Yesterday, the full House of Representatives approved H.R. 2534, otherwise known as the Insider Trading Prohibition Act. If passed by the Senate and signed by the President, this legislation would mark an important milestone in insider trading jurisprudence. For decades, the Securities and Exchange Commission (“SEC”) and Department of Justice (“DOJ”) have pursued insider trading violations through general anti-fraud provisions, which has resulted in extensive judge-made law and ambiguity as to when actors will be held liable for insider trading. Indeed, insider trading remains one of the few areas of the law that is based almost exclusively on common law.
The Insider Trading Prohibition Act seeks to rectify these issues by codifying the requirements of an insider trading violation. Specifically, the bill would prohibit a trader from buying or selling securities “while in possession of material, nonpublic information . . . if such person knows, or recklessly disregards, that such information has been obtained wrongfully.”
This new language makes two significant changes to the current state of the law. First, a tippee (an individual who receives material nonpublic information) can only be liable under the Second Circuit’s decision in United States v. Martoma, 894 F.3d 64 (2017), where the tippee has knowledge that the information was disclosed in exchange for a personal benefit. This knowledge requirement has, in effect, shielded most remote tippees, or tippees who are significantly removed from the initial disclosure of material nonpublic information, from liability. H.R. 2534 seeks to expand liability by incorporating a reckless intent standard, thereby allowing the government to prevail without demonstrating what the tippee actually knew at the time of the suspect trades. Second, H.R. 2534 broadens the conduct which is prohibited, permitting the SEC and DOJ to pursue actors who deceptively take material, nonpublic information, whether or not they breached a fiduciary duty. Currently, the SEC can only pursue tipper (individuals who disclose material nonpublic information) for insider trading violations if they breach a fiduciary duty through their disclosure. This has significantly curtailed the SEC’s ability to pursue tippees, who derive their insider trading liability from the initial tippers. For example, hackers, thieves, and other persons who physically steal information owe no such duty. The Act seeks to resolve this gap in liability.