Monday, April 26, 2021
Ten days ago, co-blogger John Anderson posted about a new insider trading paper co-authored by Sureyya Burcu Avci, Cindy Schipani, Nejat Seyhun, and Andrew Verstein, A revised version of the paper, entitled Insider Giving, was recently posted on SSRN. In the interim, I have been in communication with two of the co-authors, both friends of the BLPB (and of mine), Cindy Schipani and Andrew Verstein. This paper, forthcoming in the Duke Law Journal, has a lot to offer.
As an insider trading nerd, I was pulled into this paper from the get-go. Having written my own insider trading piece about gifting information a few years ago, I was intrigued by the ides of looking at the gifting of the subject securities themselves as possible violative conduct. Of course, what Insider Giving starkly portrays is a situation in which stock is not donated wholly “from a ‘detached and disinterested generosity,’ ... ‘out of affection, respect, admiration, charity or like impulses.’” Commissioner v. Duberstein, 363 U.S. 278, 285 (1960) (citations omitted) (defining a gift for federal income tax purposes). The article presents significant information about insider gifts, including background on the motivation for these transactions, empirical data on abnormal returns, and relevant legal principles and analyses. #recommend!
Although I support reform of the nation's insider trading laws (as do the article's co-authors), my principal interest in the article relates to its analysis of the legality under § 10(b) and Rule 10b-5 (of and under, respectively, the Securities Exchange Act of 1934, as amended) of a charitable gift of a publicly traded firm’s stock made by a clear insider (officer or director) of the firm to a recognized IRC § 501(c)(3) entity while the insider is in possession of material nonpublic information. Specifically, I am focused on a gift that is made at a time when negative material facts about the issuer of the gifted security remain undisclosed. Although in various places the article refers to a gift of this kind as manipulative, my understanding of that term (as used in the Section 10(b)/Rule 10b-5 context) is that it relates to conduct that alters markets (e.g., for securities, trading price or volume). Instead, I conceptualize these gifts (as portrayed in the article), as potentially deceptive conduct in connection with the purchase or sale of a security--the general basis for insider trading liability under § 10(b)/Rule 10b-5. I provide a brief analysis below.
The deception in insider trading occurs through the breach of a fiduciary or fiduciary like duty of trust and confidence by someone holding that duty. In the posited scenario, that duty holder is the corporate insider. A person with that duty of trust and confidence must refrain from trading while aware (in possession) of material nonpublic information, unless that information is disclosed (and, as applicable, fully disseminated in relevant trading markets). Accordingly, leaving aside the applicable scienter requirement, the legality of the charitable gift as a matter of § 10(b)/Rule 10b-5 insider trading law would depend on whether the insider breached their duty and whether the gift constitutes, or otherwise is in connection with, a sale of the subject securities.
The breach of duty seems clear. The stock gift was not made for the firm’s purposes/in the firm’s best interest. It was made for the insider’s purposes/ for their self-interest, which may include both altruism and a tax benefit (among other things). The resulting excess benefits inuring to the insider may be seen to be "secret profits," as referenced by the U.S. Securities and Exchange Commission in In re Cady, Roberts & Co., 40 S.E.C. 907, 916 n.31 (1961).
But what about the requisite connection to the "sale" of a security that is essential to a successful insider trading claim under § 10(b)/Rule 10b-5? Under § 3(a)(14) of the 1934 Act, "[t]he terms 'sale' and 'sell' each include any contract to sell or otherwise dispose of." Admittedly, I have not yet taken the time to look at any rule-making or decisional law on the definition of “sale” under the 1934 Act. However, it seems from the statute that the term “sale” is even more broad under the 1934 Act than it is under § 2(a)(3) of the Securities Act of 1933, as amended (where there is a “for value” requirement—although there is a disposition for value on these facts because of the tax benefit to the donor), but for the fact that the 1934 Act statutory definition appears to necessitate a “contract” for sale or disposition. If the determination of a contract relies on common law, one might well find one in this situation, since there is an offer and acceptance and, likely(?), consideration . . . . In fact, stock donors also often sign gift agreements with charitable nonprofits that are binding at least as to some terms (and may be seen as a contract to dispose of the securities). Of course, as the article's co-authors point out, the transaction itself does not need to be a sale; but there must be some connection to a purchase or sale. I agree with that observation and note also that the “in connection with” requirement has been read relatively broadly. The co-authors also accurately indicate that charities often sell donated stock (in my experience, as soon as possible after securing record ownership), making the gift transaction look a lot like a sale of the security by the insider and a subsequent gift of the proceeds by the insider to the charity. (As the co-authors note, the U.S. Supreme Court has found that type of substance-over-form argument persuasive in the breach of duty analysis in another insider trading context--tippee liability--in Dirks v. SEC, 463 U.S. 646, 664 (1983). I also note the repetition of that language and reliance in the more recent Salman v. United States, 580 U.S. ___ (2016).)
Bottom line? I see a relatively clear path to § 10(b)/Rule 10b-5 liability here, assuming the insider has the requisite state of mind (scienter). Overall, my argument tracks the related argument in the article. I am not saying the argument is a decisive winner or that there would or should be enforcement activity. Tracking these transactions for enforcement purposes will depend on the accurate filing of a Form 5 (or a voluntary Form 4). The article describes the role that these disclosure forms serve.
Based on the analysis provided here (which is not based on research--just general knowledge), I would advise the insider that there is a real insider trading liability risk in making a gift in circumstances where the insider cannot make a sale. Do you agree? If not, what am I missing?