Friday, October 15, 2021
Can "hypermaterial" public information about a stock render the company's (once material) nonpublic internal data immaterial? Consider the following scenario involving social-media-driven trading in a meme stock:
XYZ Corporation’s stock price had been falling over the last month (from a high of $12 down to $10), due to a short-sale attack by a small group of hedge funds. In the past week, a group of individuals in a social media chatroom have attempted a now well-publicized short squeeze, motivated by a desire to punish what they view as predatory behavior by the hedge funds. As a result, the stock price has been driven up to $300, significantly above where the stock was trading before the short-sale attack. The company's nonpublic data (earnings, etc.) that will be reported next week reflects the "true" price of the company's shares should be $8. With knowledge of the above public and nonpblic information, XYZ and some of its insiders issue/sell XYZ shares.
Has XYZ and its insiders committed insider trading in violation of the antifraud provisions of Section 10(b) of the Securities Exchange Act?
Insider trading liability arises under the classical theory when the issuer, its employee, or an affiliate seeks to benefit from trading (or tipping others who trade) that firm’s shares based on material nonpublic information. In such cases, the insider (or constructive insider) violates a fiduciary or other similar duty of trust and confidence by failing to disclose the information to the firm’s shareholder (or prospective shareholder) on the other side of the trade.
In Basic Inc. v. Levinson, 485 U.S. 224, 231-2 (1988), the Supreme Court has held that information is “material” for purposes of insider trading liability if “there is a substantial likelihood that a reasonable shareholder would consider it important” in making an investment decision, and there is a “substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”
Prior to the onset of the social-media-driven trading, I think it's pretty clear that the insiders' nonpublic information that the company's stock (currently trading at $10) is actually worth $8 is material. In other words, there is a substantial likelihood that a reasonable shareholder would consider important information that a stock trading at $10 is actually worth $8. But is that same information still material after the social-media-driven trading has pushed the stock's price to $300?
In our forthcoming article,Insider Trading in Response to Social-Media-Driven Expressive Trading, my coauthors Jeremy Kidd, George A. Mocsary, and I argue that once material nonpublic internal data can be drowned out (and be rendered immaterial) by subsequent hypermaterial public information like a dramatic price movement resulting from a well-publicized social-media-driven run on a stock.
If the issuer's and insiders' nonpublic information about the firm is immaterial, then they may trade while in possession of it without violating the anti-fraud provisions of the federal securities laws. We welcome your comments! Here's the abstract:
The phenomenon of social-media-driven trading (SMD trading) entered the public consciousness earlier this year when GameStop’s stock price was driven up two orders of magnitude by a “hivemind” of individual investors coordinating their actions via social media. Some believe that GameStop’s price is artificially high and is destined to fall. Yet the stock prices of GameStop and other prominent SMD trading targets like AMC Entertainment continue to remain well above historical levels.
Much recent SMD trading is driven by profit motives. But a meaningful part of the rise has been a result of expressive trading—a subset of SMD trading—in which investors buy or sell for non-profit-seeking reasons like social or political activism, or for aesthetic reasons like a nostalgia play. To date, expressive trading has only benefited issuers by raising their stock prices. There is nothing, however, to prevent these traders from employing similar methods for driving a target’s stock price down (e.g., to influence or extort certain behaviors from issuers).
At least for now, stock prices raised by SMD trading have been sticky and appear at least moderately sustainable. The expressive aspect, which unites the traders under a common banner, is likely a reason that dramatic price increases resulting from profit-seeking SMD trading have persisted. Without a nonfinancial motivation to hold the group together, its members would be expected to defect and take profits.
Given that SMD trading appears to be more than a passing fad, issuers and their compliance departments ought to be prepared to respond when targeted by SMD trading. A question that might arise is whether and when SMD-trading-targeted issuers, and their insiders, may trade in their firms’ shares without running afoul of insider trading laws.
This Article proceeds as follows: Part I summarizes the current state of insider trading law, with special focus on the elements of materiality and publicity. Part II opens with a brief summary of the filing, disclosure, and other (non-insider-trading-related) requirements issuers and their insiders may face when trading in their own company’s shares under any circumstance. The remainder of this Part analyzes the insider trading-related legal implications of three different scenarios in which issuers and their insiders trade in their own company’s shares in response to SMD trading. The analysis reveals that although the issuer’s and insiders’ nonpublic internal information may be material (and therefore preclude their legal trading) prior to and just after the onset of third-party SMD trading in the company’s stock, subsequent SMD price changes (if sufficiently dramatic) may diminish the importance of the company’s nonpublic information, rendering it immaterial. If the issuer’s and insiders’ nonpublic information about the firm is immaterial, then they may trade while in possession of it without violating the anti-fraud provisions of the federal securities laws.
Friday, October 1, 2021
Insider trading reform has been a consistent theme in my last few posts (see, e.g., here, here, here, and here). In keeping with this theme, I’d like to highlight a new article, How Creepy Concepts Undermine Effective Insider Trading Reform, which was posted just yesterday by Professor Kevin R. Douglas (Michigan State College of Law). Professor Douglas is an important new voice in the areas of securities regulation, corporate finance, and business law more generally. Here’s the abstract:
Lawmakers are building momentum towards codifying our insider trading laws to clarify which kind of trading is illegal. In May 2021, the US House of Representatives passed the Insider Trading Prohibition Act for the second time in two years. In January 2020, a Securities and Exchange Commission sponsored task force on insider trading released a report containing proposed legislation. Both the House Bill and the task force proposal would prohibit trading while in possession of “wrongfully obtained” information and prohibit trades that involve a “wrongful use” of information. This article explains why the concept of “wrongful” trading is too ambiguous to improve insider trading law and explores the requirements of effective legislative reform.
For decades, scholars have described insider trading doctrine as mystifying and called for reform. Many explain the confusion by pointing to the stark difference in how enforcement officials and federal courts apply insider trading law. Others argue that the confusion is caused by policymakers failing to choose between fostering efficient markets and fostering fair or equitable markets. This article argues that the conflict between courts and enforcement officials is a symptom of two deeper conceptual problems—one at the doctrinal level and one at the policy level. The doctrinal confusion is more precisely caused by the attempt to simultaneously invoke two conflicting concepts of “fairness.” Fairness meaning consensual transactions, versus fairness meaning transactions in which all parties enjoy equal access to all material information and other economic values. Attempting to simultaneously apply these mutually exclusive notions of fairness has caused a slow and inconsistent conceptual creep, resulting in an incoherent doctrine.
The policy confusion is caused by officials relying on economic models that use misidentified theories of “economic efficiency.” Officials describe the policy goal of our insider trading regime as encouraging capital formation in US securities markets and economic growth in general. These goals imply an exclusive commitment to promoting “allocational efficiency”—or maximizing wealth. However, scholars usually rely on the concept of “market efficiency” when evaluating the law and practice of insider trading. The definition of market efficiency relies on assumptions that embody an unacknowledged focus on economic distribution—equalizing wealth. This includes the assumptions that all investors (1) trade at the same price (the correct price) and (2) have equal access to all available information. Conflating these forms of efficiency causes officials to unintentionally oscillate between promoting opaque distribution goals and promoting economic growth.
This article recommends clarifying insider trading law by prioritizing one of the two conflicting fairness doctrines and a compatible policy goal. Clarity requires specifying whether consent is a defense against insider trading liability. Enforcing only one fairness doctrine gives everyone the option of attempting to privately adhere to both principles while successfully applying one of the principles through law.
Friday, September 24, 2021
I'm so excited to present later this morning at the University of Tennessee College of Law Connecting the Threads Conference today at 10:45 EST. Here's the abstract from my presentation. In future posts, I will dive more deeply into some of these issues. These aren't the only ethical traps, of course, but there's only so many things you can talk about in a 45-minute slot.
All lawyers strive to be ethical, but they don’t always know what they don’t know, and this ignorance can lead to ethical lapses or violations. This presentation will discuss ethical pitfalls related to conflicts of interest with individual and organizational clients; investing with clients; dealing with unsophisticated clients and opposing counsel; competence and new technologies; the ever-changing social media landscape; confidentiality; privilege issues for in-house counsel; and cross-border issues. Although any of the topics listed above could constitute an entire CLE session, this program will provide a high-level overview and review of the ethical issues that business lawyers face.
Specifically, this interactive session will discuss issues related to ABA Model Rules 1.5 (fees), 1.6 (confidentiality), 1.7 (conflicts of interest), 1.8 (prohibited transactions with a client), 1.10 (imputed conflicts of interest), 1.13 (organizational clients), 4.3 (dealing with an unrepresented person), 7.1 (communications about a lawyer’s services), 8.3 (reporting professional misconduct); and 8.4 (dishonesty, fraud, deceit).
Discussion topics will include:
- Do lawyers have an ethical duty to take care of their wellbeing? Can a person with a substance use disorder or major mental health issue ethically represent their client? When can and should an impaired lawyer withdraw? When should a lawyer report a colleague?
- What ethical obligations arise when serving on a nonprofit board of directors? Can a board member draft organizational documents or advise the organization? What potential conflicts of interest can occur?
- What level of technology competence does an attorney need? What level of competence do attorneys need to advise on technology or emerging legal issues such as SPACs and cryptocurrencies? Is attending a CLE or law school course enough?
- What duties do lawyers have to educate themselves and advise clients on controversial issues such as business and human rights or ESG? Is every business lawyer now an ESG lawyer?
- What ethical rules apply when an in-house lawyer plays both a legal role and a business role in the same matter or organization? When can a lawyer representing a company provide legal advice to an employee?
- With remote investigations, due diligence, hearings, and mediations here to stay, how have professional duties changed in the virtual world? What guidance can we get from ABA Formal Opinion 498 issued in March 2021? How do you protect confidential information and also supervise others remotely?
- What social media practices run afoul of ethical rules and why? How have things changed with the explosion of lawyers on Instagram and TikTok?
- What can and should a lawyer do when dealing with a businessperson on the other side of the deal who is not represented by counsel or who is represented by unsophisticated counsel?
- When should lawyers barter with or take an equity stake in a client? How does a lawyer properly disclose potential conflicts?
- What are potential gaps in attorney-client privilege protection when dealing with cross-border issues?
If you need some ethics CLE, please join in me and my co-bloggers, who will be discussing their scholarship. In case Joan Heminway's post from yesterday wasn't enough to entice you...
Professor Anderson’s topic is “Insider Trading in Response to Expressive Trading”, based upon his upcoming article for Transactions. He will also address the need for business lawyers to understand the rise in social-media-driven trading (SMD trading) and options available to issuers and their insiders when their stock is targeted by expressive traders.
Professor Baker’s topic is “Paying for Energy Peaks: Learning from Texas' February 2021 Power Crisis.” Professor Baker will provide an overview of the regulation of Texas’ electric power system and the severe outages in February 2021, explaining why Texas is on the forefront of challenges that will grow more prominent as the world transitions to cleaner energy. Next, it explains competing electric power business models and their regulation, including why many had long viewed Texas’ approach as commendable, and why the revealed problems will only grow more pressing. It concludes by suggesting benefits and challenges of these competing approaches and their accompanying regulation.
Professor Heminway’s topic is “Choice of Entity: The Fiscal Sponsorship Alternative to Nonprofit Incorporation.” Professor Heminway will discuss how for many small business projects that qualify for federal income tax treatment under Section 501(a) of the U.S. Internal Revenue Code of 1986, as amended, the time and expense of organizing, qualifying, and maintaining a tax-exempt nonprofit corporation may be daunting (or even prohibitive). Yet there would be advantages to entity formation and federal tax qualification that are not available (or not easily available) to unincorporated business projects. Professor Heminway addresses this conundrum by positing a third option—fiscal sponsorship—and articulating its contextual advantages.
Professor Moll’s topic is “An Empirical Analysis of Shareholder Oppression Disputes.” This panel will discuss how the doctrine of shareholder oppression protects minority shareholders in closely held corporations from the improper exercise of majority control, what factors motivate a court to find oppression liability, and what factors motivate a court to reject an oppression claim. Professor Moll will also examine how “oppression” has evolved from a statutory ground for involuntary dissolution to a statutory ground for a wide variety of relief.
Professor Murray’s topic is “Enforcing Benefit Corporation Reporting.” Professor Murray will begin his discussion by focusing on the increasing number of states that have included express punishments in their benefit corporation statutes for reporting failures. Part I summarizes and compares the statutory provisions adopted by various states regarding benefit reporting enforcement. Part II shares original compliance data for states with enforcement provisions and compares their rates to the states in the previous benefit reporting studies. Finally, Part III discusses the substance of the benefit reports and provides law and governance suggestions for improving social benefit.
All of this and more from the comfort of your own home. Hope to see you on Zoom today and next year in person at the beautiful UT campus.
September 24, 2021 in Colleen Baker, Compliance, Conferences, Contracts, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Delaware, Ethics, Financial Markets, Haskell Murray, Human Rights, International Business, Joan Heminway, John Anderson, Law Reviews, Law School, Lawyering, Legislation, Litigation, M&A, Management, Marcia Narine Weldon, Nonprofits, Research/Scholarhip, Securities Regulation, Shareholders, Social Enterprise, Teaching, Unincorporated Entities, White Collar Crime | Permalink | Comments (0)
Friday, September 17, 2021
The Securities and Exchange Commission’s (SEC) Chairman, Gary Gensler, recently directed the staff to present recommendations to "freshen up" and tighten some provisions in Exchange Act Rule 10b5-1. In response, the SEC’s Investor Advisory Committee proposed new restrictions on the use of 10b5-1(c) trading plans as an affirmative defense against insider trading liability. The proposed changes are designed to address concerns that "some plans are used to engage in opportunistic trading behavior that contravenes the intent behind the rule," and they are consistent with recommendations outlined in the Promoting Transparent Standards for Corporate Insiders Act that passed the House of Representatives in April 2021.
But any proposed restrictions to trading plans must be considered in light of the broader context of Rule 10b5-1, and the motivation behind the affirmative defense’s adoption.
The courts have interpreted Section 10b of the Exchange Act as prohibiting insiders from trading in their own company’s shares only if they do so “on the basis” of material nonpublic information. This element of intent for insider trading liability can be difficult for regulators and prosecutors to satisfy because insiders who possess material nonpublic information at the time of their trade can often claim that they did not use the information to trade. They may claim, for example, that they only sold stock to pay their child’s college tuition bill, and the material nonpublic information had nothing to do with the trade.
Prior to 2000, the SEC and prosecutors sought to defeat this defense strategy by taking the position that knowing possession of material nonpublic information while trading satisfies the “on the basis of” element of insider trading liability. But when pressed, this strategy met with only mixed results in the courts. In an attempt to settle a circuit split over this “use-versus-possession” issue, the SEC adopted Rule 10b5-1, which defines trading “on the basis of” material nonpublic information for purposes of insider trading liability as trading while “aware” of such information.
The SEC anticipated two problems for its new awareness test: (1) It anticipated concern from the courts that imposing liability on a person who is merely aware of material nonpublic information while trading (without a causal relation between the information and the trade) would exceed the commission’s statutory authority by failing to satisfy the requirement of scienter under the general antifraud provisions of Section 10(b) of the Exchange Act. (2) There was also a concern that the broad awareness test may chill legitimate trading by insiders (e.g., for portfolio diversification), which would negatively impact the value of firm shares as a form of compensation. The 10b5-1 trading plan as an affirmative defense to insider trading liability was designed to mitigate these concerns.
Now, the SEC is considering significant new restrictions on the use of trading plans that include (a) a “cooling off” period of at least four months between plan adoption and trading or modification; (b) a prohibition on overlapping plans; and (c) new disclosure requirements.
In two recent articles, Anticipating a Sea Change for Insider Trading Law: From Trading Plan Crisis to Rational Reform and Undoing a Deal with the Devil: Some Challenges for Congress's Proposed Reform of Insider Trading Plans, I argue that additional restrictions on trading plan use like those being proposed by the SEC risk defeating the very purposes for which the affirmative defense was adopted. For example, new restrictions on 10b5-1(c) trading plans may force courts to conclude that the SEC exceeded its authority with the adoption of its broad 10b5-1(b) awareness test. Moreover, since new restrictions on trading plans will make it more difficult for employees to sell shares issued to them as equity compensation, those shares will be less valuable to employees. Firms will therefore have to offer more shares to employees to achieve the same remunerative effect. This will impose new costs on shareholders. Will the anticipated benefits of the new restrictions offset these costs?
My hope is that the SEC will take these considerations (and others I have raised) into account as it mulls the question of 10b5-1(c) trading plan reform. After all, the Commission cannot have its cake and eat it too!
Friday, September 3, 2021
I suggested in my last two posts (here and here) that as Congress and the SEC contemplate reforms to our current insider trading regime, it is important for us all to explore our intuitions about what we think insider trading is, why it is wrong, who is harmed by it, and the nature and extent of the harm. If we are going to rethink how we impose criminal and civil penalties for insider trading, we should have some confidence that the proscribed conduct is wrongful and why. One way to do this is to place ourselves in the shoes of traders and ask, “What would I do?” or “What do I think about that?” With this in mind, I developed some scenarios designed to test our attitudes regarding trading scenarios that distinguish the four historical insider trading regimes (laissez faire, fiduciary-fraud, equal access, and parity of information).
In the previous post, I offered a scenario that would result in liability under equal-access and parity-of-information regimes, but not under the fiduciary-fraud and laissez-faire models. Those of you who were not convinced that the trading in that scenario was wrongful may favor one of the less restrictive models.
In today’s post, I offer two scenarios to test our attitudes regarding trading under the fiduciary-fraud model. This model recognizes a duty to disclose material nonpublic information or abstain from trading on it, but only for those who share a recognized fiduciary or similar duty of trust and confidence to either the counterparty to the trade (under the “classical” theory) or the source of the information (under the “misappropriation” theory). The trading in the following scenario would incur liability under the classical theory of the fiduciary-fraud model (as well as under the more restrictive parity-of-information and equal-access models), but not under the misappropriation theory:
A senior VP at BIG Corp., a publicly traded company, took the lead in closing a big deal to merge BIG Corp. with XYZ Corp. The shares of BIG Corp will skyrocket when the deal is announced in seven days. The senior VP asks the CEO and board of Big Corp if he can purchase shares of BIG Corp for his personal account in advance of the announcement. The CEO and board approve the senior VPs trading. The senior VP buys Big Corp. shares in advance of the announcement and he makes huge profits when the deal is announced.
Note the difference between this scenario and the scenario in last week’s post. Here the counterparties to the trade are existing Big Corp shareholders who (if they had the same information as the senior VP) presumably would not have proceeded with the trade at the pre-announcement price. The theory assumes that such trading on the firm’s information (even with board approval) breaches a fiduciary duty of loyalty to the firm’s shareholders (fair assumption?). In last week’s post, the counterparties to the trade were XYZ Corp.’s shareholders, so the board-approved trade did not breach any fiduciary duty. Do you agree that the senior VP’s trading in the scenario above is deceptive, disloyal, or harmful to shareholders? If so, do you think such trading should be subject to civil or criminal sanction (or both)?
The trading in the next scenario would incur liability under the misappropriation theory of the fiduciary-fraud model (as well as under the more restrictive parity-of-information and equal access models), but not under the classical theory:
A senior VP at BIG Corp., a publicly traded company, took the lead in closing a big deal to merge BIG Corp and XYZ Corp. The shares of BIG Corp and XYZ Corp will both skyrocket when the deal is announced in seven days. At the closing party, the CEO and Board of BIG Corp explain to everyone on the deal team that they would like to keep the deal confidential until it is announced to the public the following week. Immediately after the party, the senior VP goes back to his office and buys shares of XYZ Corp for his personal online brokerage account. The senior VP makes huge profits from his purchase of XYZ Corp shares when the deal is announced a week later.
Here the senior VP at BIG Corp. trades in XYZ Corp. shares, so he does not breach any fiduciary duty to his shareholders. Assuming a reasonable person would conclude that a request of confidentiality includes a request not to trade (fair assumption?), the VP’s trading does, however, breach a duty of loyalty to BIG Corp. Is this trading wrongful? If so, is it more/less/equally wrongful by comparison to the trading in the classical scenario above? Finally, if you do think this trading is wrongful, should it be subject to civil or criminal sanction?
Again, the hope is that walking through these scenarios will help bring some clarity to our shared understanding of when trading on material nonpublic information is wrong and harmful—and (given our answers to these questions) the nature and extent to which it should be regulated.
Friday, August 20, 2021
As Congress and the SEC continue to contemplate reforms to the U.S. insider-trading enforcement regime, I suggested in my last post that it is important for us all to explore our intuitions about what we think insider trading is, why it is wrong, who is harmed by it, and the nature and extent of the harm. If we are going to rethink how we impose criminal and civil penalties for insider trading, we should have some confidence that the proscribed conduct is wrongful and why. One way to do this is to place ourselves in the shoes of traders and ask, “What would I do?” or “What do I think about that?” To this end, I have developed some scenarios designed to test our attitudes regarding trading scenarios that distinguish the four historical insider trading regimes (laissez faire, fiduciary-fraud, equal access, and parity of information).
In the last post, I offered a scenario that would result in liability under a parity-of-information regime, but not under the other three. Those of you who were not convinced that the trading in that scenario was wrongful may favor one of the less restrictive models.
In this post, I offer the following scenario to test our attitudes regarding trading under an equal-access model. An equal-access regime precludes trading by those who have acquired information advantages by virtue of their privileged access to sources that are structurally closed to other market participants (regardless of whether such trading violates a duty of trust and confidence). An equal access model is narrower in scope than the parity-of-information model, but broader than the laissez-faire and fiduciary-fraud models. Consider these facts:
A senior VP at BIG Corp (a publicly traded company) took the lead in closing a big deal to merge BIG Corp with XYZ Corp (another publicly traded company). The shares of both BIG Corp and XYZ Corp will skyrocket when the deal is announced to the public in seven days. The senior VP asks the CEO and board of Big Corp if, instead of receiving the usual cash bonus that would be his due for leading such a deal, he can purchase shares of XYZ Corp for his personal account in advance of the announcement. The CEO and board approve the VP’s trading—deciding that the BIG Corp shareholders will save money from this arrangement. The VP buys XYZ Corp shares in advance of the announcement and he makes huge profits when the deal is announced.
Was the senior VP’s trading wrong or harmful? If you do not think the senior VP or Big Corp has done anything wrong or harmful in this scenario, then you will probably not favor the equal-access model for insider trading regulation—which would render this conduct illegal. You will likely favor some version of the less restrictive laissez-faire or fiduciary-fraud model instead. My next post will offer a scenario to test our intuitions about the fiduciary-fraud model (the third most restrictive regime).
Again, the hope is that walking through these scenarios will help bring some clarity to our shared understanding of when trading on material nonpublic information is wrong and harmful—and (given our answers to these questions) the nature and extent to which it should be regulated. Please share your thoughts in the comments below!
Friday, August 6, 2021
In January of 2020, The Bharara Task Force on Insider Trading released its report recommending that Congress adopt sweeping reforms of our insider trading enforcement regime. And it appears there is at least some momentum building to act on this recommendation. In April of 2021, the House of Representatives passed the Promoting Transparent Standards for Corporate Insiders Act, and in May of 2021, the House passed the Insider Trading Prohibition Act. I have expressed some concerns about these bills (see, e.g., here and here). But, as I argue in my book, Insider Trading: Law, Ethics, and Reform, I am in complete agreement with the claim that our current insider trading regime is broken and needs to be reformed.
We should not, however, rush to adopt a new insider trading regime without first thoughtfully considering what constitutes insider trading; why it is wrong; who is harmed by it; and the nature and extent of the harm. The answers to these questions have been subject to endless academic debate, but are crucial for determining whether insider trading should be regulated civilly and/or criminally (or not at all), as well as for determining the nature and magnitude of any sanctions to be imposed.
Historically, insider trading regimes around the globe can be grouped (roughly) into four categories (listed from the least to most restrictive): (a) laissez-faire regimes, which permit all trading on information asymmetries, so long as there is no affirmative fraud (actual misrepresentations or concealment); (b) fiduciary-fraud regimes, which recognize a duty to disclose or abstain from trading, but only for those who share a recognized duty of trust and confidence (with either the counterparty to the trade, or with the source of the information, or both); (c) equal-access regimes, which preclude trading by those who have acquired information advantages by virtue of their privileged access to sources that are structurally closed to other market participants (regardless of whether such trading violates a duty of trust and confidence); and (d) parity-of-information regimes, which strive to prohibit all trading on material nonpublic information (regardless of the source).
The following scenario illustrates conduct that would expose the trader to liability under a parity-of-information regime, but not under an equal access, fiduciary-fraud, or laissez-faire regime. As you read through the fact pattern, ask yourself: (1) Is this trading wrong? (2) Who (if anyone) is harmed by it? (3) What is the nature and extent of the harm? (4) Should this trading be regulated (civilly or criminally)? (Please share any answers/thoughts in the comments below!):
A high-school janitor is traveling home from work late at night on a public bus. She looks down and sees a trampled piece of paper. She picks up the paper and reads it. It appears to be someone’s notes from a meeting—though there is nothing to identify the paper’s owner/author. The paper reads as follows:
Meet at HQ of XYZ Corp at 3PM on Jan. 3 to finalize the merger with BIG Corp. Merger to be announced to public on Jan 10. Note: the announcement of merger will send shares of XYZ through the roof, so everyone must maintain strict confidentiality.
The janitor looks up and sees the bus is totally empty. There is no chance of finding the person who dropped the paper. It is January 4. The janitor opens an online brokerage account when she gets home and buys as many shares of XYZ Corp as she can afford. She makes huge profits when the merger is announced on January 10.
If you do not think the janitor has done anything wrong or harmful in this scenario, then you will probably not favor the parity-of-information model for insider trading regulation—which would render this conduct illegal. You will likely favor some version of one of the other insider-trading models instead. My next post will offer a scenario to test our intuitions about the equal-access model (the second-most restrictive regime).
The hope is that walking through these scenarios will help bring some clarity to our shared understanding of when trading on material nonpublic information is wrong and harmful—and (given our answer to this question) the nature and extent to which it should be regulated.
Friday, July 23, 2021
Professor Martin Edwards (Belmont University College of Law) and I are excited to moderate a discussion group titled, “A Very Online Economy: Meme Trading, Bitcoin, and the Crisis of Trust and Value(s)—How Should the Law Respond,” at the 2022 American Association of Law Schools Annual Meeting. The discussion group is scheduled to take place (virtually) on Friday, January 7, 2022. We welcome responses to the call for participation (here). Here’s the description:
Emergent forces emanating from social and financial technologies are challenging many underlying assumptions about the workings of markets, the nature of firms, and our social relationship with our economic institutions. The 21st century economy and financial architecture are built on faith and trust in centralized institutions. Perhaps it is not surprising that in 2008, a time where that faith and trust waned, a different architecture called “blockchain” emerged. It promised “trustless” exchange, verifiable intermediation, and “decentralization” of value transfer.
In 2021, the financial architecture and its institutions suffered a broadside from socialmedia-fueled “meme” and “expressive” traders. It may not be a coincidence that many of these traders reached adulthood around 2008, when the crisis called into question whether that real money, those real securities, or that real, fundamental value were really real at all. People are engaging with questions about social values in an increasingly uneasy way. There is a flux not only in the substantive values, but also with what set of institutions people should trust to produce, disseminate, and enforce values.
One question is what role business corporations might play in this moment, which is being worked out most prominently through discussions about environmental and social governance (ESG). Social and financial technologies may be rewriting longstanding assumptions about social and economic institutions. Blockchains challenge our assumptions about the need for centralization, trust, and institutions, while meme or expressive trading and ESG challenge our assumptions about economic value, market processes, and social values.
It promises to be a great discussion!
Friday, July 9, 2021
I noted in a January post that Professor Mihailis E. Diamantis and I are joining Professors J. Kelly Strader, and Sandra D. Jordan as co-authors of the 4th edition of White Collar Crime: Cases, Materials, and Problems. I am pleased to announce that the text is now available for fall 2021 adoption, and instructors can request an electronic copy for immediate review here. Here is a description of the new edition:
White Collar Crime: Cases, Materials, and Problems is a unique, problems-focused approach to teaching and learning about federal white collar crime. The authors draw from their practice experience in prosecuting and defending white collar crime cases to present both foundational and current issues of law, policy, and theory as they arise in statutes and cases. The text includes:
- Comprehensive coverage of the substantive law of various white collar crimes (topics include conspiracy, mail fraud, wire fraud, securities fraud, computer crimes, bribery, extortion, perjury, false statements, obstruction of justice, tax fraud, currency transaction reporting crimes, money laundering, and RICO);
- Chapters dedicated to the practical and procedural issues that typically arise in, and often are unique to, white collar cases (topics include internal investigations, compliance programs, civil actions and fines, parallel proceedings, grand juries, Fifth Amendment, sentencing, and forfeitures); and
- Practice problems throughout to enhance both effective teaching and student comprehension through engagement.
For the fourth edition, the authors have continued their emphasis on the most recent, cutting-edge issues in white collar crime and litigation. They have added a number of recent United States Supreme Court and Circuit court decisions. The text expands its focus on policy and practical aspects of white collar practice, including the addition of many new practice problems and exercises.
Friday, June 25, 2021
35 Years Later: Greed Is Still Not Good, but It Is also Not a Good Justification for Imposing Criminal Liability
Now that the spring commencement address season has come to a close, I’ll take a moment to reflect on one of the most infamous commencement speeches in history. Thirty-five years ago, on May 18, 1986, Ivan Boesky addressed the graduating class of UC Berkeley’s Haas School of Business. In his speech, he famously claimed that
[g]reed is all right, by the way. I want you to know that. I think greed is really healthy. You can be greedy and still feel good about yourself.
In response, James B. Stewart notes that the “crowd burst into spontaneous applause as students laughed and looked at each other knowingly.” Den of Thieves p.261 (1992). And why not? This was the 1980s, the “Decade of Greed” (see, e.g., here and here). Boesky’s claim garnered so much attention that it was famously paraphrased by the fictional Gordon Gekko in Oliver Stone’s iconic 1987 movie, Wall Street.
But, of course, by definition greed is not good. As Aristotle explained, greed is a vice. It is the opposite of the virtue of generosity. The greedy are “shameful love[rs] of gain” who “go to excess in taking, by taking anything from any source.” Aristotle, Nicomachean Ethics (translated by Terence Irwin).
We often hear calls for criminal prosecution in response to rampant greed on Wall Street. For example, according to one California court, insider trading is “a manifestation of undue greed among the already well-to-do, worthy of legislated intervention if for no other reason than to send a message of censure on behalf of the American people.” There are, however, a number of problems with the use of the criminal law to combat the vice of greed.
In my book, Insider Trading: Law, Ethics, and Reform, I argue that greed is a poor justification for criminalizing conduct in the financial industry. (I focus on greed as a justification for the criminalization of insider trading in the book, but the arguments apply to financial crimes more generally.) First, any financial regulation targeting conduct to address the problem of greed will almost certainly be over-inclusive. The proceeds of any financial scheme can be used for greedy or generous ends (think the legend of Robinhood—not the retail broker!). Second, regulating conduct on the basis of greed will also be under-inclusive—unless the plan is to criminalize all profit-making endeavors.
Finally, while greedy acts are always harmful to the actor’s character, they are not always harmful to others. Greedy acts will typically harm others only if they are also unjust or unfair. If targeted acts are unjust or unfair, this is an independent justification for criminalization—and appeal to greed is superfluous. If, however, an act is neither unjust nor unfair, but is criminalized to combat the actor’s greed alone, then this justification violates John Stuart Mill’s time-honored Harm Principle. For Mill, the only valid justification for imposing criminal sanctions on a citizen is to prevent harm to others—harm to the character of the actor alone is insufficient justification. If a greedy act is neither unjust nor unfair, then its only conceivable harm is to the character of the actor. Consistent with Mill’s principle, Western liberal democracies have been trending away from such moralistic/vice laws. I think this is progress.
In sum, though greed is not good, it is also not a good basis for prosecuting firms or individuals. Criminal sanctions should be imposed based on considerations of justice and fairness—not character.
Friday, May 28, 2021
I just returned from my first “in-person” scholarly workshop since the onset of the pandemic. The event, “Introduction to the Economics of Information, Advertising, Privacy, and Data Security,” was hosted by the George Mason University Antonin Scalia Law School’s Law & Economics Center (LEC). The workshop took place at the Omni Amelia Island Resort—just outside of Jacksonville, Florida.
After a warm welcome from the LEC’s Director, Henry N. Butler, the program launched into nine sessions over three days:
- Introduction to Economics of Information
- Signaling/Screening/Mandated Disclosures
- Theories of Advertising, Substantiation, and Optimal Remedies
- Economics of Privacy
- Algorithmic Bias
- Economics of Data Security
- Big Data, Privacy, and Antitrust
- First Amendment Issues
- Social Media and Content Moderation.
The sessions were led by either Prof. Jane Bambauer, Prof. James C. Cooper, or Prof. John M. Yun. I’ve attended LEC workshops in the past, and have found them to be both rigorous and entertaining. This event was no exception. The assigned readings ranged from classic articles by Harold Demsetz and Jack Hirshleifer to contemporary pieces authored by the presenters and other leaders in the field. I learned a great deal and recommend future LEC workshops to anyone who may have the opportunity to participate.
But while I took a number of inspirations for future scholarship away from this workshop, I think I will remember this event most for offering the first opportunity, after a year and a half of “Zooming,” to get together with fellow scholars from around the country in person!
A number of us on the Business Law Prof Blog have written about how the pandemic has led to the discovery of wonderful new teaching and scholarly opportunities through online meeting spaces. The ability to meet “online” has certainly made me more accessible to my students (and vice versa), and I have participated in a number of conferences and panels that I would not have been able to attend even if pandemic-related travel restrictions were not in place. Nevertheless, this in-person event reminded me of the little big things that are gained by meeting in person. To note just a few:
- New friendships made while waiting in line for a coffee
- Philosophical discussions about the nature of language and sense perception over a good meal
- Long walks with old friends along the beach
- Meeting a fellow scholar at the pool who just happens to be working in the same area, and who would be perfect for the panel you are putting together…..
In sum, as wonderful as online platforms can be, there are many things about in-person meetings that are simply irreplaceable. I am grateful to George Mason and the LEC for offering me the first opportunity since the onset of the pandemic to be reminded of them.
Friday, May 14, 2021
Hiring Announcement for Instructor of Legal Analysis and Communication at Mississippi College School of Law
We are looking to hire for a position as Instructor of Legal Analysis and Communication at Mississippi College School of Law. Please don’t hesitate to reach out to me directly if you are interested. Here’s the announcement:
Mississippi College School of Law (MC Law) invites applications from candidates for a position as Instructor of Legal Analysis and Communication. Responsibilities will include teaching in MC Law’s summer entry program, its Legal Analysis and Communication program (which focuses on writing and analytical skills), and in courses and workshops targeting success in law school and on the bar exam. We seek candidates with exceptional writing skills, a distinguished academic background (having earned a J.D.), and a commitment to excellence in teaching. We particularly encourage applications from candidates who will enrich the diversity of our faculty. Applications should include a cover letter, curriculum vitae, the names and contact information of three references, and teaching evaluations (if available). Applications should be sent in a single PDF to Professor John P. Anderson, Chair, Faculty Appointments Committee, via email at firstname.lastname@example.org.
Friday, April 30, 2021
I’ve addressed the recent social-media-driven retail trading in stocks like GameStop in prior posts (here and here). In both posts, I focused on evidence that at least some of this trading seems to pursue goals other than (or in addition to) profit. For example, some of these retail traders claim that they are buying and holding stocks as a form of social, political, or aesthetic expression. My coauthors Jeremy Kidd, George Mocsary, and I recently posted a forthcoming article on this subject, Social Media, Securities Markets, and the Phenomenon of Expressive Trading, to SSRN. The article introduces the emerging phenomenon of expressive trading. It considers some of the challenges and risks expressive trading may pose to issuers, markets, and regulators--as well as to our traditional understanding of market functioning. Ultimately, the article concludes that while innovations like expressive trading "can be disruptive and demand a reimagining of the established order," market participants, issuers, and regulators would be wise to pause and observe before rushing to adopt defensive strategies or implement reforms. Here’s the abstract:
Commentators have likened the recent surge in social-media-driven (SMD) retail trading in securities such as GameStop to a roller coaster: “You don’t go on a roller coaster because you end up in a different place, you go on it for the ride and it’s exciting because you’re part of it.” The price charts for GameStop over the past few months resemble a theme-park thrill ride. Retail traders, led by some members of the “WallStreetBets” subreddit “got on” the GameStop roller coaster at just under $20 a share in early January 2021 and rode it to almost $500 by the end of that month. Prices then dropped to around $30 dollars in February before shooting back to $200 in March. But, like most amusement park rides that end where they start, many analysts expect market forces will ultimately prevail, and GameStop’s share price will soon settle back to levels closer to what the company’s fundamentals suggest it should. Conventional wisdom counsels that bubbles driven by little more than noise and FOMO—fear of missing out—should eventually burst. There are, however, signs suggesting that something more than market noise and over-exuberance is sustaining the SMD retail trading in GameStop.
There is evidence that at least some of the recent SMD retail trading in GameStop and other securities is not only motivated by the desire to make a profit, but rather to make a point. This Essay identifies and addresses the emerging phenomenon of “expressive trading”—securities trading for the purpose of political, social, or aesthetic expression—and considers some of its implications for issuers, markets, and regulators.
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?
Friday, April 16, 2021
With recent studies suggesting that insiders are availing themselves of SEC Rule 10b5-1(c) trading plains to beat the market by trading their own company’s shares based on material non-public information, Congress may be poised to act. In March of 2021, Representative Maxine Waters reintroduced a bill entitled the Promoting Transparent Standards for Corporate Insiders Act. The same bill passed the house in the 116th Congress, but died in the Senate. If passed, the bill would require the SEC to study a number of proposed amendments to 10b5-1(c), report to Congress, and then implement the results of that study through rulemaking. I identified some problems with the bill in my article, Undoing a Deal with the Devil: Some Challenges for Congress's Proposed Reform of Insider Trading Plans. But if significant reforms are in store for insider trading plans, then insiders may look to other creative “loopholes” that permit them to monetize access to their firms’ material nonpublic information.
Professors Sureyya Burcu Avci, Cindy Schipani, Nejat Seyhun, and Andrew Verstein, have identified “insider giving” as another strategy for hiding insider trading in plain sight. Here’s the abstract for their article, Insider Giving, which is forthcoming in the Duke Law Journal:
Corporate insiders can avoid losses if they dispose of their stock while in possession of material, non-public information. One means of disposal, selling the stock, is illegal and subject to prompt mandatory reporting. A second strategy is almost as effective and it faces lax reporting requirements and legal restrictions. That second method is to donate the stock to a charity and take a charitable tax deduction at the inflated stock price. “Insider giving” is a potent substitute for insider trading. We show that insider giving is far more widespread than previously believed. In particular, we show that it is not limited to officers and directors. Large investors appear to regularly receive material non-public information and use it to avoid losses. Using a vast dataset of essentially all transactions in public company stock since 1986, we find consistent and economically significant evidence that these shareholders’ impeccable timing likely reflects information leakage. We also document substantial evidence of backdating – investors falsifying the date of their gift to capture a larger tax break. We show why lax reporting and enforcement encourage insider giving, explain why insider giving represents a policy failure, and highlight the theoretical implications of these findings to broader corporate, securities, and tax debates.
Friday, April 2, 2021
We are looking to make up to two tenure-track hires at Mississippi College School of Law. I'm chairing the search committee, so please don’t hesitate to reach out to me directly if you are interested. Here’s the announcement:
Mississippi College School of Law invites applications from entry-level candidates for multiple tenure-track faculty positions expected to begin July 2021. Our search will focus primarily on candidates with an interest in teaching one or more of the following courses: Contracts, Professional Responsibility, Business Associations, Commercial Paper, Antitrust, Wills and Estates, Trusts, Domestic Relations, Criminal Procedure, Evidence, and Trial Advocacy. We seek candidates with a distinguished academic background (having earned a J.D. and/or Ph.D.), a commitment to excellence in teaching, and a demonstrated commitment to scholarly research and publication. We particularly encourage applications from candidates who will enrich the diversity of our faculty. We will consider candidates listed in the AALS-distributed FAR, as well as those who apply directly. Applications should include a cover letter, curriculum vitae, a scholarly research agenda, the names and contact information of three references, and teaching evaluations (if available). Applications should be sent in a single PDF to Professor John P. Anderson, Chair, Faculty Appointments Committee, via email at email@example.com.
Friday, March 19, 2021
The University of Connecticut School of Business hosts The Business and Human Rights Initiative, which “seeks to develop and support multidisciplinary and engaged research, education, and public outreach at the intersection of business and human rights.” Professor Stephen Park, Director of the Business and Human Rights Initiative, invited me to be a discussant at the most recent meeting of the Initiative’s workshop series. The workshop focused on Rachel Chambers' and Jena Martin's excellent paper, A Foreign Corrupt Practices Act for Human Rights. Here’s an abstract:
The global movement towards the adoption of human rights due diligence laws is gaining momentum. Starting in France, moving to the Netherlands, and now at the European Union level, lawmakers across Europe are accepting the need to legislate to require that companies conduct human rights due diligence throughout their global operations. The situation in the United States is very different: on the federal level there is currently no law that mandates corporate human rights due diligence. Civil society organization International Corporate Accountability Roundtable is stepping into the breach with a legislative proposal building on the model of the Foreign Corrupt Practices Act to prohibit corporations from engaging in grave human rights violations and to give the Securities and Exchange Commission and the Department of Justice the power to investigate any alleged violations.
The draft law, called the Foreign Corrupt Practices Act – Human Rights (FCPA-HR) follows the general framework of the FCPA, but with certain enumerated human rights violations as the prohibited conduct rather than bribery and corruption. The FCPA-HR continues where the FCPA left off by requiring companies to engage in substantive conduct to prevent any human rights violations from occurring in their course of business and to make regular reports regarding their compliance and success. This paper situates the draft law within the current picture for business and human rights legislation both in the United States and in Europe, identifies the strengths of using the FCPA model, and analyzes the FCPA-HR proposal, addressing the likely critiques of the proposal.
Though I have been following developments in the area of business and human rights for years, I must admit that I have not paid sufficient attention to the movement in my classroom and scholarship. Chambers’ and Martin’s paper reminds us all of the need for reform, and of the reality that legislation in this area is imminent (at home and abroad). Imposing civil and criminal liability on corporations and individuals for their direct or indirect involvement in human rights violations would force dramatic changes in corporate compliance practices. If the SEC will have primary responsibility for enforcement (as it does for the FCPA), then we can expect dramatic organizational changes at the Commission as well. With so much at stake, there is a real need for collaboration among human rights experts, lawyers, scholars, regulators, and issuers to find the right model. There’s a lot of work to do, and Chambers’ and Martin’s paper offers an excellent start. The paper remains a work in progress, but it will be available soon—I look forward to its publication!