Business Law Prof Blog

Testing Our Intuitions About Insider Trading - Part I

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.

Call for Papers – AALS 2022 Discussion Group: “A Very Online Economy”

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!

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.

Yoga, Materiality, and the 2021 National Business Law Scholars Conference

So much going on today . . . .   Rather than choose one focus, I will offer three.  Each is near and dear to my heart in one way or another.

Happy International Yoga Day to all.  This year's theme is "Yoga for well-being" or "Yoga for wellness." The Hindustan Times reports: "On International Yoga Day on Monday, Prime Minister Narendra Modi said yoga became a source of inner strength for people and a medium to transform negativity to creativity amid the coronavirus pandemic." The United Nations's website similarly adds that:

The message of Yoga in promoting both the physical and mental well-being of humanity has never been more relevant. A growing trend of people around the world embracing Yoga to stay healthy and rejuvenated and to fight social isolation and depression has been witnessed during the pandemic. Yoga is also playing a significant role in the psycho-social care and rehabilitation of COVID-19 patients in quarantine and isolation. It is particularly helpful in allaying their fears and anxiety.

Yes!  I am so grateful for yoga, including asanas and meditation, and other mindfulness practices at this time--for their positive effects on me, my faculty and staff colleagues, and my students.  👏🏼  Namaste, y'all.

I know from her Twitter feed today that co-blogger Ann Lipton will have much to say on today's publication of the U.S. Supreme Court's opinion in Goldman Sachs Group, Inc., at al. v. Arkansas Teacher Retirement System, et al.  I will just note here two of the more prominent statements made by the Court in this Section 10(b)/Rule 10b-5 class action.  They relate to the common ground between materiality determinations (a doctrinal love of mine and Ann's), which are matters for resolution at trial, and the establishment of a price impact of alleged misstatements and omissions, which is a matter for consideration at the class certification stage.  The Court first concurs with the parties' agreement "that courts may assess the generic nature of a misrepresentation at class certification even though it also may be relevant to materiality, which Amgen reserves for the merits."  Then, in footnote 2, the Court states the following:

We recognize that materiality and price impact are overlapping concepts and that the evidence relevant to one will almost always be relevant to the other. But “a district court may not use the overlap to refuse to consider the evidence.” In re Allstate, 966 F. 3d, at 608. Instead, the district court must use the evidence to decide the price impact issue “while resisting the temptation to draw what may be obvious inferences for the closely related issues that must be left for the merits, including materiality.” Id., at 609. 

I am not a litigator, but it would seem to be a challenge to thread that needle . . . .

Finally, I want to note the successful conclusion of the 2021 National Business Law Scholars Conference last Friday.  Despite our best efforts, there were a few technical glitches, fixed by the University of San Diego School of Law, the University of Southern California Gould School of Law, and the University of Michigan Ross School of Business, each of which assumed unplanned roles as meeting hosts for one of our sessions.  (Thanks, again, to Jordan Barry, Mike Simkovic, and Will Thomas for making those arrangements.)  But the range and quality of presenters and projects was impressive, and the sense of community among the attendees was--as it always is--a highlight of this conference.  The conference tends to bring together a spectrum of international business law teacher/scholars at different stages of their academic careers, all of whom contribute to the productive, supportive, ethos of the event.  My business law colleague George Kuney described the conference well in his opening remarks.

I am grateful to so many at UT Law--including especially George (who directs our business law center) and the faculty and staff who pitched in to host virtual meeting rooms with me.  Their support was invaluable in hosting a virtual version of the conference two years in a row.  I also want to share appreciation for the members of the National Business Law Scholars Conference planning committee (a shout-out to each of you, Afra, Tony, Eric, Steven, Kristin, Elizabeth, Jeff, and Megan) for their collaboration and encouragement, as well as the abundant trust they placed in me these past two years. 

"Alone we can do so little; together we can do so much." ~ Helen Keller

 

Social Media, Securities Markets, and Expressive Trading

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.

More On "Insider Giving"

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?

Avci, Schipani, Seyhun & Verstein on "Insider Giving"

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 116^th 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.

Chambers and Martin on a Foreign Corrupt Practices Act for Human Rights

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!

Regulatory Ritualism and other Lessons from the Global Experience of Insider Trading Law

I just posted a new article, Regulatory Ritualism and other Lessons from the Global Experience of Insider Trading Law, on SSRN. This article is the culmination of a five-year research project. It offers a comprehensive comparative study of insider-trading regimes around the globe with an eye to much-needed reform in the United States. It is the first article to consider global insider trading enforcement in light of the problem of regulatory ritualism. Regulatory ritualism occurs where great attention is paid to the institutionalization of a regulatory regime without commitment to, or acceptance of, the normative goals that those institutions are designed to achieve. The article develops and expands upon some themes and arguments that were first sketched out in Chapters 5 and 11 of my book, Insider Trading: Law, Ethics, and Reform. Here's the article's abstract:

There is growing consensus that the insider-trading regime in the United States, the oldest in the world, is in need of reform. Indeed, three reform bills are currently before Congress, and one recently passed the House with overwhelming bipartisan support. As the U.S. considers paths to reforming its own insider trading laws, it would be remiss to ignore potential lessons from global experimentation and innovation, particularly in light of the fact that so many insider trading regimes have been recently adopted around the world.

Any such comparative study should, however, be cautious in drawing its conclusions. Reformers should pay close attention to the political, social, and economic motivations that might explain the recent trend toward near-universal adoption of insider trading regulations around the globe. Evidence suggests that at least some countries have adopted their insider trading regimes ritualistically. Regulatory ritualism occurs where great attention is paid to the institutionalization of a regulatory regime without commitment to or acceptance of the normative goals that those institutions are designed to achieve. If countries' insider trading regimes are adopted only ritualistically (e.g., to receive geopolitical carrots or to avoid geopolitical sticks), then comparative analysis should account for the fact that these regimes may not reflect its citizens' (or markets') lived experience or normative commitments.

This Article aids the effort of reforming our insider-trading laws here in the United States by considering lessons that can be learned from the global experience. Part I makes the case that the insider-trading regime in the U.S. is in need of reform. Part II charts the global rise of insider trading regulation in the twentieth century. Part III summarizes important features of representative regimes around the globe (e.g., in Japan, Europe, China, Russia, India, Canada, Australia, and Brazil). Part IV notes the trend toward universality in insider trading regulations and considers some of the moral and economic conclusions scholars and regulators have drawn from this trend. Part V identifies the problem of regulatory ritualism, and its implications for global enforcement and compliance. Part VI then turns to the constructive exercise of determining what can be learned from the global experience of regulating insider trading with an eye to reforming the American regime.

Tomorrow In Securities Regulation: Investors

I tell my students that the participants in securities transactions are "the three Is" or  "I³": issuers, intermediaries, and investors.  Tomorrow morning, having covered the definition of a security and the concept of materiality, I offer some foundational words on investors. 

What to tell?  Of course, I will talk a bit about investment theory, the investor protection policy and mechanisms of federal securities law, the composition/demographics of the typical equity ownership of a public company, etc.  But what do I say about GameStop Corp.?  Set forth below is a chart summarizing the trading in GameStop common stock for the past five days: (courtesy of Google Finance):

Who are the investors in the market for GameStop common stock, options, and short positions now?  Who will they be in a month or six months or a year (assuming a trading market can be sustained)?  And what do the changes in GameStop's investor profile say about the firm itself, about the New York Stock Exchange, and about various related aspects of securities regulation?  

There remain few answers to the fundamental question of who owns or is trading in GameStop's publicly traded common stock.  Nevertheless, there are many worthy conversation starters around the GameStop phenomenon that raise interesting opportunities for longer-term exploration.  More on all this as time marches on.  "Once more unto the breach, dear friends, once more . . . ."

[Editorial note (2/9/2021): I should have mentioned that I do plan to use John Anderson's post from Saturday (which echos points he made in our UT Law roundtable last week) to talk about whether some of the people he mentions or alludes to (thrill-seekers, political speech purveyors, trading gamers, populist performers, nostalgic market-watchers) are or should be considered to be investors.]

GameStop and Retail Securities Trading as Political, Social, or Aesthetic Speech

    Commenters have likened the recent retail “meme” trading in stocks such as GameStop Corp. to buying a ticket on 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.” See, Bailey Lipschultz and Divya Balji, Historic Week for Gamestop Ends with 400% Rally as Shorts Yield, Bloomberg (January 29, 2021).

    The comparison is apt in a number of respects. These retail traders, led by some members of the “WallStreetBets” group on the Reddit social media platform, “got on” GameStop a couple weeks ago at just under $20 a share, and, despite its rapid rise to a high of just under $500 a share, I think most people expect (including the meme traders) that the price at which this turbulent ride will end is somewhere around where it began. After all, GameStop’s fundamentals have not changed. It remains a brick-and-mortar business that was devastated by the pandemic, and it is expected to steadily lose market share to online vendors.

    For anyone interested in the mechanics of the “short squeeze” and how these traders managed to move price of GameStop so far out of whack with its presumed value, see some helpful articles here, here, and here. For some thoughts on the controversial limitations on trading by retail brokerage firms such as Robinhood, see my Co-bloggers Ben Edwards’ and Anne Lipton’s recent posts here and here. And see some other interesting takes from my Co-blogger Joan Macleod Heminway here. My purpose in this post is to highlight one aspect of the meme-trading phenomenon that has, I think, been underappreciated.

    Given that we all have a pretty good idea of how this roller-coaster ride is going to end, why did many retail traders (along with others) continue to pile on? One answer is that these traders were just blinded by greed and FOMO. Indeed, concern that amateur traders are being led astray in this way by social media influencers and "game-like" trading interfaces has led some to call for paternalistic trading restrictions by brokerage firms and/or regulatory intervention. But it seems to me that something quite different may be going on here as well. There is evidence to suggest that at least some of the meme traders who have taken the markets by storm over the last couple weeks are not (and never were) buying these heavily-shorted stocks simply to make money, but rather to make a point.

    The “points” being made by these traders are not necessarily coordinated or consistent. They range from the oft-expressed goal of “taking it to” Wall-Street hedge funds to "hurt the big guys" in the same vein as the Occupy Wall Street movement of 2008, to protesting the demise of bricks-and-mortar businesses by Big-Tech and mega online vendors, to the populist rejection of perceived top-down elitism (private and public) that elevated Donald Trump to the Presidency in 2016. Indeed, former SEC Commissioner, Laura Unger, recently compared the recent social-media-driven short squeezes to the Capitol Hill riots on January 6. Some have even gone so far as to suggest that some meme traders are buying stocks on aesthetic grounds, to bring back retro companies like Blackberry and Blockbuster as “nostalgia plays.”

    If retail traders are trading as a form of political, social, or aesthetic expression, then what are the implications? What does this mean for the Efficient Market Hypothesis? What (if anything) should (or can) regulators and/or legislators do about it? These are some questions my co-authors Jeremy Kidd, George Mocsary, and I plan to explore in a forthcoming article. I plan to post some more thoughts on the possibility of retail securities trading as a form of speech (and its social, market, and regulatory implications) in the coming weeks.

Prediction: GameStop Will Be 2021's Great Gift To Business Law Professors

Wow.  All I can say is . . . wow.  Last Monday, GameStop Corp. was, for me, just a dinosaur in the computer gaming space--a firm with a bricks-and-mortar retail store in our local mall that I have visited maybe once or twice.  What a difference a week makes . . . .

Now, GameStop is: frequent email messages in my in box; populist investor uprisings against establishment institutional investors; concern about students investing through day-trading accounts; news and opinion commentary on all of the foregoing (and more); compulsion to inform an under-informed (and, in some cases, bewildered) community of friends and family.  This change of circumstances, which is centered on, but not confined to, the volatile market for GameStop's common stock, raises many, many questions--legal questions and factual questions.  Some are definitively answerable, others are not.

The legal questions run the gamut from possibilities of securities fraud (including insider trading) and market manipulation, to the governance of trading platforms, the propriety of trading limitations and halts, and the authority and control of clearinghouses.  Co-blogger Ben Edwards published a post here last Thursday on the trading halts in GameStop stock, the role of clearinghouses, and the possibility of market manipulation.  Others also have written about these and other legal issues--including the role of the U.S. Securities and Exchange Commission as the cop on the beat (see, e.g., here and here).

But there are few answers to these legal queries given that many facts remain unknown.  Who are the short-sellers in these stocks?  Who are the community members on electronic bulletin boards (and elsewhere) urging active trading in the stock of GameStop and other firms that have been subject to significant short-selling that has led to perceived under-valuation by others in the market?  Who are the populist traders actively bidding up the price of these firms?  What knowledge do all of these people have about GameStop and the trading of its securities?  Assumptions are being made about all of these things and more.  However, our current knowledge is limited and, as time progresses, the composition of these groups undoubtedly has changed and will continue to change as traders rapidly enter and exit the market for these securities.  

As many of our law schools hold forums on the GameStop phenomenon (UT Law has a roundtable featuring some of your favorite BLPB editors on Wednesday), more legal and factual questions will be raised.  The situation will be dynamic, and regulators and policymakers will enter the fray in unknown (and perhaps unanticipated) ways.  As I teach Securities Regulation and Advanced Business Associations this semester, all of this will be happening.  Some of the topics of conversation would not normally be part of my course plans.  But, like others I know who teach business law courses, I am pivoting to meet the need to respond to these evolving circumstances in our securities markets.  Throughout, there are many roles that lawyers (and law professors) are playing and will continue to play.  I suspect GameStop will be an asset this semester in educating our students on securities law and much more.

New Edition of Problem-Based White Collar Crime Textbook Forthcoming

    Along with my co-authors J. Kelly Strader, Mihailis E. Diamantis, and Sandra D. Jordan, I am pleased to announce that the Fourth Edition of our textbook White Collar Crime: Cases, Materials, and Problems has gone to press and is expected to be available through Carolina Academic Press by June of 2021, in plenty of time for Fall 2021 adoptions.

    Professor Diamantis and I are excited to join Professors Strader and Jordan in the new edition. We hope that our unique practice experiences and theoretical perspectives will add value to what is already a popular White Collar casebook. We have posted the current drafts of Chapter 1 (Overview of White Collar Crime) and Chapter 5 (Securities Fraud) on SSRN as samples for review. Here, also, is an excerpt from the Preface summarizing our approach to the new edition:

[W]e have endeavored to write a problem-based casebook that provides a topical, informative, and thought-provoking perspective on this rapidly evolving area of the law. We also believe that the study of white collar criminal law and practice raises unique issues of criminal law and justice policy, and serves as an excellent vehicle for deepening our understanding of criminal justice issues in general. For the fourth edition, we have continued to emphasize the text’s focus on practice problems while also deepening policy and theoretical discussion. …

Throughout the text, our goal has been to provide leading and illustrative cases in each area, focusing where possible on United States Supreme Court opinions. …

In the introductory materials to each of the substantive crime chapters, we have included an overview of the law and the statutory elements. Because our goal is to teach principally through the study of the cases, we have tried to edit the cases judiciously. We include a number of concurring and dissenting opinions, both because these opinions help elucidate the issues and because in close cases today’s dissent may be tomorrow’s majority. Following the cases, we also include notes on important issues those cases raise on matters of law, policy, and theory. We have tried to keep the notes concise, where possible, and hope that they will service as starting points for rich class discussions.

Finally, we intersperse practice problems throughout the casebook. The problems focus on substantive law, procedural issues, and ethical dilemmas that arise in white collar practice. The text is designed to be used flexibly and thus lends itself both to comprehensive study of black letter law and to a problems-based approach.

    The textbook includes a teacher's manual with teaching tips, possible side topics for course discussion, and detailed solutions to practice problems.

Ten Business Questions for the Biden Administration

If you read the title, you’ll see that I’m only going to ask questions. I have no answers, insights, or predictions until the President-elect announces more cabinet picks. After President Trump won the election in 2016, I posed eleven questions and then gave some preliminary commentary based on his cabinet picks two months later. Here are my initial questions based on what I’m interested in -- compliance, corporate governance, human rights, and ESG. I recognize that everyone will have their own list:

1. How will the Administration view disclosures? Will Dodd-Frank conflict minerals disclosures stay in place, regardless of the effectiveness on reducing violence in the Democratic Republic of Congo? Will the US add mandatory human rights due diligence and disclosures like the EU??
2. Building on Question 1, will we see more stringent requirements for ESG disclosures? Will the US follow the EU model for financial services firms, which goes into effect in March 2021? With ESG accounting for 1 in 3 dollars of assets under management, will the Biden Administration look at ESG investing more favorably than the Trump DOL? How robust will climate and ESG disclosure get? We already know that disclosure of climate risks and greenhouse gases will be a priority. For more on some of the SEC commissioners’ views, see here.
3. President-elect Biden has named what is shaping up to be the most diverse cabinet in history. What will this mean for the Trump administration’s Executive Order on diversity training and federal contractors? How will a Biden EEOC function and what will the priorities be?
4. Building on Question 3, now that California and the NASDAQ have implemented rules and proposals on board diversity, will there be diversity mandates in other sectors of the federal government, perhaps for federal contractors? Is this the year that the Improving Corporate Governance Through Diversity Act passes? Will this embolden more states to put forth similar requirements?
5. What will a Biden SEC look like? Will the SEC human capital disclosure requirements become more precise? Will we see more aggressive enforcement of large institutions and insider trading? Will there be more controls placed on proxy advisory firms? Is SEC Chair too small of a job for Preet Bharara?
6. We had some of the highest Foreign Corrupt Practices Act fines on record under Trump’s Department of Justice. Will that ramp up under a new DOJ, especially as there may have been compliance failures and more bribery because of a world-wide recession and COVID? It’s more likely that sophisticated companies will be prepared because of the revamp of compliance programs based on the June 2020 DOJ Guidance on Evaluation of Corporate Compliance Programs and the second edition of the joint SEC/DOJ Resource Guide to the US Foreign Corrupt Practices Act. (ok- that was an insight).
7. How will the Biden Administration promote human rights, particularly as it relates to business? Congress has already taken some action related to exports tied to the use of Uighur forced labor in China. Will the incoming government be even more aggressive? I discussed some potential opportunities for legislation related to human rights abuses abroad in my last post about the Nestle v Doe case in front of the Supreme Court. One area that could use some help is the pretty anemic Obama-era US National Action Plan on Responsible Business Conduct.
8. What will a Biden Department of Labor prioritize? Will consumer protection advocates convince Biden to delay or dismantle the ERISA fiduciary rule? Will the 2020 joint employer rule stay in place? Will OSHA get the funding it needs to go after employers who aren’t safeguarding employees with COVID? Will unions have more power? Will we enter a more worker-friendly era?
9. What will happen to whistleblowers? I served as a member of the Department of Labor’s Whistleblower Protection Advisory Committee for a few years under the Obama administration. Our committee had management, labor, academic, and other ad hoc members and we were tasked at looking at 22 laws enforced by OSHA, including Sarbanes-Oxley retaliation rules. We received notice that our services were no longer needed after the President’s inauguration in 2017. Hopefully, the Biden Administration will reconstitute it. In the meantime, the SEC awarded record amounts under the Dodd-Frank whistleblower program in 2020 and has just reformed the program to streamline it and get money to whistleblowers more quickly.
10. What will President-elect Biden accomplish if the Democrats do not control the Congress?

There you have it. What questions would you have added? Comment below or email me at mweldon[email protected] 

Podgor on Whether Being Gay Mattered in Carpenter v. United States

Many of us have been looking for new opportunities to raise and discuss issues of diversity and inclusion (including, but not limited to, race, gender, and LGBTQ issues) in our Business Associations and Securities Regulations classes. Along these lines, I’ve been inspired by a number of my BLPB co-editors’ recent posts. (See, e.g., here, here, and here—just in the last week!) With these thoughts in mind, and as we start preparing our course syllabi for the spring semester, I recommend you read Professor Ellen Podgor’s forthcoming article, Carpenter v. United States, Did Being Gay Matter?, 15 Tenn. J. L. Pol’y 115 (2020). Here’s the abstract:

Carpenter v. United States (1987) is a case commonly referenced in corporations, securities, and white collar crime classes. But the story behind the trading of pre-publication information from the "Heard on the Street" columns of the Wall Street Journal may be a story that has not been previously told. This Essay looks at the Carpenter case from a different perspective - gay men being prosecuted at a time when gay relationships were often closeted because of discriminatory policies and practices. This Essay asks the question of whether being gay mattered to this prosecution.

This article was written for the same symposium on insider trading stories held at the University of Tennessee College of Law that my BLPB co-editor Joan Heminway wrote about here and here.

Oh, and while I’m touting the excellent work of Professor Podgor, I should note another of her forthcoming articles recently posted to SSRN: The Dichotomy Between Overcriminalization and Underregulation, 70 Am. U. L. Rev. __ (forthcoming 2021). Here’s an edited version of the abstract:

The U.S. Securities and Exchange Commission (SEC) failed to properly investigate Bernard Madoff’s multi-billion-dollar Ponzi scheme for over ten years. Many individuals and charities suffered devastating financial consequences from this criminal conduct, and when eventually charged and convicted, Madoff received a sentence of 150 years in prison. Improper regulatory oversight was also faulted in the investigation following the Deepwater Horizon tragedy. Employees of the company lost their lives, and individuals were charged with criminal offenses. These are just two of the many examples of agency failures to properly enforce and provide regulatory oversight, with eventual criminal prosecutions resulting from the conduct. The question is whether the harms accruing from misconduct and later criminal prosecutions could have been prevented if agency oversight had been stronger. Even if criminal punishment were still necessitated, would prompt agency action have diminished the public harm and likewise decreased the perpetrator’s criminal culpability? …

This Article examines the polarized approach to overcriminalization and underregulation from both a substantive and procedural perspective, presenting the need to look holistically at government authority to achieve the maximum societal benefit. Focusing only on the costs and benefits of regulation fails to consider the ramifications to criminal conduct and prosecutions in an overcriminalized world. This Article posits a moderated approach, premised on political economy, that offers a paradigm that could lead to a reduction in our carceral environment, and a reduction in criminal conduct.

Spousal Misappropriation - A Special Breed of Insider Trading Action

In a recently published article just posted to SSRN, I examine spousal misappropriation as a basis for an insider trading claim.  The article, Women Should Not Need to Watch Their Husbands Like [a] Hawk: Misappropriation Insider Trading in Spousal Relationships, leverages the facts of a specific Securities and Exchange Commission enforcement action (SEC v. Hawk, No. 5:14-cv-01466 (N.D. Cal.)), to undertake an analysis of applicable statutory and regulatory principles, existing decisional law, and the realities of the legal and social context.  The SSRN abstract, derived from the text of the article, follows.

This article endeavors to sort through and begin to resolve key unanswered questions regarding spousal misappropriation as a basis for U.S. insider trading liability, some of which apply to insider trading more broadly. It identifies and describes misappropriation insider trading liability under U.S. law, recounts and analyzes probative doctrine and policy relevant to spousal misappropriation cases, and (before briefly concluding) offers related observations about the impact of that doctrine and policy on a specific motivating Securities and Exchange Commission ("SEC") enforcement action and other spousal misappropriation cases.

The analysis undertaken in the article supports enforcement actions based on a strong threshold presumption of a relationship of trust and confidence in spousal relations, as recognized by the SEC through its adoption of Rule 10b5-2(b)(3). This support derives from a focus on two fundamental building blocks of spousal misappropriation cases addressed in the article—a broad understanding of deception as it is relevant to these cases and longstanding accepted sociolegal wisdom on the nature of marital relationships as evidenced in the spousal communications privilege. Essentially, marriage is best seen as a relationship of trust and confidence. To the extent a spouse’s breach of that trust or confidence is deceptive and occurs in connection with the purchase or sale of securities, the breach should be deemed to provide a basis for insider trading enforcement (and liability). Market integrity is damaged through marital deception in the same way that it is damaged through the deception by an attorney of a client or the attorney’s law firm partners. Market actors depend on the confidentiality of information shared in marriages as well as information shared in attorney-client relationships and partnerships.

The article is one of a number that were written for a symposium on insider trading stories held at The University of Tennessee College of Law last fall.  They all occupy the same issue of the Tennessee Journal of Law & Policy, which hosted the symposium.  The other authors include (in the order of their respective article's appearance in the journal): Donna Nagy, BLPB co-editor John Anderson, Eric Chaffee, Mike Guttentag, Ellen Podgor, Kevin Douglas, and Jeremy Kidd.  The ideas for these articles were originally the subject of a discussion group convened by John Anderson and me at the 2019 Annual Conference of the Southeastern Association of Law Schools ("SEALS"). 

That reminds me to note for all that it is now time to submit proposals for the 2021 SEALS conference.  John Anderson and I will again convene an insider trading group for this meeting.  And I also will be proposing a discussion group (based in part on the colloquy between Ann Lipton and me here) on the treatment of business entity organic documents (including corporate charters and bylaws, limited liability company/operating agreements, and partnership agreements) as contracts and the application of contract law to their interpretation and enforcement.  If you have a desire to participate in either group or want to propose a program of your own (whether it be a panel or a discussion group), please let me know in the comments or by private message.

Verstein on Insider Trading and the "Use-versus-Possession" Controversy

The courts have interpreted Section 10b of the Securities and 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 scienter for insider trading liability is sometimes tricky for regulators and prosecutors to satisfy because insiders who possess material nonpublic information at the time of their trade will often claim they did not use that information. The insider may claim that her true motives for trading were entirely innocent (e.g., to diversify her portfolio, to pay a large tax bill, or to buy a new house or boat). Such lawful bases for trading can be easy for insiders to manufacture and are often difficult for regulators and prosecutors to disprove.

Historically, the SEC and prosecutors sought to overcome this challenge by taking the position that knowing possession of material nonpublic information while trading is sufficient to satisfy the "on the basis of" test. This strategy met mixed results before the courts, with some circuits holding that proof of scienter under Section 10b requires proof that the trader actually used the inside information in making the trade.

Facing a circuit split, the SEC attempted to settle the “use-versus-possession” debate by adopting 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. A number of commentators, however, question the statutory authority for Rule 10b5-1, and some courts have simply “ignored” it. See Donald C. Langevoort, “Fine Distinctions” in the Contemporary Law of Insider Trading, 2013 Columbia Bus. L. Rev. 429, 439 (2013).

Professor Andrew Verstein’s forthcoming article, Mixed Motives Insider Trading, (Volume 106 of the Iowa Law Review) charts a “third way” to resolve the ongoing use-versus-possession controversy. Professor Verstein would impose liability for mixed-motives insider trading only where material nonpublic information provides the “primary motive” for the trading. While I have argued elsewhere that a strict “use” test best complies with Section 10b’s scienter requirement, Professor Verstein’s primary-motive test offers a significant improvement over the strict awareness test reflected in both SEC Rule 10b5-1 and the Insider Trading Prohibition Act recently passed by the House of Representatives. For these reasons, Professor Verstein’s proposal warrants serious consideration as regulators and legislators consider paths to reform.

The SSRN abstract to Professor Verstein’s article follows:

If you trade securities on the basis of careful research, then you are a brilliant and shrewd investor. If you trade on the basis of a hot tip from your brother-in-law, an investment banker, then you are a criminal. What if you trade for both reasons?

There is no single answer, thanks to a three-way circuit split. Some courts would forgive you according to your lawful trading motives, some would convict you in keeping with your bad motives, and some would hand the issue to the jury. Sometimes called the “awareness/use” debate or the “possession/use” debate, the proper treatment of mixed motive traders has occupied dozens of law review articles over the last thirty years.

This Article demonstrates that courts and scholars have so far followed the wrong reasons to the wrong answers. Instead, this Article takes trader motives seriously, drawing on insights and solutions from the broader jurisprudence of mixed motive. This analysis generates a new legal test and demonstrates the test’s superiority.

Chiarella at 40: Upcoming Conference

The NYU Pollack Center for Law & Business, Indiana University Maurer School of Law, and Securities and Exchange Commission Historical Society invite you to a virtual program entitled "Insider Trading: Honoring the Past｜A Program Commemorating the 40th Anniversary of Chiarella v. United States," which will take place on Thursday, November 5th from 10am-noon Eastern Time.

The program will explore the fascinating backstories of the Chiarella prosecution and the Supreme Court argument as well as the SEC’s and DOJ’s insider trading enforcement strategies in the wake of the Court’s ruling. The Chiarella case is also the subject of Donna Nagy’s recent essay, Chiarella v. United States and its Indelible Impact on Insider Trading Law.

A webinar link will be circulated to all those who RSVP, which you can do here. Conference details and schedule are below.

Conference Organizers:

Stephen Choi, Murray and Kathleen Bring Professor of Law, NYU School of Law, Co-Director Pollack Center for Law and Business
Donna M. Nagy, C. Ben Dutton Professor of Law, Indiana University Maurer School of Law
Jane Cobb, Executive Director, SEC Historical Society

Schedule:

10:00am Welcome by Stephen Choi, Murray and Kathleen Bring Professor of Law, NYU School of Law, Co-Director Pollack Center for Law and Business

10:10-11:10am    Session I: The Chiarella Prosecution and Supreme Court Litigation

• John S. Siffert, Co-Founding Partner, Lankler Siffert Wohl; Adjunct Professor—NYU School of Law (Assistant US Attorney in the SDNY 1974-1979, prosecuted the Chiarella case and argued the 2nd Circuit appeal)
• John “Rusty” Wing, Partner, Lankler Siffert Wohl (Chief of the Securities and Business Fraud Unit for the SDNY’s U.S. Attorney’s Office 1971-1978)
• Hon. Judge Jed S. Rakoff, U.S. District Judge SDNY (Chief of the Securities and Business Fraud Unit for the SDNY’s U.S. Attorney’s Office 1978-1980)
• Stanley S. Arkin, founding member of Arkin Solbakken (represented Vincent Chiarella at his criminal trial, 2nd Circuit appeal, and argument before the Supreme Court)
• Panel Moderator: Donna M. Nagy, C. Ben Dutton Professor of Law, Indiana University Maurer School of Law

11:10am-12:00pm    Session II: The SEC and DOJ’s Response to the Supreme Court’s Chiarella Decision

• Donald C. Langevoort, Thomas Aquinas Reynolds Professor of Law, Georgetown University Law Center (SEC Special Counsel, Office of General Counsel, 1978-1981)
• Lee S. Richards III, Co-Founding Partner, Richards Kibbe & Orbe (Assistant US Attorney in the SDNY 1977-1983, prosecuted US v. Newman based on the misappropriation theory advanced in, but left undecided by, the Court’s Chiarella ruling)
• Hon. Judge Jed S. Rakoff, U.S. District Judge SDNY (SDNY Fraud Unit Chief during the Newman investigation, later served as defense counsel in Carpenter v. United States)
• Panel Moderator: Robert B. Thompson, Peter P. Weidenbruch, Jr. Professor of Business Law Georgetown University Law Center

Sex, Lies, and M&A- Part II

No. You didn't miss Part 1. I wrote about Weinstein clauses last July. Last Wednesday, I spoke with a reporter who had read that blog post.  Acquirors use these #MeToo/Weinstein clauses to require target companies to represent that there have been no allegations of, or settlement related to, sexual misconduct or harassment. I look at these clauses through the lens of a management-side employment lawyer/compliance officer/transactional drafting professor. It’s almost impossible to write these in a way that’s precise enough to provide the assurances that the acquiror wants or needs.

Specifically, the reporter wanted to know whether it was unusual that Chevron had added this clause into its merger documents with Noble Energy. As per the Prospectus:

Since January 1, 2018, to the knowledge of the Company, (i), no allegations of sexual harassment or other sexual misconduct have been made against any employee of the Company with the title of director, vice president or above through the Company’s anonymous employee hotline or any formal human resources communication channels at the Company, and (ii) there are no actions, suits, investigations or proceedings pending or, to the Company’s knowledge, threatened related to any allegations of sexual harassment or other sexual misconduct by any employee of the Company with the title of director, vice president or above. Since January 1, 2018, to the knowledge of the Company, neither the Company nor any of its Subsidiaries have entered into any settlement agreements related to allegations of sexual harassment or other sexual misconduct by any employee of the Company with the title of director, vice president or above.

Whether I agree with these clauses or not, I can see why Chevron wanted one. After all, Noble’s former general counsel left the company in 2017 to “pursue personal interests” after accusations that he had secretly recorded a female employee with a video camera under his desk. To its credit, Noble took swift action, although it did give the GC nine million dollars, which to be fair included $8.3 million in deferred compensation. Noble did not, however, exercise its clawback rights. Under these circumstances, if I represented Chevron, I would have asked for the same thing. Noble’s anonymous complaint mechanisms went to the GC’s office. I’m sure Chevron did its own social due diligence but you can never be too careful. Why would Noble agree? I have to assume that the company’s outside lawyers interviewed as many Noble employees as possible and provided a clean bill of health. Compared with others I’ve seen, the Chevron Weinstein clause is better than most.

Interestingly, although several hundred executives have left their positions due to allegations of sexual misconduct or harassment since 2017, only a small minority of companies use these Weinstein clauses. Here are a few:

1. Merger between Cotiviti and Verscend Technologies:

Except in each case, as has not had and would not reasonably be expected to have, individually or in the aggregate, a Company Material Adverse Effect, to the Knowledge of the Company, (i) no allegations of sexual harassment have been made against (A) any officer or director of the Acquired Companies or (B) any employee of the Acquired Companies who, directly or indirectly, supervises at least eight (8) other employees of the Acquired Companies, and (ii) the Acquired Companies have not entered into any settlement agreement related to allegations of sexual harassment or sexual misconduct by an employee, contractor, director, officer or other Representative.

1. Merger between Genuine Parts Company, Rhino SpinCo, Inc., Essendant Inc., and Elephant Merger Sub Corp.:

To the knowledge of GPC, in the last five (5) years, no allegations of sexual harassment have been made against any current SpinCo Business Employee who is (i) an executive officer or (ii) at the level of Senior Vice President or above.

1. AGREEMENT AND PLAN OF MERGER BY AND AMONG WORDSTREAM, INC., GANNETT CO., INC., ORCA MERGER SUB, INC. AND SHAREHOLDER REPRESENTATIVE SERVICES LLC:

(i) The Company is not party to a settlement agreement with a current or former officer, employee or independent contractor of the Company or its Affiliates that involves allegations relating to sexual harassment or misconduct. To the Knowledge of the Company, in the last eight (8) years, no allegations of sexual harassment or misconduct have been made against any current or former officer or employee of the Company or its Affiliates.

1. AGREEMENT AND PLAN OF MERGER By and Among RLJ ENTERTAINMENT, INC., AMC NETWORKS INC., DIGITAL ENTERTAINMENT HOLDINGS LLC and RIVER MERGER SUB INC.:

(c) To the Company’s Knowledge, in the last ten (10) years, (i) no allegations of sexual harassment have been made against any officer of the Company or any of its Subsidiaries, and (ii) the Company and its Subsidiaries have not entered into any settlement agreements related to allegations of sexual harassment or misconduct by an officer of the Company or any of its Subsidiaries.

Here are just a few questions:

1. What's the definition of "sexual misconduct"? Are the companies using a legal definition? Under which law? None of the samples define the term.
2. What happens of the company handbook or policies do not define "sexual misconduct"?
3. How do the parties define "sexual harassment"? Are they using Title VII, state law, case law, their diversity training decks,  the employee handbook? None of the samples define the term.
4. What about the definition of "allegation"? Is this an allegation through formal or informal channels (as employment lawyers would consider it)? Chevron gets high marks here.
5. Have the target companies used the best knowledge qualifiers to protect themselves?
6. How will the target company investigate whether the executives and officers have had “allegations”? Should the company lawyers do an investigation of every executive covered by the representation to make sure the company has the requisite “knowledge”? If the deal documents don't define "knowledge," should we impute knowledge?
7. What about those in the succession plan who may not be in the officer or executives ranks?

Will we see more of these in the future? I don’t know. But I sure hope that General Motors has some protection in place after the most recent allegations against Nikola’s founder and former chairman, who faces sexual assault allegations from his teenage years. Despite allegations of fraud and sexual misconduct, GM appears to be moving forward with the deal, taking advantage of Nikola’s decreased valuation after the revelation of the scandals.

I’ll watch out for these #MeToo clauses in the future. In the meantime, I’ll ask my transactional drafting students to take a crack at reworking them. If you assign these clauses to your students, feel free to send me the work product at [email protected].

Take care and stay safe.

What Do People Really Think of Insider Trading? Part IV

This is the fourth installment of a multi-part guest blog presenting some of the results of the first comprehensive, large-scale, national survey of public attitudes regarding insider trading. My co-authors (Jeremy Kidd and George Mocsary) and I present the survey’s complete results in our forthcoming article, Public Perceptions of Insider Trading. This installment focuses on the public’s views concerning the ethics of insider trading in different factual scenarios.

The survey presented each respondent with five basic insider-trading scenarios. In each scenario, the inside information pertained to the acquisition of a small company by a larger company. Respondents were placed in the shoes of (1) the CEO of the small firm being acquired by the larger firm; (2) a janitorial employee of the small firm; (3) an outside accountant hired to audit the small firm; (4) the friend of a middle manager of the small firm who learns the inside information at a holiday party; and (5) a stranger who overhears the material nonpublic information in an elevator. The survey instrument randomly directed respondents down multiple question paths for each of these scenarios. I will summarize just some of the results for the CEO scenario in this post, but see here for the complete results.

When asked whether it would be ethical for the CEO of the smaller company to trade in her own company’s shares based on material nonpublic information of the imminent acquisition, 37% said yes. That number increased to 50%, however, when respondents were asked if it would be ethical for the CEO to trade in the larger, acquiring company based on the same information. The 13-point difference may be explained by the fact that the CEO's trading in her own company implicates both the classical and misappropriation prohibitions for insider trading under our current enforcement regime, while trading in the other firm's shares would only implicate the misappropriation theory. Under the classical theory, the harm of insider trading is said to stem from a breach by the insider of a duty to disclose to her company's current or prospective shareholders on the other side of the trade (so this theory would not apply to the trade in the other, large company's shares). Under the misappropriation theory, the harm of insider trading is located in a breach of duty to the source of the information (so in both scenarios the source is the same). The difference in responses therefore suggests there are some respondents whose intuitions align with either the classical theory or the misappropriation theory, but not both.  If all respondents found the classical and misappropriation theories equally compelling, we would not expect a difference.

After providing their initial answers to these scenario-based questions, respondents were then presented with a short piece of propaganda about insider trading. They were offered a statement suggesting either that insider trading has positive, negative, or neutral consequences for markets. The propaganda had a surprising impact. For instance, respondents were much more willing (by a margin of 9%) to condone the CEO’s trading in his own company’s shares (46%) after having been presented with the short propaganda piece. These results suggest that the public’s ethical views concerning even the most straightforward insider-trading scenarios under our current enforcement regime are neither clear nor firm.

(Modified on 9/24/20 at 11:30 am CST)