 

Mr. MACEY. Right. Well, the— 

Chairman SPECTER. And you say it is less pervasive than other 

places, but— 

Mr. MACEY. Fair enough. 

Chairman SPECTER. Is it pervasive—well, I guess if you say it is 

less pervasive, it is pervasive. How about insidious? 

Mr. MACEY. Well, I think by definition it is insidious because it 

is sneaky, to the extent that it is illegal. But, you know, I think 

again we have to look at causation. We have to look at the great 

efficiency of U.S. markets. And Mr. Thomas’ company does suggest 

in its study that there is more—that they have more of this aberrant activity in the U.S. than, say, in London. 

Chairman SPECTER. Well, I think that is a pretty comprehensive 

indictment to call it pervasive and insidious. I do not often ask the 

same question to other panelists, but is it pervasive and insidious, 

Mr. Marchman? 

Mr. MARCHMAN. Chairman Specter, our numbers do indicate that 

in recent years, at least with regard to our referrals, activity which 

could be labeled as insider trading is on the upswing. Of course, 

I agree with all the panelists— 

Chairman SPECTER. On the upswing. But is it pervasive? 

Mr. MARCHMAN. It is an area of concern for our regulatory group 

given— 

Chairman SPECTER. It is a matter of concern for your regulatory 

groups, but is it pervasive? 

Mr. MARCHMAN. It is a conduct that we are attempting to ascertain the extent of the pervasiveness of the— 

Chairman SPECTER. Conduct attempting to obtain an evaluation 

of the pervasiveness. OK. I am not going to ask it a fourth time. 

Mr. Thomas, is it pervasive and insidious? Mr. Thomas, is illegal 

insider trading pervasive and insidious? 

Mr. THOMAS. Well, certainly insidious if it is illegal. There is no 

doubt about that at all, and— 

Chairman SPECTER. Well, it is illegal, so we now know it is insidious. But is it pervasive? 

20

Mr. THOMAS. Certainly it seems to be pervasive based on our 

studies and the reports out of London and personal experience in 

the past. 

Chairman SPECTER. Well, I do not have so much interest as to 

whether it is pervasive and insidious in London. How about in the 

United States? 

Mr. THOMAS. According to our studies, it would certainly appear 

to be. 

Chairman SPECTER. Professor Coffee, is it pervasive and insidious? 

Mr. COFFEE. It is pervasive and insidious enough to need a 

stronger regulatory response. 

Chairman SPECTER. OK. You have touched a core issue, Professor Coffee, on the parallel tracks matter, and what is the best 

rationale to be said in support of the Federal court decision striking an indictment because of cooperation? It seems to me a telephone call from— 

Mr. COFFEE. There are two decisions— 

Chairman SPECTER. Two cases. Well, one was the perjury trap 

and the other was the coordination—or were they both coordination? 

Mr. COFFEE. Well, they both involved coordination, which created, in the view of one judge— 

Chairman SPECTER. But was the rationale in both— 

Mr. COFFEE. I think the underlying rationale— 

Chairman SPECTER. The absence of parallel and disconnected 

tracks. 

Mr. COFFEE. I think the underlying rationale is the defendant is 

somehow entitled to warning so that he could assert his Fifth 

Amendment rights if he knew that the U.S. Attorney was using the 

SEC proceeding as a way of gathering evidence for purposes of the 

criminal prosecution. However, in the past, Congress has written 

right into the Federal securities laws that the SEC can turn this 

information over. We just have a gap as to whether or not the two 

bodies can consult during the process of investigation, and that is 

where I think there could be a further fix, because right now there 

is considerable confusion in the law. And, frankly, any zealous defense counsel is almost duty bound to make a motion alleging that 

the Government has violated this perjury trap or somehow improperly cooperated between the civil and criminal sides. 

Chairman SPECTER. I have not been in the prosecution business 

for a while. Is there an evolved doctrine of perjury trap? It is the 

first time I have heard of it. 

Mr. COFFEE. Scrushy is the first time I heard it, and I think it 

is very surprising to most prosecutors. But as long as we have two 

decisions out there and no circuit court decisions, we are in a state 

of considerable uncertainty. 

Chairman SPECTER. Entrapment is a well-accepted doctrine for a 

defense, but perjury— 

Mr. COFFEE. Entrapment, as you are well aware, Senator— 

Chairman SPECTER. Well, come back to the question which I 

have interrupted. What is the best rational for the conclusion that 

the SEC attorneys and the Department of Justice attorneys ought 

to be on totally separate tracks? 

21

Mr. COFFEE. Well, I think the argument implicitly of the Scrushy

court is that if you knew that the SEC was a stalking horse, was 

working hand in glove with the U.S. Attorney, you would have 

taken your Fifth Amendment rights, assert it at the SEC proceeding, and you would have had the case probably determined adversely against you because you can take inference— 

Chairman SPECTER. That is the best rationale? 

Mr. COFFEE. The rationale is that we should broadly protect—I 

do not agree with this rationale, but the rationale would be that 

we should give the defendant fair notice that the Government is 

going to use this evidence and permit him to assert his Fifth 

Amendment rights knowing the intended use of the evidence. 

Chairman SPECTER. Well, a person ought to be on guard at all 

times for anything which is said which is incriminating, because it 

can be used in an evidentiary way, as we all know, by anybody who 

hears it as an admission, even on a hearsay basis, let alone if you 

have a governmental agency conducting an investigation. 

Professor Macey, do you think that criminal sanctions ought not 

to be employed against illegal insider trading? 

Mr. MACEY. No. I think criminal sanctions should be employed 

against illegal insider trading. 

Chairman SPECTER. Professor Cox, Professor Macey has emphasized a view that the reputational penalties for insider trading are 

very high. Now, he does not think that they should be exclusive, 

as he just testified, but how meaningful do you think reputational 

penalties are for insider—to discourage illegal insider trading. 

Mr. COX. My sense is not enough, and the reason for that is that 

we still see individuals who are engaged in professions which trade 

on reputation—lawyers, accountants, certain high-level investment 

bankers that still cross the line, and they must appreciate the fact 

ex ante that if they get caught, they will no longer be a lawyer or 

an accountant because nobody will ever retain them in their firm. 

So I think individuals discount heavily the loss of reputation 

going into it. I think the loss of reputation is an important part of 

addressing—causing people to adhere to a norm. But it breaks 

down in lots of areas, and I suspect that the reputation loss for 

those that are business people, not professional people, is not nearly as great because the little bit of casual knowledge I know, individuals that have been involved in insider trading continue to be 

executives of firms; whereas, those who are lawyers or accountants 

find another profession other than being a lawyer or accountant. So 

it depends upon a little bit about where you came from, but also 

it depends a lot on who you are as well. 

Chairman SPECTER. Reputational factors are not as important to 

business people as to lawyers or accountants because the penalties 

are not as high. They can keep their jobs. 

Mr. COX. That is what my surmise would be, sir. 

Chairman SPECTER. Mr. Thomas, Professor Cox has raised a 

question as to whether the data base is sufficient and wants to 

know if you cross-check lawyers and accountants and other professionals who are engaged in demonstrable illegal insider trading as 

a factor to be considered in your studies. Does your data base take 

into account what Professor Cox has asked about? 

22

Mr. THOMAS. Senator, we have no idea who the particular parties 

are doing the trading. Something we do do is analyze the individual number of trades, and it usually happens that when tippees 

are involved, the number of individual trades or transactions increases significantly beyond the norms, independent of the absolute 

volume. And this is an important indicator that something funny 

may be going on. 

Chairman SPECTER. Do you think it would be a better study if 

you tracked lawyers and accountants for the reasons Professor Cox 

articulates? 

Mr. THOMAS. If someone paid us and gave us the mandate to do 

so, we would be happy to do it. 

Chairman SPECTER. Well, this Committee is not in a position to 

pay you to do so. 

Mr. THOMAS. I am just pointing out, Senator, with due respect, 

that is not the business we are in. 

Chairman SPECTER. But you might propose it to the New York 

Times. Or they might have heard about it from what we are saying 

here. 

It is a very interesting study that you have conducted, beyond 

any question. 

Mr. THOMAS. Thank you. 

Chairman SPECTER. And you have been commissioned to do so, 

according to the Times, by the New York Times itself. Correct? 

Mr. THOMAS. Correct, yes. 

Chairman SPECTER. Do you know the genesis as to why the 

Times decided to make these inquiries? 

Mr. THOMAS. Our company and the New York Times have been 

talking for a while about exchanging—our providing some of our information. And then when the Financial Times of London reported 

on the FSA study the 30-percent number out of London, the New 

York Times said, Hey, could you do the same sort of study over 

here for the United States for, say, mergers and acquisitions— 

Chairman SPECTER. So it was inspired by the London Times 

story as opposed to some preconception that there might be something rotten in Denmark. 

Mr. THOMAS. There might have been that preconception. I have 

no idea. But the London Times, the Financial Times story was the 

trigger that got this investigation going. 

Chairman SPECTER. Mr. Marchman, your statistics are very interesting about your referrals and the significant increase in referrals. Do you track what the SEC does with your referrals in terms 

of sanctions? 

Mr. MARCHMAN. We do. We do, and the— 

Chairman SPECTER. Are they doing a good job? 

Mr. MARCHMAN. With the— 

Chairman SPECTER. I withdraw that question. You probably 

should not be asked that question. What are they doing? I will not 

ask you a leading question. Professor Macey raised his eyebrows on 

that. 

Mr. MARCHMAN. Well, what they do do, after we referred the 

matter, is that—and, Chairman Specter, I would note that before 

we do refer a matter to the SEC, there is an extensive process that 

is involved by my staff where we do, in fact, have an extensive data 

23

base which contains information with regard to the identities of attorneys, accountants, individuals who may have been involved 

with— 

Chairman SPECTER. So you pick up some of what Professor Cox 

suggested. 

Mr. MARCHMAN. We pick up almost all of what Professor Cox has 

suggested. 

Chairman SPECTER. And what has the SEC done with your referrals? 

Mr. MARCHMAN. With our referrals, they have instituted a number of disciplinary actions, as noted in my written testimony, as a 

result of the referrals. We do keep track with regard to the numbers. We have discussions with regard to any additional information that they may need as they are going forward. And we also 

are mindful of the evidentiary burdens that do confront the SEC 

with regard to the referrals that we make. 

The referrals that we do make, as I noted in my written testimony, are indications of potential violations of insider trading, not 

actual evidence. 

Chairman SPECTER. Mr. Marchman, would you provide to the 

Committee your information as to what has happened on the referrals? 

Mr. MARCHMAN. Sure. 

Chairman SPECTER. And give us an evaluation, if you care to do 

so—I know this is sensitive—as to whether you think what the 

SEC has done is adequate. And we are going to track them on the 

other end with the SEC and with the Department of Justice to see 

what they are doing. 

Mr. Coffee, you have raised the possibility of altering the mens 

rea test but think that that would be unwise to do. Would you expound upon that? 

Mr. COFFEE. Well, right now, any criminal prosecution for securities fraud, which is how insider trading is classically prosecuted, 

requires you to show that the defendant has a mens rea of willfully 

violating the statute, and there are a series of decisions by eminent 

judges, like Henry Friendly, that say willfulness in this context requires proof of a conscious awareness of wrongdoing on your part. 

That is a very high standard, and it is one of the problems. I do 

not think it is the principal problem. I think the principal problem 

is getting proof that you actually possessed material nonpublic information. 

So it would be a move that would simplify the prosecution. I do 

not recommend it because I believe this is an extremely regulated 

and complex area, much like the tax law. And there are many people who trade believing that they are permitted to trade because 

they are not breaching a duty. And I think you should have some 

awareness that you are breaching a duty before you get criminally 

prosecuted for insider trading and face a penalty of up to 25 years. 

Chairman SPECTER. You mentioned Judge Friendly and his test. 

What was it like, Professor Macey, clerking for Judge Friendly? 

Mr. MACEY. He was a brilliant lawyer, particularly in the business law, white-collar crime, corporate and securities area, and a 

keen, keen intellect. It was a great honor and privilege. 

24

Chairman SPECTER. Chief Justice Roberts clerked for Judge 

Friendly, too. 

Mr. MACEY. That is correct. 

Chairman SPECTER. Why didn’t you then go ahead to clerk for 

Chief Justice Rehnquist and become Chief Justice? 

[Laughter.] 

Mr. MACEY. I like academic life, and one clerkship year was plenty for me. I guess Chief Justice Roberts had a bigger appetite for 

clerking than I did. 

Chairman SPECTER. When you were on the Yale Law Journal, 

did you write a note or comment? 

Mr. MACEY. Yes. 

Chairman SPECTER. What were the subjects? 

Mr. MACEY. The Banking Act of 1933, the Glass-Steagall Act. 

Chairman SPECTER. Well, gentlemen, thank you very much for 

your participation here today. As a final question, I would like each 

of you to give an opinion, if you care to do so, on whether there 

is sufficient criminal law enforcement by the Department of Justice 

on insider trading or stock exchange manipulations generally on 

back-dating options or fraud in a variety of ways. Adequate or inadequate, Professor Cox? If you care to say. 

Mr. COX. Well, I think I would like to see more prosecution just 

because I think that captures the attention of lots of people who 

need to have the message. And my sense is that we do not have 

a lot of prosecutions, and I will be very interested to see, with 

back-dating of stock options, whether there are criminal prosecutions there. I would certainly hope so. 

Chairman SPECTER. What is your view, Professor Coffee? 

Mr. COFFEE. It has only been in the last couple of years that U.S. 

Attorneys outside of New York have been willing to give priority 

to white-collar criminal prosecutions for securities fraud. This is 

still a developing transition. I think that there are many districts 

where you do not see the U.S. Attorney giving any attention to 

white-collar crime, and insider trading can occur anyplace. 

So I think there is need for more enforcement, and there is an 

uneven pattern in the use of criminal sanctions across this country, 

as different U.S. Attorneys have different priorities. 

Chairman SPECTER. Well, it is something the Department of Justice, Main Justice can handle. They certainly should weigh in. They 

have some control there. 

Professor Macey? 

Mr. MACEY. Just two quick points. One, I agree with Jack Coffee 

that there is strong evidence of regional asymmetries, biases. Some 

places are much more active—the Southern District of New York, 

for example—in criminal prosecutions. 

But, two, before saying that the Department of Justice or the 

SEC should do more, I would really like to see a few factual stories 

and saying this person did the following, engaged in the following 

trading, and shouldn’t that person have been prosecuted. Otherwise, I think it is too easy to say, gee, I am a good guy, we should 

be doing a lot more of this. And, you know, I think that to the extent that we can identify tangible examples of such misconduct, 

then I would look at those on a case-by-case basis. 

25

Chairman SPECTER. Mr. Thomas, does the Crown bring enough 

prosecutions? 

Mr. THOMAS. Does the Crown bring enough prosecutions? 

Chairman SPECTER. Well, yes. 

Mr. THOMAS. I doubt it. But Professor Laura Beny of the University of Michigan Law School has done a study insider trading law 

enforcements around the world, and her thesis is that the stronger 

the restrictions are and the more they are enforced, the more liquid 

and fair the markets become. I think that is a worthy goal. 

Chairman SPECTER. And does Canada bring enough criminal 

prosecutions? 

Mr. THOMAS. I doubt it. 

Chairman SPECTER. Would you care to venture an opinion on the 

United States’ criminal prosecutions adequacy? 

Mr. THOMAS. I would prefer not to, Senator. 

Chairman SPECTER. Well, you are not under subpoena so you do 

not have to. 

[Laughter.] 

Chairman SPECTER. Mr. Marchman, enough prosecutions under 

the criminal statutes in the United States? 

Mr. MARCHMAN. Chairman Specter, I can only comment from the 

interaction that I have been fortunate to have with the U.S. Attorney’s Office in the Southern District, and they have a very vigorous 

and active program. So from that vantage point, I do believe it is 

adequate. 

Chairman SPECTER. Without objection, we will admit into the 

record a statement from Senator Grassley. 

I am going to tell my colleagues what a good hearing they missed 

today, and I think next time I am not going to invite anybody. I 

like the current make-up of the panel. 

[Laughter.] 

Chairman SPECTER. I maintain a record of adhering strictly to 

time limits, and each questioner has 5 minutes, and I am now in 

excess of 20 minutes, 15 minutes over my time, which is a first for 

me. I am prompted to think about one-person grand juries, and we 

may adopt that policy for this Committee. 

[Whereupon, at 11:15 a.m., the Committee was adjourned.] 

Questions and answers and submissions for the record follow.]

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