Source: http://creditsshop.com/2009/11/04/defending-against-insider-trading-claims/
Timestamp: 2017-07-25 12:48:10
Document Index: 60611328

Matched Legal Cases: ['§ 78', '§ 240', '§ 78', '§ 7244', '§ 243', '§ 2038', '§ 78', '§ 240', '§ 240', '§ 78', '§ 78', '§ 929', '§ 5565', '§ 240', '§ 240', '§ 243', '§ 78', '§ 2']

Defending Against Insider Trading Claims – Creditsshop.com
Defending Against Insider Trading Claims
by Patrick · November 4, 2009
Defending Against Insider Trading Claims No corporate legal issue captures public attention quite like insider trading. These cases epitomize the worst stereotypes of Wall Street and often involve high-profile individuals. Government prosecutors and securities regulators also are drawn to insider trading cases, and pursue them vigorously. The US Attorney’s Office in Manhattan alone obtained 85 consecutive insider trading convictions, through trials and guilty pleas, until eventually being dealt an acquittal in 2014. Both the Securities and Exchange Commission (SEC) and Department of Justice (DOJ) have publicly identified insider trading as an enforcement priority, and the US Supreme Court is currently poised to weigh in on disputed issues in this area.
This article provides an overview of insider trading law and looks at current issues and trends in the context of government investigations, criminal prosecutions, and civil enforcement proceedings. It identifies…
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February/March 2016 | Practical Law34 © 2016 Thomson Reuters. All rights reserved.
Mike focuses his practice on securities
and white collar litigation, business
litigation, and complex commercial
litigation. Previously, he was the Regional
Trial Counsel for the Pacific Regional
Office of the SEC.
Jon represents corporations and
individuals in white collar litigation,
government investigations, and
securities enforcement matters,
including insider trading cases. He is
a former federal prosecutor and SEC
litigation counsel, and has tried more
than three dozen jury trials.
KATIE RUFFING
Katie dedicates her practice to securities
and professional liability litigation. She
has extensive involvement in numerous
investigations involving the Public
and the SEC, and has worked on complex
litigation and class action suits.
Prosecutors and regulators
increasingly use modern
and aggressive enforcement
tactics to pursue insider
trading cases. However,
well-prepared counsel can
take advantage of various
substantive defenses to
build a successful defense
35The Journal | Litigation | February/March 2016© 2016 Thomson Reuters. All rights reserved.
No corporate legal issue captures public attention quite like insider trading. These cases epitomize the worst stereotypes of Wall Street and often involve high-profile individuals. Government prosecutors and securities
regulators also are drawn to insider trading cases, and pursue
them vigorously. The US Attorney’s Office in Manhattan alone
obtained 85 consecutive insider trading convictions, through
trials and guilty pleas, until eventually being dealt an acquittal
in 2014. Both the Securities and Exchange Commission (SEC)
and Department of Justice (DOJ) have publicly identified insider
trading as an enforcement priority, and the US Supreme Court is
currently poised to weigh in on disputed issues in this area.
This article provides an overview of insider trading law and
looks at current issues and trends in the context of government
investigations, criminal prosecutions, and civil enforcement
proceedings. It identifies:
„„ The laws governing insider trading violations.
„„ The primary regulatory agencies pursuing insider trading
investigations and enforcement.
„„ The elements of an insider trading claim.
„„ The investigative techniques used by regulators.
„„ The sanctions and penalties available to regulators.
„„ The most common substantive defenses to insider trading claims.
„„ The key strategies for counsel in defending against insider
SECTION 10(b) AND THE LEGAL FRAMEWORK
Insider trading refers to buying or selling a security, in breach
of a fiduciary duty or other relationship of trust and confidence,
while in possession of material nonpublic information about
the security. Violations also might involve securities trading by
individuals who misappropriate material nonpublic information.
Insider trading claims most commonly are based on alleged
violations of Section 10(b) of the Securities Exchange Act of 1934
(Exchange Act) and its implementing regulation, Rule 10b-5.
Section 10(b) is a catch-all anti-fraud provision that prohibits
“manipulative and deceptive devices” in connection with the
purchase or sale of securities. (15 U.S.C. § 78j.)
Search Liability Provisions: Securities Offerings for more on Section 10(b)
and Rule 10b-5.
Insider trading is merely one type of “device, scheme, or artifice
to defraud” enforced under Section 10(b). The law has emerged
from the founding principle that violating the relationship of
trust and confidence that exists “between the shareholders of a
corporation and those insiders who have obtained confidential
information by reason of their position with that corporation”
amounts to fraud. (United States v. O’Hagan, 521 U.S. 642,
651-52 (1997) (internal quotations omitted).)
These types of claims also can be pursued under other Exchange
Act provisions and laws, including:
„„ Rule 14e-3 under the Exchange Act. This rule prohibits insider
trading in connection with tender offers. (17 C.F.R. § 240.14e-3a.)
„„ Section 20(a) of the Exchange Act. This provision creates
secondary control person liability over any entity that has
control over another person engaged in insider trading, unless
the controlling person acted in good faith and did not directly
or indirectly induce the acts constituting the violation or cause
of action. (15 U.S.C. § 78t(a).)
„„ The Sarbanes-Oxley Act of 2002. This statute prohibits any
director or executive officer of an issuer of any equity security
from, directly or indirectly, purchasing, selling or otherwise
acquiring or transferring any equity security of the issuer
during a pension plan blackout period. (15 U.S.C. § 7244
(Section 306(a)).)
„„ Regulation Fair Disclosure (Regulation FD). This issuer
disclosure rule prevents selective disclosure, that is, disclosing
important nonpublic information to securities analysts or
institutional investors before making full disclosures to the
general public. (17 C.F.R. § 243.100-103.) The SEC has likened
selective disclosure to “tipping” or insider trading because
“a privileged few gain an informational edge” (Selective
Disclosure and Insider Trading, Release Nos. 33-7881,
34-43154 (Aug. 15, 2000), available at sec.gov).
„„ The Stop Trading on Congressional Knowledge (STOCK)
Act. This statute prohibits members of Congress and other
government employees from trading based on nonpublic
information obtained in the course of their duties. (Pub. L. No.
112-105, § 2038, 126 Stat. 291 (2012).)
Defending against insider trading allegations often involves
dealing with several investigative entities. These include:
„„ The SEC, which has principal authority for enforcing the
nation’s securities laws, and can seek civil penalties,
disgorgement, and the imposition of suspensions and bars
from engaging in certain activities.
„„ The DOJ, including the US Attorney’s Offices in each judicial
district, which enforces criminal securities laws and can initiate
grand jury investigations and criminal prosecutions that can
result in imprisonment, fines, and criminal forfeiture based on
insider trading violations.
„„ The Financial Industry Regulatory Authority (FINRA), a not-
for-profit organization authorized by Congress to regulate the
„„ Other agencies, including state regulatory and criminal
Search Federal Securities Regulators: Overview for more on the
government agencies responsible for regulating and enforcing federal
These authorities often work together, sharing information and
pursuing common enforcement goals. For example:
„„ FINRA may conduct an inquiry into trading activity in
connection with a merger announcement, requesting
information from a public company and its officers concerning
suspicious trading, and then share the results with the SEC if
it believes there is evidence of a possible securities offense.
February/March 2016 | Practical Law36 © 2016 Thomson Reuters. All rights reserved.
„„ The SEC may advance the investigation by issuing administrative
subpoenas and taking investigative testimony. If the SEC
identifies evidence sufficient in nature and quality to sustain
the higher burden of a criminal prosecution (including
evidence of fraudulent intent rising to the beyond a reasonable
doubt standard), a referral to the DOJ might follow.
„„ If the DOJ opens a criminal investigation, it may issue grand
jury subpoenas for documents and testimony, and use
additional investigative resources and techniques involving
federal law enforcement agents. If authorities pursue criminal
charges, the result could be a criminal indictment on federal
securities charges.
When facing an inquiry related to possible insider trading
allegations, counsel must assume that information provided to
civil or regulatory authorities will be passed along to others with
enforcement authority, even federal prosecutors in the most
serious instances. Before responding to an inquiry, producing
documents to regulators, or testifying before the SEC, counsel
must consider and advise their client of:
„„ The dangers of making admissions in an insider trading
„„ The potential for criminal charges if the client waives his Fifth
Amendment right against self-incrimination and cooperates
with authorities (see below Cooperation).
There is no statute defining unlawful insider trading or the
elements of an insider trading violation. Rather, insider trading
is a type of securities fraud, and its legal contours are largely the
result of judicial opinions and enforcement actions arising under
certain securities statutes and rules.
A securities fraud charge under Section 10(b) of the Exchange
Act requires proof of:
„„ A breach of a fiduciary duty or other relationship of trust and
„„ The use or possession of material nonpublic information in
„„ Scienter.
„„ A personal benefit, for cases where corporate insiders (tippers)
pass or “tip” material nonpublic information to outsiders
(tippees) who trade based on that information.
An aider and abettor is liable to the same extent as a principal
in criminal cases. In a civil enforcement action, the government
must prove every element of its case by a preponderance of the
evidence. In criminal cases, the DOJ must prove its case beyond a
reasonable doubt. (See 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5;
see also United States v. Gansman, 657 F.3d 85, 91 n.7 (2d Cir. 2011).)
An insider trading claim requires the existence of a fiduciary
duty. There are two broad, sometimes overlapping, theories
defining the types of duty that, when breached, can lead to
insider trading violations:
„„ Classical theory.
„„ Misappropriation theory.
In a limited number of cases, the SEC has asserted insider
trading allegations in the absence of a fiduciary duty, where
a defendant has obtained material nonpublic information by
fraudulent means (such as computer hacking), based on an
affirmative misrepresentation theory. Unlike the traditional
theories of insider trading, liability under this theory does
not depend on a breach of a duty. (See, for example, SEC v.
Dorozhko, 574 F.3d 42, 49-50 (2d Cir. 2009) (holding that an
affirmative misrepresentation can constitute actionable fraud
despite the absence of a fiduciary duty, and distinguishing
affirmative misrepresentations from remaining silent where
there is a duty to disclose).)
Under the classical theory of insider trading, liability arises for
corporate officers or insiders who owe a fiduciary duty to the
company and its shareholders. A duty arises where:
„„ A relationship of trust and confidence exists between the
insiders and shareholders of a company.
„„ The insiders have obtained confidential information due to
their position with the company.
If a duty exists, the insiders who possess material information
„„ Refrain from trading on the information.
„„ Publicly disclose the information before trading.
(See Chiarella v. United States, 445 U.S. 222, 228-29 (1980).)
The classical theory also can extend to temporary insiders, such as
underwriters, accountants, lawyers, or consultants, who have both:
„„ Entered into a special confidential relationship in the conduct
„„ Access to information solely for corporate purposes.
(See Dirks v. SEC, 463 U.S. 646, 655 n.14 (1983).)
The Supreme Court articulated in Chiarella the two key principles
underlying an insider’s or a temporary insider’s duty:
„„ The insider has access to information intended to be available
only for a corporate purpose and not for anyone’s personal
„„ The unfairness inherent in trading on information that is
inaccessible to those with whom one is dealing.
(445 U.S. at 241-42.)
In misappropriation cases, no fiduciary duty exists between
the person trading securities and the shareholders of the
issuing company. Instead, the misappropriation theory rests
on a duty of trust and confidence that the person making the
trade owes to the source of the confidential information. Rule
10b5-2 under the Exchange Act includes a non-exhaustive list of
circumstances giving rise to a duty of trust and confidence that,
if breached, can form the basis of a misappropriation insider
trading violation. A duty exists where:
„„ A person has agreed to keep information confidential.
„„ Information is shared between people with a history or
pattern of sharing confidences, where it should be reasonably
37The Journal | Litigation | February/March 2016© 2016 Thomson Reuters. All rights reserved.
understood that the information being discussed is to be kept
„„ Information is shared between relatives, such as spouses,
siblings, or a parent and child, unless the relationship is such
that the parties should not have expected the information to
(17 C.F.R. § 240.10b5-2(b).)
USE OR POSSESSION OF MATERIAL NONPUBLIC
An insider trading violation must include the use or possession
of material nonpublic information in connection with the
purchase or sale of a security, including purchases and sales of
options and warrants on securities and short sales. This does
not mean that the SEC must prove that a trade would not have
happened “but for” the use of inside information. In many cases
(including those brought in the Second Circuit), the SEC merely
must show that a defendant had “knowing possession” of the
information when making a trade. Although some circuit courts
have rejected this position, the use requirement imposes a
relatively low threshold in practice. (See below Lack of Use.)
Material information can include anything that a reasonable
investor would consider significant when deciding whether to buy
or sell stock. Common examples of material information include:
„„ News of a possible corporate merger or acquisition.
„„ An anticipated earnings announcement that might cause a
company’s stock to rise or fall.
Materiality is often shown by a fluctuation in stock prices once
the information is publicly released. It is not required, however,
that an investor would buy or sell stock based solely on the
information at issue, if the information is significant enough to
alter the total mix of available information.
Search Securities Litigation: Pleading and Proving Materiality for more
on materiality.
Nonpublic information is information that is unavailable through
news media or other publicly available sources. Information
can be nonpublic even where it is known to a limited group of
outside individuals. By contrast, where information has been
effectively disseminated to the investing public, the information
generally is reflected in the existing price of a company’s stock.
(See Basic Inc. v. Levinson, 485 U.S. 224, 246-47 (1988).)
In a civil case, proof of scienter, meaning either knowing or reckless
conduct, is enough to establish an insider trading violation.
Scienter must be established by a preponderance of the
evidence. (See SEC v. Johnson, 174 F. App’x 111, 115 (3d Cir. 2006).)
Search Securities Litigation: Pleading and Proving Scienter for more
on scienter.
In a criminal case, proof of the defendant’s intent to defraud is
required and must be established beyond a reasonable doubt
(see Gansman, 657 F.3d at 91 n.7).
PERSONAL BENEFIT IN TIPPER-TIPPEE CHAINS
Where an insider, or someone who misappropriated inside
information, gives a third party a tip about material nonpublic
information and the third party trades on the information, then
both the tipper and the tippee can be liable for insider trading.
All of the elements of insider trading apply equally in tipper-
tippee cases. Additionally, the government must establish that:
„„ The tipper knew (or reasonably should have known) that the
tippee would trade on the information.
„„ The tipper personally benefitted from giving the tip.
„„ The tippee must have known (or recklessly disregarded) that
the information was obtained in breach of a duty and for
(See Dirks, 463 U.S. at 660, 662; United States v. Newman, 773
F.3d 438, 446 (2d Cir. 2014).)
This process can have many layers, with tippees becoming
tippers by passing information along to others later in the chain
of events. The farther the information gets from its source, the
more difficult the case is for government attorneys to prove.
What constitutes a personal benefit in a tipping chain case
is perhaps the most significant current legal issue in insider
trading law. Historically, the personal benefit requirement had
a relatively low threshold, but lately it has been the subject of
much scrutiny. The test is “whether the insider personally will
benefit, directly or indirectly, from his disclosure” (Dirks, 463 U.S.
at 662). This might consist of:
„„ A direct financial gain.
„„ Intangible benefits, such as gaining a reputational advantage,
currying favor with a boss, or merely intending the information
as a gift to the recipient.
What constitutes a personal benefit in a tipping chain case is
perhaps the most significant current legal issue in insider trading
law. Historically, the personal benefit requirement had a
relatively low threshold, but lately it has
been the subject of much scrutiny.
February/March 2016 | Practical Law38 © 2016 Thomson Reuters. All rights reserved.
However, circuit courts are grappling with the extent to which
an inference of personal benefit can be drawn in the absence
of evidence of direct financial gain. For example, the US
Court of Appeals for the Second Circuit requires evidence of
a “relationship between the insider and the recipient that
suggests a quid pro quo from the latter, or an intention to benefit
the [latter].” Inferring a personal benefit based on the existence
of a friendship is impermissible absent proof of a meaningfully
close personal relationship that generates an exchange that:
„„ Is objective.
„„ Is consequential.
„„ Represents at least a potential gain of a pecuniary interest or
another valuable interest.
(Newman, 773 F.3d at 452.)
After Newman was decided, the US Court of Appeals for the
Ninth Circuit held that proof that the insider “disclosed material
nonpublic information with the intent to benefit a trading
relative or friend is sufficient” to establish the personal benefit
element of an insider trading claim (United States v. Salman, 792
F.3d 1087, 1094 (9th Cir. 2015)).
There is some confusion in the courts on whether, under Dirks,
the personal benefit to the insider requires proof of an objective,
consequential, and pecuniary gain, as required under Newman,
or instead can rest simply on a close family relationship between
the tipper and tippee. Having granted certiorari in the Salman case,
the Supreme Court is poised to weigh in on this issue (see Salman v.
United States, No. 15-628, 2016 WL 207256 (U.S. Jan. 19, 2016)).
The manner in which the government investigates allegations of
insider trading has changed over time. Making a successful case
once depended on a painstaking process of manually reviewing
trade information (referred to as “blue sheets”) supplied by
brokers and clearinghouses, and there was little likelihood
of capturing a defendant’s real-time communications with
co-actors. Today, technological advances and the aggressive use
of law enforcement tactics have changed the nature of insider
trading investigations in both civil and criminal actions.
The SEC has ramped up its insider trading enforcement through
„„ Cooperation program. In the past five years, the SEC’s
Enforcement Division has developed and implemented
a cooperation program like those traditionally used by
prosecutors’ offices. The SEC will enter into cooperation
agreements with admitted wrongdoers and grant leniency in
exchange for testifying against others. The SEC has touted
the effectiveness of its cooperation program in insider trading
investigations, where regulators often are eager to obtain
testimonial evidence to fill in evidentiary gaps. (See, for
example, Press Release, SEC Charges Six Individuals With
Insider Trading in Stock of E-Commerce Company Prior to
Acquisition by eBay (Apr. 25, 2014), available at sec.gov.)
„„ Whistleblower incentives. The SEC aggressively courts
tipsters and whistleblowers, particularly since establishing its
whistleblower program following the passage of the Dodd-
Frank Wall Street Reform and Consumer Protection Act of
2010 (Dodd-Frank Act). Offering large rewards in exchange
for information (up to 30% of any penalty of $1 million or
more that resulted from a whistleblower’s tip) provides a
tremendous incentive for individuals, including company
outsiders, to report allegations of misconduct to authorities.
(See 2015 Annual Report to Congress on the Dodd-Frank
Whistleblower Program, available at sec.gov; Press Release,
SEC Awards Whistleblower More Than $700,000 for Detailed
Analysis (Jan. 15, 2016), available at sec.gov; see generally SEC
Office of the Whistleblower, available at sec.gov.)
Advances in investigative techniques provide various
benefits to the government in its efforts to combat
insider trading. For example, by exploiting the use of
big data, the SEC can identify trading patterns and
relationships that would have been undetectable in the
past. Data analytics can reveal parallel trading among
several participants whose associations with each
other is unknown, or whether an individual trader buys
or sells securities in patterns. As an enforcement tool,
this information can lead to witnesses, documents,
and trading transactions that give SEC staff attorneys
greater knowledge of the facts and more evidence of
an alleged insider trading scheme.
Further, aggressive enforcement tactics, including
the use of cooperators and an increased emphasis on
obtaining electronic communications, are designed to
help the SEC and DOJ get a more complete picture of
the trading transactions and a look into the minds of
the people executing them. Eyewitness testimony from
cooperators and real-time electronic communications,
such as emails and text messages, can provide
incriminating details about whether participants are
trading on unlawful inside information.
In some circumstances, defendants can take
advantage of these enhanced capabilities by raising
expectations with judges and juries. Given all of
the resources at the government’s disposal for
investigating insider trading cases, juries might
come to expect (or even require) the government to
produce recorded conversations and many layers of
corroborative evidence, and defendants can argue
forcefully that any gaps in evidence should be held
39The Journal | Litigation | February/March 2016© 2016 Thomson Reuters. All rights reserved.
„„ Technological advances. Perhaps most importantly,
advances in technology have given authorities the ability to
examine vast amounts of data to detect, investigate, and
pursue insider trading charges against suspected violators.
The SEC’s market surveillance now allows regulators to:
„z pinpoint suspicious trading across multiple securities; and
„z identify possible relationships among traders.
(See Andrew Ceresney, Director of the SEC Division of
Enforcement, Keynote Address at Compliance Week 2014
(May 20, 2014), available at sec.gov.)
In criminal investigations, federal prosecutors, aided by
law enforcement agents from the FBI and elsewhere, have
demonstrated their increasing willingness to use techniques
traditionally reserved for violent criminal enterprises to pursue
those suspected of insider trading and other white-collar
offenses. Investigators have vast data resources and are using a
variety of tools to uncover trading patterns and communications
revealing possible evidence of insider trading, including:
„„ Judicially approved wiretaps.
„„ Undercover surveillance.
„„ Cooperating witnesses.
„„ Search warrants.
Given that agencies often collaborate in these investigations,
witnesses providing off-the-record statements or administrative
testimony to the SEC should consider the possibility that the
SEC staff is coordinating with criminal authorities and has
access to investigative work product that incriminates the
witness (see, for example, James B. Stewart, A Dragnet at Dewey
& LeBoeuf Snares a Minnow, N.Y. Times, Mar. 14, 2004 (describing
the participation of prosecutors and law enforcement during an
SEC interview of a former Dewey & LeBoeuf employee)).
While some attorneys might view it as “sandbagging” a witness,
regulators and prosecutors often do not reveal to a witness
that they possess incriminating communications until after
the witness has made what the government perceives to be a
false statement. In that scenario, counsel for the witness should
„„ Stop the interview to fully analyze the implications of
„„ Advise the witness to assert his Fifth Amendment right
The possible sanctions for insider trading depend on the type of
case. If convicted criminally, an insider can face:
„„ Imprisonment for up to 20 years.
„„ Fines of up to:
„z $5 million for an individual; or
„z $25 million for a corporate entity.
„„ Criminal forfeiture.
(15 U.S.C. § 78ff.)
Criminal prosecution for insider trading also can result in
attendant charges of aiding and abetting, conspiracy, and
obstruction of justice, among others.
If found civilly liable for insider trading, a defendant or
respondent can be subject to disgorgement and monetary
penalties of up to three times the profit gained or the loss
avoided (15 U.S.C. § 78u-1; see also Dodd-Frank Act, Pub. L. No.
111-203, § 929P(a), 12 U.S.C. § 5565).
In addition to attacking the sufficiency of the evidence
supporting each of the substantive elements of an insider
trading claim, defense counsel also should consider the viability
of a defense based on:
„„ The mosaic theory.
„„ An operative trading plan created in accordance with Rule
10b5-1 under the Exchange Act.
„„ The defendant’s reliance on the advice of counsel.
„„ The defendant’s lack of knowledge that certain information
„„ The defendant’s failure to use the material nonpublic
„„ The issuer’s public disclosure of the information at issue.
„„ The defendant’s reporting of its insider trades.
Search Defending Against Insider Trading Claims Checklist for a quick
guide on the substantive defenses to insider trading claims.
Under the mosaic theory defense, the defendant argues
that a person can legally obtain bits and pieces of nonpublic
information that, when pieced together with public information,
including rumors, can lead to the discovery of material
nonpublic information. To assert this defense, the defendant
must demonstrate that each piece of the mosaic is, in and of
itself, immaterial information. This defense historically has been
used in cases involving securities analysts. (See Dirks, 463 U.S.
at 658-59 (noting that it is commonplace for analysts to “ferret
out and analyze information” that forms the basis for judgments
on the market worth of a company’s stock) (internal quotations
However, more aggressive interpretation and enforcement of the
materiality standard by the SEC and, to a lesser extent, the DOJ
appear to be eroding the mosaic theory defense. In particular,
this defense is now more vulnerable due to:
„„ The SEC’s adoption of Regulation FD. The SEC has stated
that, while an issuer is not prohibited from disclosing an
immaterial piece of information to an analyst, Regulation
FD prohibits issuers from attempting to “render material
information immaterial simply by breaking it into ostensibly
non-material pieces” (Selective Disclosure and Insider Trading,
Release Nos. 33-7881, 34-43154).
„„ The regulators’ new evidence-gathering methods.
Regulators have access to technology that allows them to
February/March 2016 | Practical Law40 © 2016 Thomson Reuters. All rights reserved.
track and analyze trades virtually in real-time. Together with
tactics previously reserved for organized crime investigations,
such as aggressive use of wiretaps, cases now brought to
court have substantial, concrete evidence to back them. This is
a significant change from older insider trading cases that were
based on conjecture and circumstantial evidence.
Courts and juries have followed the SEC’s lead and increasingly
are rejecting the mosaic theory defense. For example, billionaire
hedge fund founder Raj Rajaratnam contended that he
based trading decisions on immaterial bits of information he
pieced together, but the jury rejected the defense in light of
overwhelming contradictory evidence contained in recorded
conversations (United States v. Rajaratnam, 802 F. Supp. 2d 491,
513-14 (S.D.N.Y. 2011)).
Rule 10b5-1 allows individuals, including executives, officers,
and directors, to adopt trading plans that implement periodic,
scheduled trades, even if the plan holder is in possession of material
nonpublic information at the time of the trading. The rule provides:
„„ A general affirmative defense, which is available to both
„„ An alternative affirmative defense, which is available only
Search Rule 10b5-1 Trading Plans and Rule 10b5-1 Plans: Best
Practices Checklist for more on establishing a plan and the affirmative
defenses under Rule 10b5-1.
A defense under Rule 10b5-1 can be vulnerable to dismissal if
there is concern that the plan gave an insider an unfair trading
advantage (see Linda Chatman Thomsen, Director of the
SEC Division of Enforcement, Remarks at the 2007 Corporate
Counsel Institute (Mar. 8, 2007), available at sec.gov). While no
enforcement action has yet called into question a Rule 10b5-1
plan, the continued public and regulatory scrutiny of officers
and directors and their compensation virtually guarantees that
a regulator or prosecutor will at some point test the limits of
Rule 10b5-1 protection.
General Affirmative Defense
To assert an affirmative defense under Rule 10b5-1, the
defendant bears the burden of establishing that:
„„ The person for whom the plan is being implemented was not
in possession of material nonpublic information at the time
the plan was adopted.
„„ No trading under the plan occurred until after a reasonable
period of time had passed after adoption of the plan.
„„ The insider had only one plan at a time, with minimal
terminations or amendments to the plan.
(See, for example, Press Release, SEC Charges Former
Countrywide Executives with Fraud (June 4, 2009), available
at sec.gov (charging a CEO with insider trading where he set
up four 10b5-1 trading plans within a three-month period while
in possession of material nonpublic information, and started
trading under the plans shortly after the plans’ establishment).)
The trading plan must do at least one of the following:
„„ Set the date, price, and amount of any trades.
„„ Specify an algorithm, formula, or program that will determine
„„ Delegate the ability to determine the date, price, and amount
of any trades to a third party who does not possess material
nonpublic information at the time of the trades.
(17 C.F.R. § 240.10b5-1(c)(1).)
Alternative Entity Affirmative Defense
An additional affirmative defense is available only to entities,
such as issuers or investment banks. An entity can avoid liability
if it can demonstrate that:
„„ The individual making an investment decision on the entity’s
behalf was not aware of any material nonpublic information.
„„ The entity had implemented reasonable policies and
procedures to prevent insider trading, such as the use of
robust informational barriers to stem the flow of knowledge
between different divisions or units within the issuer and its
affiliated broker-dealers.
(17 C.F.R. § 240.10b5-1(c)(2).)
Regulators have access to technology that
allows them to track and analyze trades
virtually in real-time. Together with tactics
previously reserved for organized crime
investigations, such as aggressive use of
wiretaps, cases now brought to court have
substantial, concrete evidence to back them.
41The Journal | Litigation | February/March 2016© 2016 Thomson Reuters. All rights reserved.
This alternative affirmative defense is particularly useful for a
broker-dealer affiliated with a company that often facilitates
trades in the company’s securities, however, it has not yet been
Search Sample Corporate Policy on Insider Trading for a sample
corporate policy prohibiting any form of insider trading and imposing
special trading restrictions on directors and officers, with explanatory
notes and drafting tips.
A defendant may refute an insider trading claim based on his
reliance on counsel’s advice. Reliance on counsel is not an
absolute defense, but it serves to rebut any allegation of the
defendant’s intent to violate the securities laws. To assert this
defense, the defendant must establish that he:
„„ Disclosed all relevant facts and circumstances to counsel.
„„ Requested advice from counsel about the contemplated
„„ Received advice from counsel that the contemplated trading
„„ Relied in good faith on counsel’s advice.
(See SEC v. Goldfield Deep Mines Co. of Nev., 758 F.2d 459, 467
(9th Cir. 1985).)
Defense counsel should bear in mind that asserting the reliance
on counsel defense requires waiver of the attorney-client
privilege, which could open the door to disclosures that are
better kept privileged and confidential.
Search Attorney-Client Privilege: Waiving the Privilege for more on
the scope of a privilege waiver when asserting the reliance on
counsel defense.
NO KNOWLEDGE OF CONFIDENTIALITY
A defendant may resist an insider trading claim by challenging
his awareness of a breach of duty in cases brought under:
„„ The tipper-tippee theory.
„„ The misappropriation theory.
Claims Based on Tipper-Tippee Theory
Under the tipper-tippee theory, liability for the tippee rests on
whether he knew or was aware of the tipper’s breach of fiduciary
duty (see above Fiduciary Duty). The standard is the same
regardless of whether the tipper’s duty stems from the classical
or misappropriation theory. Before the use of wiretaps and email
evidence, prosecutors often showed this awareness through
circumstantial evidence. Even with the new evidence-gathering
techniques available to law enforcement, circumstantial evidence
still plays an important role in proving a tippee’s liability. Courts
tend to focus on whether the tippee knew the source of the
material nonpublic information. If that source is a corporate
insider, knowledge and awareness generally are established.
For defense counsel representing a tippee, challenging
awareness of a breach of duty is an important defense strategy.
In cases involving multiple trades, tips, tippers, and tippees,
counsel should analyze any distinctions among the individual
tippees, such as how they learned of the material nonpublic
information and their relationship (if any) with the tipper. The
defendant must establish at least one of the following:
„„ The tippee did not know, and had no reason to know, that the
tipper breached a duty of trust or confidence.
„„ The tipper received no direct or indirect personal benefit.
(See Newman, 773 F.3d at 446.)
Claims Based on Misappropriation Theory
Under the misappropriation theory, a person might be liable
if he breaches either a clear fiduciary duty or a relationship
of trust and confidence, such as a spousal or other familial
relationship, or a business partner, employee, or consultant.
There are other ways a duty of trust and confidence can arise,
and the analysis is highly fact-specific. Rule 10b5-2 lists several
circumstances and factors indicative of a relationship of trust
and confidence (see above Misappropriation Theory). This can
be a fruitful area for defense counsel to attack the government’s
case. (See, for example, SEC v. Payton, 2015 WL 9463182, at *2-3
(S.D.N.Y. Dec. 28, 2015) (genuine issues of material fact existed
on whether an equities salesman who received confidential
information owed a duty of trust and confidence to his close
friend and attorney for purposes of determining insider trading
liability under a misappropriation theory).)
In September 2015, the DOJ issued new guidance to prosecutors,
directing them to focus on the accountability of individuals in their
investigations of corporate wrongdoing, and requiring companies
to disclose to prosecutors all relevant facts about the
individuals involved in corporate misconduct
to be eligible for any cooperation credit.
February/March 2016 | Practical Law42 © 2016 Thomson Reuters. All rights reserved.
Some jurisdictions allow defendants to assert a lack of use
defense in insider trading cases. Before Rule 10b5-1 was
enacted, the circuit courts were divided on whether possession
of material nonpublic information alone was sufficient for insider
trading liability or whether an actual causal connection was a
necessary element. For example:
„„ Knowing possession of material nonpublic information at the
time of the trade was sufficient in the Second Circuit (see, for
example, United States v. Teicher, 987 F.2d 112, 119 (2d Cir. 1993)).
„„ Actual use of the material nonpublic information was required
in the Eleventh Circuit, which could be inferred from the fact that
an insider traded while in possession of inside information (see,
for example, SEC v. Adler, 137 F.3d 1325, 1337 (11th Cir. 1998)).
„„ The government was required to show actual use of the
material nonpublic information by the trader in the Ninth Circuit
(see, for example, United States v. Smith, 155 F.3d 1051, 1067-69
(9th Cir. 1998) (distinguishing this criminal prosecution from
Adler, a civil enforcement proceeding, and finding that the
court is “not at liberty, as was the Adler court, to establish an
evidentiary presumption that gives rise to an inference of use,”
and instead requiring actual evidence of use)).
When Rule 10b5-1 was enacted, the SEC adopted an
“awareness” standard identical to the knowing possession
standard followed by the Second Circuit. To the SEC, the
affirmative defenses in Rule 10b5-1 are the exclusive defenses
available to defendants accused of insider trading. (See Selective
Disclosure and Insider Trading, Release Nos. 33-7881, 34-43154.)
However, several courts have reverted to a non-use analysis (see,
for example, SEC v. Talbot, 430 F. Supp. 2d 1029, 1045 (C.D. Cal.
2006), rev’d on other grounds, 530 F.3d 1085 (9th Cir. 2008)).
Under Regulation FD, when a securities issuer selectively
discloses material nonpublic information to a party such as a
broker-dealer or an investment adviser, the issuer also must
effect a broad, non-exclusionary distribution of the information
to the public to avoid liability. Disclosure may be made through
a Form 8-K or another method of mass information distribution.
Where the selective disclosure was made intentionally, the
public disclosure must be made simultaneously. If it was
made unintentionally, the shared information must be made
to the public promptly, meaning that it is effected by the later
of 24 hours or the beginning of the next trading day on the
New York Stock Exchange. In either case, public disclosure
must be made after a senior official of the issuer learns of
the selective disclosure and knows, or should know, that the
disclosed information was material and nonpublic. (17 C.F.R.
§ 243.100-103.)
Search Complying with Regulation FD (Fair Disclosure) for more on
the requirements of Regulation FD.
REPORTING OF INSIDER TRADES
A company insider may trade in the company’s securities if he
reports the trades to the SEC by filing the appropriate disclosure
form under Section 16 of the Exchange Act (15 U.S.C. § 78p). To
be lawful, the trades cannot be based on material information
that is not in the public domain.
There are important strategic considerations for both individuals
and companies under investigation or prosecution for insider
trading. These include evaluating and continually reassessing
which individuals or entities are the subjects of the investigation
and whether they are in jeopardy of criminal prosecution. To
make informed decisions, counsel should:
„„ Conduct an internal review.
„„ Take appropriate steps to preserve information.
„„ Assess whether (and to what degree) the client should
cooperate with the authorities.
„„ Consider possible legal challenges to raise in an
These considerations can differ greatly for individuals and
companies, particularly since companies have no Fifth
Amendment right against compelled self-incrimination.
Significantly, in September 2015, the DOJ issued new guidance
The Federal Securities Litigation and Enforcement Toolkit available on Practical Law offers a collection of
resources to assist counsel with the procedural and substantive aspects of federal securities litigation and
enforcement matters. It features a range of continuously maintained resources, including:
„Ÿ Criminal and Civil Liability for Corporations, Officers,
„Ÿ Internal Investigations: US Privilege and Work
„Ÿ Securities Enforcement: A Roadmap of the SEC’s
Investigation and Enforcement Process
„Ÿ Securities Enforcement: Settling Securities Cases
„Ÿ Securities Litigation: Answer
„Ÿ Securities Litigation: Defending a Private Securities
Fraud Lawsuit Checklist
„Ÿ Trends in Federal White Collar Prosecutions
Federal Securities Litigation and Enforcement Toolkit
43The Journal | Litigation | February/March 2016© 2016 Thomson Reuters. All rights reserved.
to prosecutors, directing them to focus on the accountability of
individuals in their investigations of corporate wrongdoing, and
requiring companies to disclose to prosecutors all relevant facts
about the individuals involved in corporate misconduct to be
eligible for any cooperation credit.
Search I Want You! DOJ’s New Policy on Corporate Investigations
Focuses on Individuals for more on the DOJ’s new guidance.
As soon as the government launches an investigation, counsel
must make every effort to help an individual or entity client
get ahead of that investigation. The way to do so is through an
effective internal investigation, comprised of:
„„ Litigation holds.
„„ Document collection and review.
„„ Witness interviews.
„„ Legal research.
Counsel must not risk making uninformed decisions, which can
be costly for their client both in terms of monetary sanctions
and reputational harm. The goal of an internal investigation
is to learn as much about the evidence as possible before
beginning to meet with the government, tendering documents,
offering witnesses for testimony, and engaging in settlement
negotiations. Every effort should be made to preserve the
attorney-client privilege during the course of the investigation.
Search Conducting Internal Investigations Toolkit for a collection of
resources to assist counsel in preparing for an internal investigation
and protecting privilege during the course of the investigation.
Once law enforcement begins an investigation, the subject
company should promptly issue a litigation hold. The hold should
explicitly include all forms of potentially responsive information.
Data like text messages and instant messaging communications
sometimes contain key evidence, and can remain in existence
long after the actual communication took place.
Before issuing a litigation hold, counsel and their client must
determine its scope, including:
„„ The time period covered by the hold.
„„ The subject matter of the data to be retained.
„„ The persons and departments subject to the hold.
Additionally, counsel must make immediate efforts to determine
whether backup tapes, disks, files, cloud storage, and similar
materials exist and secure them for possible review.
To the extent an investigation focuses on potentially ongoing
conduct, the litigation hold must provide for the preservation of
newly created documents and communications that also might
be relevant to the investigation. Custodians subject to the hold
must be told to:
„„ Not delete or otherwise destroy any potentially responsive
material, to prevent a later claim of evidence spoliation, or
worse, obstruction of justice.
„„ Further identify and retain other email or data files from
personal or home accounts that might be responsive.
Counsel should periodically reassess the parameters of the
hold (particularly for identification of additional custodians and
subject areas), as investigations tend to evolve, and periodically
remind recipients that the hold remains in place.
Search Litigation Hold Toolkit for a collection of resources to assist
counsel with properly preserving documents and implementing a
To help a client decide whether to cooperate in an insider
trading case, counsel must have extensive knowledge of the
facts and circumstances, state of the law, and strength of the
government’s evidence. Cooperation also could have significant
privilege implications. The decision cannot, and should not, be
Because companies have no Fifth Amendment right against
self-incrimination, they have limited avenues to challenge
government subpoenas requiring the production of documents.
Further, a company responding to a government investigation
might benefit from cooperating with authorities should it face
allegations of wrongful conduct, because prosecutors and
regulators tend to want (or need) the company’s cooperation to
effectively target individuals in later civil or criminal proceedings.
In these circumstances, a company might avoid a criminal
prosecution or obtain a more favorable resolution, subject to the
DOJ’s all-or-nothing approach to cooperation credit. Under the
DOJ’s approach, companies must provide all facts to prosecutors
about individual misconduct to receive any cooperation credit.
Search Securities Enforcement: Responding to Regulator’s Request
for Information and Documents for more on strategic considerations
for a company communicating with a regulator.
The cooperation calculus for an individual is different. If the
individual is a potential whistleblower, he can avoid liability and
even obtain a monetary recovery under the SEC’s whistleblower
program. If an individual is a potential target of an investigation,
he has critical decisions to make about cooperation and
representation. The individual should consider whether to:
„„ Assert his Fifth Amendment right against self-incrimination
and further refuse to cooperate with any internal investigation.
„„ Seek separate counsel early in the process.
Search Handling a Government Investigation of a Senior Executive
Checklist for more on strategic considerations for an individual facing
Since the Dodd-Frank Act greatly expanded the SEC’s ability
to bring its cases in administrative proceedings, the SEC’s
Enforcement Division has moved aggressively to bring all types
of cases in that venue, from accounting fraud to insider trading
cases. Traditionally, insider trading civil cases brought by the
February/March 2016 | Practical Law44 © 2016 Thomson Reuters. All rights reserved.
SEC were filed only in federal court, however, this is no longer
the case. The SEC now may bring administrative proceedings
against all alleged insider traders, including unregulated
individuals, and may seek monetary penalties in addition to
disgorgement. After an administrative law judge (ALJ) renders
a decision, the first level of appellate review is by the five SEC
Commissioners. A federal court may review the case only after
that review by the panel.
Counsel involved in an SEC administrative proceeding should
be aware of procedural differences from court proceedings,
„„ The timing of administrative decisions, which must be issued
within 300 days after the case is first filed.
„„ The unavailability of traditional document discovery. Instead,
the SEC turns over its investigative case file, including its
witness statements and exculpatory records, under Brady v.
Maryland (a benefit over civil litigation, where Brady does not
apply) (373 U.S. 83 (1963)).
„„ The parties’ inability to take depositions except under unusual
„„ The defendant’s limited power to subpoena third parties for
records or testimony.
Counsel should prioritize hearing preparations, because the
cases move quickly. Generally, a contested administrative
hearing, which is equivalent to a federal court trial, begins four
months after the initial conference of all parties. Counsel also
should learn the preferences and priorities of the ALJ as early as
possible, because no right to a jury exists in an administrative
The SEC has taken notice of the rising tide of criticism aimed
at its administrative process. In late 2015, the SEC proposed
changes to the administrative proceeding rules that would allow
for some deposition discovery, up to eight months before the
trial begins (as compared to the current four months), and a few
other minor adjustments. This is a rapidly evolving area of the
law. Counsel should anticipate divergent opinions from different
courts until there is either a legislative fix or a Supreme Court
opinion that addresses directly the constitutionality of current
SEC administrative proceedings.
Given these procedural challenges, defense counsel should
„„ Moving to dismiss on the ground that the administrative
proceeding is unconstitutional. Some courts have
questioned the constitutionality of the SEC’s appointment
of ALJs. The SEC appoints all of the ALJs who hear its
administrative cases, but their appointment is not done by the
SEC Commissioners, in potential violation of Article II of the
US Constitution (see U.S. Const. art. II, § 2, cl. 2). Courts have
questioned the constitutionality of a government agency suing
an otherwise unregulated person in the agency’s home court
(see, for example, Hill v. SEC, 2015 WL 4307088, at *19 (N.D.
Ga. June 8, 2015)).
„„ Seeking injunctive relief in federal court. Defense counsel
may move for injunctive relief on the ground that the
administrative proceeding is unconstitutional, which stays
any administrative proceedings. Although these motions are
rarely successful, a few have been granted and are currently
working their way through the federal appellate process (see,
for example, Duka v. SEC, 2015 WL 4940083, at *1 (S.D.N.Y.
Aug. 12, 2015)).
45The Journal | Litigation | February/March 2016
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