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Insider Trading A Comparative Perspective. Marc I. Steinberg * - PDF
Insider Trading A Comparative Perspective. Marc I. Steinberg *
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1 Insider Trading A Comparative Perspective Marc I. Steinberg * The United States Securities law framework may be perceived as a model to be adapted to the culture 1 and needs of other jurisdictions. Included within this framework are issues focusing on insider trading practices. Examining U.S. law on this subject, however, reveals a regime that at times fails to accord fair 2 treatment to market participants and impedes commercial certainty. Countries abroad thus may be ill served by embracing the U.S. model in this area. Indeed, with respect to insider trading regulation, a survey of the 3 securities laws of developed markets reveals that these countries have rejected the U.S. approach. By adhering 4 to an insider trading prescription premised on participant equal access to material nonpublic information, a 5 6 number of these countries reflect the U.S. law in the pre-chiarella era. * Rupert and Lillian Radford Professor of Law and Senior Associate Dean for Academics, Southern Methodist University; Visiting Professorial Fellow, Centre for Commercial Law Studies, University of London; Editor-in-Chief, The International Lawyer, The Securities Regulation Law Journal. Copyright 2002 by Marc I. Steinberg. All rights reserved. 1 See generally M. Steinberg, International Securities Law A Contemporary and Comparative Analysis (1999) See infra notes and accompanying text. See infra notes and accompanying text. See infra notes and accompanying text. Chiarella v. United States, 445 U.S. 222 (1980). See infra notes and accompanying text. 1
2 Given the ambiguity and complexity of U.S. law in the insider trading area, the Congress and the Securities and Exchange Commission (SEC) may be advised to assess the regulatory framework in certain other countries and determine their feasibility of application to the U.S. system. It may eventuate that key principles readily can be implemented from favored securities jurisdictions in order to enhance the clarity and efficiency of 7 the U.S. framework. Regardless of its purported shortcomings, the U.S. securities regime maintains a critical component that other countries thus far have failed to achieve: an enforcement framework, based on government as well as private actions, that enhances compliance with the law and facilitates the levying of sanctions should violations 8 occur. Effective enforcement is the key attribute of the U.S. securities law framework that distinguishes it from the regulatory structure existing in other countries. Hence, although the contours of U.S. securities law in the insider trading area may need refinement, effective enforcement elevates the U.S. framework to preeminence among securities markets. Briefly put, it is far more beneficial for achieving market integrity and investor confidence to effectively implement imperfect (yet palatable) securities laws than have admirable statutes that are rarely or episodically enforced. 9 This paper thus focuses on regulation of insider trading regulation in developed securities markets. First, the U.S. regime is discussed. Thereafter, the securities laws of selected developed markets are addressed in order to provide contrasts to the U.S. approach. Last, the paper focuses on a number of significant issues that merit exploration. 7 See, e.g., infra notes and accompanying text. 8 9 See infra notes and accompanying text. See infra note and accompanying text. 2
3 I. U.S. REGULATION OF INSIDER TRADING A. Preeminence of Federal Law The following discussion examines key aspects of U.S. law in the insider trading area. With respect to 10 insider trading regulation, federal law is the primary source of regulation. Although some states, such as New 11 York, allow derivative suits against inside traders based on unjust enrichment and perceived injury to the corporate enterprise, state law often is unavailable in this context. For example, the nonrecognition by state 14 courts of an insider s disclosure obligation when transactions occur on impersonal securities markets as well as 15 such courts refusal to find the requisite injury to the corporation signify that allegedly aggrieved traders must 16 turn to federal law to seek redress. 10 See generally W. Wang & M. Steinberg, Insider Trading (1996 & 2002 supp.) 11 See, e.g., Diamond v. Oreanumo, 24 N.Y.2d 494, , 248 N.E.2d, 910, 912, 301 N.Y.S.2d 78, 81 (1969). 12 Id. at , 248 N.E.2d at , 301 N.Y.S.2d at th See, e.g., Freeman v. Decio, 584 F.2d 186, (7 Cir. 1978) (applying Indiana law); Schein v. Chasen, 313 So.2d 739, 746 (Fla. 1975); W. Wang & M. Steinberg, supra note 10, 16.1, at 1106 ( State law is rarely applied to stock market insider trading. ). 14 See, e.g., Van Shaack Holdings, Ltd. v. Van Shaack, 867 P.2d 892 (Colo. 1994); Bailey v. Vaughan, 178 W.Va. 371, 359 N.E.2d 599 (1987); Hotchkiss v. Fischer, 136 Kan. 530, 16 P.2d 531 (1932). 15 Sources cited note 14 supra. See Branson, Choosing the Appropriate Default Rule Insider Trading Under State Law, 45 Ala. L. Rev. 753 (1994); Hazen, Corporate Insider Trading: Reawakening the Common Law, 39 Wash. & Lee L. Rev. 845 (1982). 16 Steinberg, supra note 1, at Note that certain state securities laws may allow government and/or private actions based on alleged insider trading violations. See W. Wang & M. Steinberg, supra note 10, at See generally M. Steinberg & R. Ferrara, Securities Practice: Federal and State Enforcement 12:01-12:29 (2d ed. 2001). 3
4 17 Section 16 of the Securities Exchange Act of 1934 governs short-swing trading by directors, officers, and ten percent equity holders of publicly-held entities. Pursuant to Section 16(b), such persons are subject to strict liability, requiring disgorgement of all profit, if they buy and sell (or sell and buy) an equity security of a subject entity withing a six-month period. Section 16 raises several complex issues, including whether the 20 statute has outlived its usefulness and should be repealed. This paper declines to enter the Section 16 fray, focusing instead on the securities acts antifraud provisions, which constitute the essence of insider trading regulation in the United States. B. Rejection of Access and Parity Theories Under U. S. Law, no statute codifies the contours of the insider trading prohibition. Rather, the federal courts and the SEC are the principal actors. Prior to U.S. Supreme Court decisions in the 1980s, lower courts U.S.C. 78p. 18 th See, e.g., Whittaker v. Whittaker Corp., 639 F.2d 516 (9 Cir. 1981); Smolowe v. Delendo Corp., 136 F.2d 231 (2d Cir. 1943). See generally P. Romeo & A. Dye, Section 16 Reporting Guide (2001). 19 For example, these issues include the concepts of beneficial ownership and attribution, identifying which persons may be officers, and applying the objective versus the pragmatic approach. See, e.g., Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582 th (1973); CBI Industries, Inc., v. Horton, 682 F.2d 643 (7 Cir. 1982); Merrill Lynch, Pierce, th Fenner and Smith v. Livingston, 566 F.2d 1119 (9 Cir. 1978); Securities Exchange Act Release No , [ Transfer Binder] Fed. Sec. L. Rep. (CCH) 84,709 SEC 1991). 20 See O Conner, Toward a More Efficient Deterrence of Insider Trading: The Repeal of Section 16(b), 58 Fordham L. Rev. 309 (1989). But see Thel, The Genius of Section 16: Regulating the Management of Publicly Held Companies, 42 Hastings L.J. 391 (1991). See generally Steinberg & Lansdale, The Judicial and Regulatory Constriction of Section 16(b) of the Securities Exchange Act of 1934, 68 Notre Dame L. Rev. 33 (1992). 4
5 21 22 adhered to the parity of information and equal access approaches when interpreting the disclose or abstain mandate of Securities Exchange Act Section 10(b) (and SEC Rule 10b-5 ) in the insider trading setting. Under the parity of information theory, as enunciated by the U.S. Court of Appeals for the Second Circuit, anyone in possession of material inside information must either disclose it to the investing public, or... must 25 abstain from trading in or recommending the securities concerned while such information remains undisclosed. The equal assess theory, a more narrow approach, posits that [a]nyone corporate insider or not who regularly receives material nonpublic information may not use this information to trade in securities without 26 incurring an affirmative duty to disclose. Insofar as tipper-tippee liability, lower courts held that a tippee stood in the shoes of the tipper. A tippee knowingly receiving material nonpublic information from a tipper, 27 when such tipper could not trade on that information, likewise was subject to the disclose or abstain mandate. As will be discussed in the paper s next section, a number of countries by statute adhere to at least some of the 28 foregoing principles. 21 See, e.g., SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968) (en banc); infra note 25 and accompanying text. 22 See, e.g., United States v. Chiarella, 588 F.2d 1358, 1365 (2d Cir. 1978), rev d, 445 U.S. 222 (1980); infra note 26 and accompanying text U.S.C. 78j(b) C.F.R b-5. See generally Ferrara & Steinberg, A Reappraisal of Santa Fe: Rule 10b-5 and the New Federalism, 129 U. Pa. L. Rev. 263 (1980) SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968) (en banc). United States v. Chiarella, 588 F.2d 1358, 1365 (2d Cir. 1978), rev d, 445 U.S. 222 (1980). 27 See, e.g., Elkind v. Liggett & Myers, Inc., 635 F.2d 156 (2d Cir. 1980); Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 495 F.2d 228 (2d Cir. 1974). 28 See infra notes and accompanying text. 5
6 Today, the parity of information and equal access approaches for Section 10(b) purposes no longer retain 29 validity. Rather, as construed by the U.S. Supreme Court, the breadth of the insider trading proscription under 30 Section 10(b) is premised on principles based on fiduciary duty and trust and confidence. Other key concepts 31 in this context include the materiality of the particular information and whether that information is confidential 32 (namely, whether it has been adequately disseminated and absorbed by the investment community). Hence, as interpreted by the U.S. Supreme Court, trading on the basis of material nonpublic information by a director, officer, or other insider (e.g., a controlling shareholder) in the subject company s securities is prohibited under Section 10(b) because, by engaging in such trading, such person breaches a fiduciary duty owed to the company and to the parties on the opposite side of the transaction(s), namely, the company s 33 shareholders. Accordingly, a disclosure obligation arises in this context from a relationship of trust and 29 See, e.g., Dirks v. SEC, 463 U.S. 646 (1983); Chiarella v. United States, 445 U.S. 222 (1980). 30 See e.g., Chiarella, 445 U.S. at 230 (opining that such liability is premised upon a duty to disclose arising from a relationship of trust and confidence ). 31 See, e.g., Basic, Inc. v. Levinson, 485 U.S. 224, 232, 240 n. 18 (1988); Ganino v. Citizens Utilities Company, 228 F.3d 154 (2d Cir. 2000); SEC v. Mayhew, 121 F.3d 44 (2d Cir. 1997). 32 See, e.g., United States v. Libera, 989 F.2d 596, 601 (2d Cir. 1993); In re Faberge, Inc., 45 S.E.C. 244, 256 (1973); Steinberg, supra note 1, at From a general perspective: [M]aterial information becomes public in either of two ways. The first view is that information that is disseminated and absorbed by the investment community is public. The second view is premised on the efficient market theory, and under this view, information is deemed public when the active investment community is aware of such information. Under the efficient market theory, information that is known by the investment community will be reflected in the price of an efficiently traded security. M. Steinberg, Securities Regulation: Liabilities and Remedies 3.03 (2001). 33 See, e.g., Chiarella, 445 U.S. at
7 34 confidence between the transacting participants. Likewise, the subject company s consultants, including lawyers, accountants, and bankers, who become privy to material nonpublic information with the understanding that this information must remain confidential, are defined as quasi-insiders and thereby are deemed to have a 35 relationship of trust and confidence with the company and its shareholders. Such persons accordingly are subject to the disclose or abstain mandate, to wit, that they must adequately disclose the material information to 36 the marketplace or abstain from trading (as well as tipping) until such dissemination is effected. Nonetheless, insiders, who elect to make adequate disclosure prior to their trade(s) (or tip(s)), violate the corporation s need 37 for confidentiality regarding such information and incur state law liability exposure. In regard to outsiders, namely, those individuals who do not have a fiduciary obligation to those who 38 trade on the other side of the subject transaction(s), the misappropriation theory may be invoked. Under this theory, a Section 10(b) violation occurs when the subject actor misappropriates material nonpublic information for securities trading objectives, resulting in breaching a relationship of trust and confidence to the source of the 39 information, irrespective whether such source is or is not a party to the trade. Accordingly, an employee who misappropriates material confidential information entrusted to her employer and who uses such information for 34 Id. 35 Dirks, 463 U.S. 646, 655 n. 14 (1983). 36 Id. ( The basis for recognizing this fiduciary duty is not simply that such persons acquired nonpublic corporate information, but rather that they have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes. ) See Steinberg, supra note 1, at ; W. Wang & M. Steinberg, supra note 10, at 5.2. See, e.g., United States v. O Hagan 117 S.Ct (1997). 39 Id. at See United States v. Falcone, [2001 Transfer Binder] Fed. Sec. L. Rep. (CCH) 91,489 (2d Cir. 2001). 7
8 securities trading purposes breaches a relationship of trust and confidence to her employer and perhaps to her 40 employer s clients. Turning to unlawful tipping under Section 10(b), the critical inquiries are whether the tipper breached his fiduciary duty (or a relationship of trust and confidence) by communicating the subject information to his 41 tippee(s) and whether the subject tippee(s) knew or should have known of the breach. Without the finding of a 42 breach, a tippee may trade and tip without violating Section 10(b). Consistent with Supreme Court analysis, an insider is held to breach his fiduciary duty by tipping the subject information when having the motivation to receive a personal benefit. Such personal benefit normally is of a pecuniary nature, such as cash or elevation in 43 status that will result in future financial benefits. A gift also is deemed a sufficient personal benefit: The gift of tipping the material nonpublic information is likened to trading by the insider himself with the transfer to the 44 tippee-recipient of the profits generated from the trades. C. Rule 14e-3 Insider Trading in the Tender Offer Setting S. Ct. at See United States v. Newman, 664 F.2d 12 (2d Cir. 1981); Steinberg, supra note 1, at 111. See generally W. Wang & M. Steinberg, supra note 10, at 5.4 (2001 supp.); Bromberg & Lowenfels, Misappropriation in the Supreme Court, 31 Rev. Sec. & Comm. Reg. 37 (1998); Nagy, Reframing the Misappropriation Theory of Insider Trading Liability: A Post-O Hagan Suggestion, 59 Ohio St. L. J (1998); Ramirez & Gilbert, The Misappropriation Theory of Insider Trading Under United States v. O Hagan: Why Its Bark Is Worse Than Its Bite, 26 Sec. Reg. L.J. 162 (1998); Weiss, United States v. O Hagan: Pragmatism Returns to the Law of Insider Trading, 23 J. Corp. L. 395 (1998) Dirks v. SEC, 463 U.S. 646 (1983). Id. at 662. Id. at Id. at 664 (opining that [t]he tip and trade resemble trading by the insider followed by a gift of the profits to the recipient ); Steinberg, supra note 1, at 111. See Hiler, Dirks v. SEC A Study in Cause and Effect, 43 Md. L. Rev. 292 (1984). 8
9 In contrast to the Section 10(b) jurisprudence of insider trading is SEC Rule 14e-3 which applies only in 45 the tender offer setting. In this limited context, the proscriptions against trading and tipping on material confidential information are significantly broader. Under Rule 14e-3, a person who obtains material confidential information regarding a tender offer directly or indirectly from the offeror (bidder), target corporation, or an 46 intermediary neither can trade nor tip prior to adequate public disclosure (and absorption) of such information. In addition, a tippee of material confidential information relating to a tender offer who knows or should know that the subject information comes directly or indirectly from an offeror, target corporation or intermediary 47 similarly cannot trade or tip prior to adequate public disclosure (and absorption) of this information. Rule 14e- 3 provides an exception to this expansive disclose or abstain rule for multi-service financial institutions that adopt and implement sufficient screening mechanisms that effectively prevent the flow of confidential information to those who effect or recommend trades in the subject company s securities. 48 D. Critique of U.S. Insider Trading Law U.S. law on insider trading is far from laudable. Today, as a result of Supreme Court decisions, concepts focusing on fiduciary duty, misappropriation, and financial benefit determine the propriety of transactions C.F.R e-3. Rule 14e-3 was adopted in Securities Exchange Act Release No , [1980 Transfer Binder] Fed. Sec. L. Rep. (CCH) 82,646 (1980). 46 See Rule 14e-3(a), (d), 17 C.F.R e-3(a), (d). The Supreme Court upheld Rule 14e- 3's validity in United States v. O Hagan, 117 S.Ct (1997). 47 Rule 14e-3(d), 17 C.F.R e-3(d). 48 Rule 14e-3(b); M. Steinberg, supra note 1, at 112. See SEC Division of Market Regulation, Broker-Dealer Policies and Procedures Designed to Segment the Flow and Prevent the Misuse of Material Nonpublic Information, [ Transfer Binder] Fed. Sec. L. Rep. (CCH) 84,520 (1990); Levine, Gardiner & Swanson, Multiservice Securities Firms: Coping With Conflicts in a Tender Offer Context, 23 Wake Forest L. Rev. 41 (1988); Steinberg & Fletcher, Compliance Programs for Insider Trading, 47 SMU L. Rev (1994). 9
10 consummated or contemplated. The objective of ensuring that ordinary investors are on an equal footing with market professionals to access material nonpublic information is no longer viable under Section 10(b) insider 49 trading jurisprudence. Although Congress clearly intended the federal securities acts to extend greater investor protection than state law, the Supreme Court s foremost reliance on state law premised on concepts of fiduciary duty slights that congressional objective. 50 Indeed, the SEC, acting ostensibly within its rulemaking authority, has sought to minimize restrictive Supreme Court law. One example is the SEC s promulgation of Rule 14e-3 which sets forth expansive parity of 51 information and anti-tipping mandates in the tender offer context. In the Section 10(b) setting, the 52 Commission has advocated a broad construction of Supreme Court precedent, even prescribing new rules that 49 See supra notes and accompanying text. 50 See Chiarella, 445 U.S. at (Blackmun, J., dissenting). As Justice Blackmun opined: By its narrow construction of 10(b) and Rule 10b-5, the Court places the federal securities laws in the rearguard of this movement, a position opposite to the expectations of Congress at the time the securities laws were enacted.... I cannot agree that the statute and Rule are so limited. The Court has observed that the securities laws were not intended to replicate the law of fiduciary relations. Rather, their purpose is to ensure the fair and honest functioning of impersonal national securities markets where common-law protections have proved inadequate. As Congress itself has recognized, it is integral to this purpose to assure that dealing in securities is fair and without undue preferences or advantages among investors. Id. at 248. See also, Anderson, Fraud, Fiduciaries, and Insider Trading, 10 Hofstra L. Rev. 341 (1982); Bainbridge, Incorporating State Law Fiduciary Duties Into the Federal Insider Trading Prohibition, 52 Wash. & Lee L. Rev (1995). 51 See supra notes and accompanying text. 52 Two such examples are the SEC s assertion that applicable Supreme Court decisions allow for broad interpretations of trading on the basis of inside information and the requisite th benefit for tipping purposes. See, e.g., SEC v. Adler, 137 F.3d 1325 (11 Cir. 1998) (rejecting SEC s assertion but adopting a presumption of use when one trades while knowingly possessing material nonpublic information); SEC v. Stevens, SEC Litigation 10
11 53 in effect overturn lower court authority. In another recent regulatory action, the SEC adopted Regulation FD that seeks to terminate the practice by companies of selectively disclosing material nonpublic information to 54 market professionals and favored shareholders. While these selective disclosure practices constitute illegal 55 insider tipping under the laws of many countries and indeed were illegal in this country prior to the Supreme 56 Court s decision in Dirks, such conduct is impermissible under Section 10(b) today only if the tipper is 57 motivated by a desire to benefit personally from the selective disclosure. Release No (March 19, 1991) (settlement where SEC alleged that insider received personal benefit under Dirks test by tipping inside information to securities analysts). 53 See SEC Rules 10b5-1, 10b5-2, 17 C.F.R b5-1, 10b5-2, adopted in, Securities Exchange Act Release No , [2000 Transfer Binder] Fed. Sec. L. Rep.(CCH) 86,319 (2000). By adopting in Rule 10b5-1 a broad awareness test rather than a use standard for determining when trading is on the basis of material nonpublic information, the SEC rejected the standards set forth in at least two appellate court decisions. See United States v. th th Smith, 55 F.3d 1051 (9 Cir. 1998); SEC v. Adler, 37 F.3d 1325 (11 Cir. 1998); Horowitz & Bitar, Insider Trading: New SEC Rules and an Important New Case, 28 Sec. Reg. L.J. 364 (2000); Nagy, The Possession Vs. Use Debate in the Context of Securities Trading By Traditional Insiders: Why Silence Can Never Be Golden, 67 U. Cin. L. Rev (1999); Sinai, Rumors, Possession v. Use, Fiduciary Duty and Other Current Insider Trading Considerations, 55 Bus. Law. 743 (2000). Moreover, by its promulgation of Rule 10b5-2, the SEC has overturned the Second Circuit s decision in United States v. Chestman, 947 F.2d 551 (2d Cir. 1991) (en banc) (discussed infra notes and accompanying text). 54 See Securities Exchange Act Release No , [2000 Transfer Binder] Fed. Sec. L. Rep. (CCH) 86,319 (2000). 55 See infra notes and accompanying text. 56 See, e.g., Elkind v. Liggett & Myers, Inc., 635 F.2d 156 (2d Cir. 1980); supra note 27 and accompanying text. 57 See supra notes and accompanying text. 11
12 Some concrete examples illustrate the erratic treatment of insider trading law in the United States. One 58 striking illustration is the different treatment accorded to tender offers due to SEC Rule 14e-3. Literally, an individual can legally retain profits by trading on material inside information or be held liable simply by the fortuity of whether a tender offer is implicated. For example, Barry Switzer, the former football coach of the Dallas Cowboys and the University of Oklahoma, inadvertently received material nonpublic information from a 59 key corporate executive relating to a forthcoming merger transaction. Knowing the information to be reliable because of his relationship with the insider, Switzer (along with his cronies) traded on the basis of this 60 information and made a handsome profit. In that the insider was unaware of Switzer being privy to the 61 communications at issue, the court held there was no unlawful tipping. Because the tippee s liability under 62 Section 10(b) is derivative in nature, the finding that the insider-tipper did not breach his fiduciary duty 63 signified that Switzer as the tippee traded lawfully, and, hence, was entitled to keep his profits. The result in Switzer would have been entirely different if the subject transaction had been structured as a tender offer rather that a merger. In that event, Rule 14e-3 as well as Section 10(b) would have applied. Although Switzer would have avoided liability under Section 10(b), he would have violated Rule 14e-3 by 64 trading on material nonpublic information that he knew derived from a reliable inside source. Hence, pursuant 58 For a description of Rule 14e-3, see supra notes and accompanying text SEC v. Switzer, 590 F. Supp. 756, 758, 762 (W.D. Okla. 1984). Id. at Id. at 758, 766. Dirks, 463 U.S. at See supra notes and accompanying text. Switzer, 590 F. Supp. at See Rule 14e-3(a), 17 C.F.R e-3(a). 12
13 to Rule 14e-3, irrespective of the tipper s liability, a tippee incurs liability by knowingly trading on material 65 inside information that directly or indirectly derives from a subject corporation. Thus, Switzer s avoidance of liability and lawful retention of significant profits were owed to the manner in which the affected transaction was structured. 66 This inconsistency becomes more poignant when the Chestman scenario, involving a criminal prosecution, is considered. There, the Second Circuit en banc held that Chestman was not liable under Section 10(b) because his tipper breached no fiduciary duty by conveying material inside information relating to a 67 forthcoming tender offer. Nonetheless, Chestman s criminal conviction under Rule 14e-3 was upheld due to that he knowingly traded while in possession of material nonpublic information relating to a tender offer that 68 derived, directly or indirectly, from a subject corporate source. Thus, while Chestman (like Switzer) avoided Section 10(b) liability because his tipper did not unlawfully tip, Chestman (unlike Switzer) was subject to liability because, unfortunately for Chestman, the structure of the transaction took the form of a tender offer rather than another feasible acquisition alternative, such as a merger or sale of assets. Such inconsistency cannot 65 Id. See W. Wang & M. Steinberg, supra note 10, at ; supra notes and accompanying text, infra note 68 and accompanying text. 66 United States v. Chestman, 947 F.2d 551 (2d Cir. 1991) (en banc) Id. at Id. at Note, moreover, that Rule 14e-3 does not require that a person charged with violating the rule have knowledge that the nonpublic information in his possession st relates to a tender offer. SEC v. Sargent, 229 F.3d 68, 79 (1 Cir. 2000). Accord, United th States v. O Hagan 139 F.3d 641, 650 (8 Cir. 1998); Securities Exchange Act Release No (1980). 13
14 be reconciled with market integrity, investor protection, or basic concepts of fair treatment among similar market participants. 69 The Chestman case has another troubling aspect. In ascertaining whether a fiduciary duty existed 70 so as to trigger the disclose or abstain mandate, the Second Circuit held that marriage, standing alone, 71 does not manifest a fiduciary relationship. To have such a relationship of trust and confidence, there must exist other attributes, such as an understanding to keep the material information confidential or a 72 pre-existing pattern of being privy to family business secrets. In addition to minimizing family values, one can understandably be concerned about the law giving greater sanctity to a shareholder s relationship with a director of a publicly-held company (with whom such shareholder has never spoken or met) than to one s spouse, child, sibling, or parent. Such an approach is an outcome of the U.S. Supreme Court s focus on the existence of a fiduciary relationship (or a relationship of trust and confidence) based on state law principles. Without a rule premised on equal access, state law notions of fiduciary duty can trigger, as it did in Chestman, an absurd result. By adopting Rule 10b5-2, the SEC effectively has nullified this 69 See, e.g., United States v. Naftalin, 441 U.S. 768 (1979) (stating that purposes of Securities Act include investor protection, achieving a high standard of business ethics... in every facet of the securities industry, and observing that the welfare of investors and financial intermediaries are inextricably linked frauds perpetrated upon either business or investors can redound to the detriment of the other and to the economy as a whole ). 70 See supra notes and accompanying text. 71 Chestman, 947 F.2d at 571 (stating that Keith s status as Susan s husband could not itself establish fiduciary status ). 72 Id. at But see SEC v. Lenfest, 949 F. Supp. 341 (E.D. Pa. 1996); United States v. Reed, 601 F. Supp. 685 (S.D.N.Y.), rev d on other grounds, 773 F.2d 477 (2d Cir. 1985). 73 In a separate opinion, Judge Winter reasoned: [F]amily members who have benefitted from the family s control of the corporation are under a duty not to disclose confidential corporate information 14
15 aspect of Chestman. The rule implicates the misappropriation theory under Section 10(b) when a person receives material nonpublic information from a spouse, child, sibling, or parent unless such person can establish that, due to the particular family relationship, there existed no reasonable expectation of confidentiality. One can certainly question whether the SEC s interpretation will be upheld. After all, the Commission in practical effect has overturned a decision rendered by the U.S. Court of Appeals. 77 From an overall perspective, the conclusion seems inescapable that U.S. law on insider trading is far from 78 ideal. Statutes are largely silent on insider trading, thus leaving this subject to the courts. The U.S. Supreme Court, rejecting the parity of information and equal access doctrines, has focused on traditional state law issues that comes to them in the ordinary course of family affairs. In the case of family-controlled corporations, family and business affairs are necessarily intertwined, and it is inevitable that from time to time normal familial interactions will lead to the revelation of confidential corporate matters to various family members. Indeed, the very nature of familial relationships may cause the disclosure of corporate matters to avoid misunderstandings among family members or suggestions that a family member is unworthy of trust. Id. at 579 (Winter, J., concurring in part and dissenting in part) C.F.R b Id. See Securities Exchange Act Release No , [2000 Transfer Binder] Fed. Sec. L. Rep. (CCH) 86,319 (2000). 76 Cf. The Business Roundtable v. SEC, 905 F.2d 406 (D.C. Cir. 1990) (invalidating SEC Rule 19c-4). 77 See Securities Exchange Act Release No , [ Transfer Binder] Fed. Sec. L. Rep. (CCH) 86,228, at 82,863-82,864 (1999) (release proposing Rule 10b5-2 and expressing dissatisfaction with Chestman as being too restrictive). 78 Statutory treatment exists with respect to certain issues relating to insider trading, such as short-swing trading, option traders, the ability of contemporaneous traders to bring a private right of action, the levying of money penalties, and the adoption of specific mechanisms to be implemented by broker-dealers and investment advisers. See, e.g., Sections 16, 20(d), 20A, 21A of the Securities Exchange Act, discussed in W. Wang & M. Steinberg, supra note 10, at 6.2, 6.3, 6.8, 7.3.3; supra notes and accompanying text. 15
16 79 80 of fiduciary duty. This approach, in turn, as exemplified by the Chestman and Switzer cases, has led to illogical lower court decisions. On another front, the SEC, seeking to combat restrictive Supreme Court decisions under the Section 10(b) law of insider trading, has asserted expansive interpretations of those decisions. 81 The Commission, thus faced with frustration regarding its now limited authority under Section 10(b), has 82 responded by promulgating Rules 14e-3 and Regulation FD. The ultimate consequence is all too often the presence of inconsistent and erratic insider trading regulation that ill serves the investing public. Hence, the U.S. framework on insider trading is not one to be emulated. Other countries evidently agree. 83 II. REGULATION OF INSIDER TRADING IN OTHER DEVELOPED MARKETS Unlike the United States where the law of insider trading largely has been formulated by the courts, 84 countries abroad have enacted specific and detailed legislation defining the contours of the insider trading 85 prohibition. Regardless of this codification approach, ambiguities exist in such legislation that await judicial or 86 legislative resolution. 79 See supra notes, 30, 33-35, 50 and accompanying text See supra notes and accompanying text. See supra notes and accompanying text. 82 See 17 C.F.R ; [2000 Transfer Binder] Fed. Sec. L. Rep. (CCH) 83,683 (SEC 2000) See infra notes and accompanying text. See supra notes and accompanying text. See infra notes and accompanying text. See infra notes and accompanying text. 16
17 A. Use of Statutorily Defined Terms 87 Unlike the United States, key terms constituting the insider trading offense are set forth by statute. By way of example, the United Kingdom (U.K.) defines inside information as information that (1) relates to particular securities or their issuers; (2) is specific or precise; (3) has not been made public; and (4) if it were 88 made public would be likely to have a significant effect on the price or value of any security. An insider 87 See infra notes and accompanying text. 88 Criminal Justice Act 1993 (CJA), ch. 36, part V, 56, 60(4), as set forth in Alcock, United Kingdom in International Securities Regulation vol. 5, bklt. 1, 30 (R. Rosen ed. 1994). In 1989, the Council of the European Communities promulgated the European Economic Community Directive Coordinating Regulation on Insider Trading. Council Directive 89/592 of November 13, 1989 Coordinating Regulations on Insider Dealing 1989 OJ (L 344) 30 (the Directive). The Directive, for example, sets forth minimum standards for defining the concepts inside information and insider with respect to which Member States of the European Union must comply. Directive art. 5. Nonetheless, significant details regarding methods of enforcement are left principally to the Member States. Directive art. 8. See Pingel, The EC Directive of 1989, in Insider Trading: The Laws of Europe, the United States and Japan 5, 5-6 (E. Gaillard ed. 1992). Article I of the Directive provides that inside information is information which has not been made public of a precise nature... which, if it were made public, would be likely to have a significant effect on the price of the... security. Directive art. 1. Article 2 sets forth that an insider is any person who... by virtue of his membership of the administrative, management or supervisory bodies of the issuer, by virtue of his holding in the capital of the issuer, or because he has access... by virtue of the exercise of his employment, profession or duties, possesses inside information [and takes] advantage of that information with full knowledge of the facts by acquiring or disposing of for his own account or for the account of a third party, either directly or indirectly, transferable securities of the issuer... to which that information relates. Directive art. 2. Article 4 provides that a secondary insider is any person [other than a primary insider] who with full knowledge of the facts possesses inside information, the direct or indirect source of which could not be other than a [primary insider]. Directive art. 4. The Directive, providing minimum standards only, leaves to the judgment of the 17
18 fact under German law is knowledge of a fact not publicly known relating to one or more issuers of insider securities or to insider securities and which fact is capable of substantially influencing the price of the insider 89 securities in the event of it becoming publicly known. Other countries similarly define by statute the elements 90 of an inside fact or privileged information. In addition, other key concepts are defined by statute, including, for instance, those persons who are deemed: insiders, to have a special relationship with the company, or to have 91 access to insider information. Note that a number of interpretive issues remain under these statutes. Under the U.K. framework, for example, when is information specific or precise rather than general or not specific? Is information relating to the issuer engaging in relatively preliminary merger negotiations with a prospective suitor precise or not Member States whether to adhere to more stringent requirements than those promulgated in the Directive. Directive art. 6. The Directive mandates that each Member State designate competent authorities to ensure that the provisions adopted pursuant to [the] Directive are applied [and that those authorities] be given all supervisory and investigatory powers that are necessary for the exercise of their functions. Directive art. 6. The Directive declines to require whether administrative, civil or criminal sanctions should be implemented by each Member State for enforcement purposes. Rather, Article thirteen provides that [e]ach Member State shall determine the penalties to be applied for infringement of the measures taken pursuant to [the] Directive. See Pincus, supra note 1, at 6-21; Steinberg, supra note 1, at See also, New Curbs on Insider Trading, Market Abuse Agreed to by EU Parliament, 34 Sec. Reg. & L. Rep. (BNA) 432 (2002). 89 Securities Act 13. See Hickinbotham & Vaupel, Germany in International Insider Dealing 129, 134 (M. Stamp & C. Welsh eds. 1996). 90 See, e.g., France Commission des Opérations de Bourse (COB) Regulation 90-08; Italy Consolidated Act on Financial Intermediation Art. 180, para. 3, implemented by CONSOB Regulation No See also, Steinberg, supra note 1, at , See, e.g., European Community Directive on Insider Trading, note 88 supra; Australia Corporations Law 1002G(1); Canada Ontario Securities Act 76(1), 76(5). 18
19 92 sufficiently specific for purposes of the statute? Under German law, when is a fact not publicly known so as to 93 become an insider fact? Also, contrary to the U.S. definition, the concept of materiality is connected to the 94 information s impact on market price. The U.S. standard, focusing on whether the subject information would assume importance to the mythical reasonable investor in making his investment decision, has not been adopted with great frequency elsewhere. To illustrate the widespread rejection of the U.S. definition of materiality, the laws of the following jurisdictions focus their inquiry 92 The ambiguity of the United Kingdom s definition of inside information has been criticized. See Stamp & Welsh, United Kingdom in International Insider Dealing 95, 100 (M. Stamp & C. Welsh eds. 1996). Note that the French judiciary has held that privileged information encompasses negotiations relating to a prospective takeover offer by a French company seeking to acquire the securities of a publicly-held U.S. corporation. See CA Paris, 6 July 1994, Les Petites Affiches (Petites Affiches) No. 137, 16 Nov. 1994, p. 17, note Ducouloux-Favard, discussed in, Peterson, France in International Insider Dealing 152, 156 (M. Stamp & C. Welsh eds. 1996). 93 See Krause, The German Securities Trading Act (1994): A Ban on Insider Trading and an Issuer s Affirmative Duty to Disclose Material Nonpublic Information, 30 Int l Law. 555, 562 (1996) ( Neither the German Act nor the EC Insider Trading Directive offer guidance as to when information should be considered known to the public. ) Cf. Australian Corporations Law 1002B(2) (setting forth that information is generally available if (a) it consists of readily observable matter; or (b) without limiting the generality of paragraph (a), both the following subparagraphs apply: (i) it has been made known in a manner that would, or would be likely to, bring it to the attention of persons who commonly invest in securities of bodies corporate of a kind whose price or value might be affected by the information; and (ii) since it was so made known, a reasonable period for it to be disseminated among such persons has elapsed ) See infra notes and accompanying text. See, e.g., Basic, Inc. v. Levinson, 485 U.S. 224 (1988). 96 See Article 1 of the EC Directive on Insider Trading, note 88 supra; infra notes and accompanying text. 19
20 97 98 on the information s effect on the market price of the subject security: (Ontario) Canada, Mexico, United Kingdom, France, Germany, Italy, and Australia. Indeed, relatively few countries, 104 such as Japan, follow the U.S. approach. Hence, although awaiting judicial clarification for unresolved issues, the insider trading statutes outside of the United States set forth the key terms and definitions that comprise the offense. As will 97 Ontario Securities Act 1(1) (defining a material fact as a fact that significantly affects or would reasonably be expected to have a significant effect on, the market price or value of securities [of the subject issuer] ). Note that there is no federal securities law in Canada. Rather, regulation is provided by each of that country s ten provinces and two territories. The Ontario securities legislation is viewed as the most significant and will be used as the exemplar in this paper. See generally Anisman, The Proposals for a Securities Market Law for Canada: Purpose and Process, 19 Osgoode Hall L.J. 330 (1981) Securities Market Law art. 16-Bis. Criminal Justice Act 60(4). 100 Commission des Opérations de Bourse Art. 1 (defining privileged information as any precise non-public information... which, if made public, might affect the price of the security ). 101 Security Act Consolidated Act on Financiál Intermediation Art. 180, para. 3. Cf. former Law No. 157 art. 3. See Casella, Italy in Insider Trading: The Laws of Europe, the United States and Japan 109, (E. Gaillard ed. 1992). See generally Ruggiero, The Regulation of Insider Trading in Italy, 22 Brook. J. Int l L. 157 (1996). 103 Corporations Law 1002G(1) (setting forth that the information, if it were generally available, might have a material effect on the price or value of [the subject] securities ). 104 Securities and Exchange Law art. 166, para. 2 (defining material facts as encompassing those facts which may have significant influence on the investment decision of investors ). See Steinberg, supra note 1, at 146 (and sources cited therein). 20
Material Nonpublic Information by Credit Market Participants
Statement of Principles and Recommendations Regarding the Handling of Material Nonpublic Information by Credit Market Participants ISDA October 2003 Statement of Principles and Recommendations Regarding