Monday, May 1, 2017

The Criminalization of Insider Trading: Has It Gone Too Far?

A bit more than a year ago, I had the opportunity to participate in a conference on corporate criminal liability at the Stetson University College of Law.  The short papers from the conference were published in a subsequent issue of the Stetson Law Review.  This was the second time that Ellen Podgor, a friend and white collar crime scholar on the Stetson Law faculty, invited me to produce a short work on corporate criminal liability for publication in a dedicated edition of the Stetson Law Review.  (The first piece I published in the Stetson Law Review reflected on corporate personhood in the wake of the U.S. Supreme Court's Citizen's United opinion.  It has been downloaded and cited a surprising number of times.  So, I welcomed the opportunity to publish with the law review a second time.)

For the 2016 conference, I chose to focus on the reckless conduct of employees and its capacity to generate corporate criminal insider trading liability for the employer.  The abstract for the resulting paper, (Not) Holding Firms Criminally Responsible for the Reckless Insider Trading of their Employees (recently posted to SSRN), is as follows:

Criminal enforcement of the insider trading prohibitions under Section 10(b) and Rule 10b–5 is the root of corporate criminal liability for insider trading in the United States. In the wake of assertions that S.A.C. Capital Advisors, L.P. actively encouraged the unlawful use of material nonpublic information in the conduct of its business, the line between employer and employee criminal liability for insider trading becomes both tenuous and salient. An essential question emerges: when do we criminally prosecute the firm for the unlawful conduct of its employees?

The possibility that reckless employee conduct may result in the employer's willful violation of Section 10(b) and Rule 10b–5 (and, therefore, criminal liability for that employer firm) motivates this article. The article first reviews the basis for criminal enforcement of the insider trading prohibitions established in Section 10(b) and Rule 10b–5 and describes the basis and rationale for corporate criminal liability (a liability that derives from the activities of agents undertaken in the course of the firm’s business). Then, it reflects on that basis and rationale by identifying the potential for corporate criminal liability for the reckless insider trading violations of employees under Section 10(b) and Rule 10b–5, arguing against that liability, and suggesting ways to eliminate it.

I was not the only conference participant concerned about the criminal liability of an employer for the insider trading conduct of an employee.  John Anderson, who co-led an insider trading discussion group with me at the 2017 Association of American Law Schools annual meeting back in January and also enjoys exploring criminal insider trading issues, contributed his research on the overcriminalization of insider trading at the conference.  His paper, When Does Corporate Criminal Liability for Insider Trading Make Sense?, identifies the same overall problem as my article does (employer criminal liability for insider trading based on employee conduct).  However, he views both the problem and the potential solutions more broadly.  

The abstract for his article is set forth below.

Corporations are subject to broad criminal liability for the insider trading of their employees. Critics have noted that this results in a harsh irony. “After all,” Professor Jonathan Macey argues, “it is generally the employer who is harmed by the insider trading.” In the same vein, former chairman of the Securities and Exchange Commission (SEC) Harvey L. Pitt and Karen L. Shapiro point out that, “[f]ar from being responsible for their employees’ violations of the law…most of the employers who have had the unfortunate experience of employing [insider traders] are in fact the only true victims, in an otherwise victimless crime.”

It is clear that not all insider trading is victimless, and not all employers of insider traders are innocent. But I am convinced that these critics are correct to point out that the current enforcement regime is absurdly overbroad in that it affords no principled guarantee to corporate victims of insider trading that they will not be indicted for the crimes perpetrated against them.

The law should be reformed to insure that corporations are only held criminally liable where they are guilty of some wrongdoing. Section I of this Article outlines current law in the United States concerning corporate criminal liability in general. Section II then looks at corporate liability for insider trading under the current regime. Section III explains why the current regime is absurdly overbroad and in dire need of reform. Section IV then points the way to some reforms that would render corporate criminal liability for insider trading more rational, efficient, and just.

I enjoyed hearing John's presentation on the paper at the conference, and I also enjoyed reading the paper.  John's focus on "the corporation as victim" is thought-provoking.  Moreover, the two papers, taken together, offer a view of criminal insider trading law in the United States through the lens of corporate criminal liability more generally that may be of interest to those engaged with both insider trading and corporate crime.  

In addition, some of you may want to read Ellen's introduction to the Stetson Law Review book in which the articles are published.  In that introduction, she provides a summary of the articles included in the book and a synthesis of information gleaned from them.  The articles cover a number of important corporate criminal liability topics that may intersect with your work in this area.

Conferences, Corporate Governance, Joan Heminway, Securities Regulation, White Collar Crime | Permalink


The Newman/Chiasson/Second Circuit/Bharara episode speaks volumes on this issue. Jurisprudentially (an adverb I do not often have occasion to use), I am quite disturbed at criminal prosecution of crimes not defined by Congress, nor by even precisely drawn regulations, but rather defined by prosecutorial fiat. Consider that one minute, immediately before the Second Circuit ruled: (i) Newman was facing 54 months in prison, $1 million in fines and a forfeiture of $737,724; and (ii) Chiasson was facing 78 months in prison, $5 million in fines and a forfeiture of $1,382,217. (And, Newman's Diamondback Capital had already suffered the death penalty.) The next minute, Newman and Chiasson were facing no penalties of any kind and the U.S. Attorney was prohibited from going after them in a retrial. I doubt if that makes sense to anyone other than Preetinder Singh Bharara.

Posted by: Craig Sparks | May 1, 2017 8:53:32 AM

I appreciate the additional thoughts and example, Craig. I also have been concerned about prosecutorial discretion in insider trading enforcement in other academic work (precursors to this short piece). Neither constitutional law nor the U.S. Attorneys' Manual provide the right constraints, imv.

Posted by: joanheminway | May 1, 2017 11:52:23 AM

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