Friday, February 18, 2022

Time for a Broad Prophylactic Against Congressional Insider Trading

With a recent poll showing that 76 percent of voters think members of Congress have an "unfair advantage" in stock trades, I argued in my last post that Congress should adopt a broad rule against trading in individual stocks by sitting cogresspersons (and perhaps their spouses, children, and staff). I argued that such a move would go a long way toward restoring the perception that members of Congress are public servants, as opposed to the current perception shared by many voters that they are public parasites. In addition to restoring public confidence in the legislative branch, I argued adopting such a prophylactic against insider trading would also help improve public confidence in the integrity of our securities markets—a goal Congress has touted repeatedly for almost a century.

I have since posted a short paper on SSRN, Time for a Broad Prophylactic against Congressional Insider Trading, that develops these arguments. Part I offers a brief summary of the current state of insider trading laws, with a special focus on their application to Congress. Part II surveys some of the proposed insider trading reform bills under consideration. Part III argues that, given congresspersons’ unique role vis-à-vis securities markets, a broad prophylactic against congressional trading is both justified and needed.

February 18, 2022 in Ethics, John Anderson, Securities Regulation, White Collar Crime | Permalink | Comments (0)

Friday, February 4, 2022

Public Servants or Parasites? Why a Broad Prophylactic against Congressional Insider Trading Makes Sense

In 2011, Peter Schweizer published a book, Throw Them All Out, in which he exposed some questionable means by which (according to one study) politicians manage to increase their personal wealth 50% faster than the average American.

According to Schweizer, trading on material nonpublic information appears to be a popular method among congresspersons for achieving outsized returns on their investments. He cites one study finding:

  • The average American investor underperforms the market.
  • The average corporate insider, trading his own company’s stock, beats the market by 7% a year.
  • The average senator beats the market by 12% a year.

Schweitzer’s book was followed by a feature story on the CBS News show, 60 Minutes, highlighting some dubious stock trades by leaders of both political parties. These stories got the public’s attention and spurred Congress to act—adopting the Stop Trading on Congressional Knowledge (STOCK) Act in April of 2012.

The STOCK Act made explicit what many already understood as implicit—that congressional trading based on material nonpublic information acquired by virtue of their position as a public servant was a breach of their fiduciary duties and would therefore violate Section 10b of the Securities Exchange Act of 1934. The Act also expanded disclosure requirements for members of Congress, the executive branch, and their staff members.

But no sooner had the STOCK Act passed than it was quietly overhauled to weaken certain of its key provisions, and, in any event, the Act has not been consistently enforced since its adoption. As a result, public cynicism concerning congressional insider trading has once again snowballed. For example, Speaker Nancy Pelosi's stock trades are monitored by popular Twitter, TikTok, and Reddit accounts with handles like "@NancyTracker," and the search “Pelosi stock trades” hit a record high on Google in January 2022.

Of course, Pelosi is not the only congressperson the public suspects of insider trading. For example, a number of U.S. Senators were scrutinized over suspicious stock trades as the threat of the COVID-19 pandemic emerged in 2020.

So what is to be done? Just as they did in 2011, members of Congress on both sides of the aisle are rushing to get out in front of the issue. A number of congressional insider trading reform bills have garnered bipartisan support. Many of these bills propose the broad prophylactic of proscribing members of congress from trading in individual stocks. Some bills would go so far as proscribing trades by spouses and dependent children as well.

There is precedent for broad prophylactics against insider trading. Consider, for example, Exchange Act Rule 14e-3, which permits civil and criminal liability for trading based on material nonpublic information concerning tender offers, even if there is no accompanying proof of fraud.

Though I have argued for reducing the scope of insider trading liability in some contexts (e.g., where such trading is licensed by the issuer of the stock being traded), I have consistently recognized misappropriation trading (such as when a congressperson misappropriates material nonpublic government information to trade for personal gain) as morally wrong, and as warranting civil and criminal sanctions. And I think extending the scope of liability for congressional insider trading with a broad prophylactic (e.g., proscribing all individual stock trades) is warranted for the following reasons (among others):

  • Congress’s influence over the SEC and DOJ makes aggressive enforcement by those agencies more challenging—and when actions are brought, there will always be the specter of political motivation. The broad prophylactic would simplify enforcement, and thereby mitigate these worries.
  • Given the above concerns, even legitimate stock trades by members of Congress will be the subject of continued public suspicion and cynicism. Such suspicion undermines public confidence in the integrity of the legislative branch--and the markets.
  • Protestations that a broad proscription of individual stock trading would be Un-American because "We're a free-market economy" and “[Members of Congress] should be able to participate in that” are totally unavailing. People voluntarily assume roles that deprive them of rights they would otherwise enjoy all the time (e.g., by joining the military), and public service has always been understood as just such a role.
  • Members of congress should not be (significantly) financially disadvantaged by a rule precluding trades in individual stocks. Given the efficient market hypothesis (roughly, that an individual stock’s price always reflects all currently available public information about that stock), members of congress should not expect their individual stock trades to outperform a similar trade in, say, a mutual fund in any event….unless, that is, they have information that is NOT publicly available.... Diversification is typically the best long-term investment strategy.

The most recent ReacClearPolitics Poll Average shows that Congress currently enjoys the approval of 21% of Americans. If Congress would like to begin improving those numbers, I suggest it adopt one of the proposed insider trading bills proscribing individual stock trading by its members. This might go a long way toward restoring the perception that members of Congress are public servants, as opposed to the current perception shared by many Americans (justified or not) that they are public parasites.

February 4, 2022 in Ethics, John Anderson, Securities Regulation, White Collar Crime | Permalink | Comments (3)

Friday, January 7, 2022

AALS Annual Meeting 2022 Discussion Group on "A Very Online Economy"

We just wrapped up a fascinating discussion group titled "A Very Online Economy: Meme Trading, Bitcoin, and the Crisis of Trust and Value(s)--How Should the Law Respond?" as part of the AALS 2022 Annual Meeting. I co-moderated the group with Professor Martin Edwards (Belmont University School of Law). 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. Blockchain technologies challenge our assumptions about the need for centralization, trust, and financial institutions. Meme trading puts pressure on our assumptions about economic value and market processes. Environmental and social governance initiatives raise important questions about the relationship between economic institutions and social values. These issues will certainly drive policy debates about social and economic good in the coming years.

The group gathered some amazing presenters and commentators for the discussion, including:

The discussion was lively and informative, and I look forward to seeing the final versions of these projects in print! 

January 7, 2022 in Corporate Governance, Corporations, Financial Markets, John Anderson, Securities Regulation, Technology, Web/Tech | Permalink | Comments (0)

Friday, December 10, 2021

New Challenges for Insider Trading Compliance (SEALS 2022)

It is an exciting time for insider trading law. BLPB coblogger Joan MacLeod Heminway and I will be moderating a discussion group, New Challenges for Insider Trading Compliance,  at the upcoming Southeastern Law Schools (SEALS) Annual Conference (July 27-August 3, 2022). The conference is scheduled to be held in person in Sandestin, Florida. Here's the description for our discussion group:

Insider trading law in the United States is in a state of flux and uncertainty. In May of 2021, the House of Representatives passed the Insider Trading Prohibition Act. If this bill becomes law, it will impose an entirely new statutory regime for civil and criminal enforcement. Moreover, Securities and Exchange Commission (SEC) Chairman Gary Gensler recently directed the staff to present recommendations to "freshen up" and tighten the operative provisions in Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. In response, in August of 2021, the SEC's Investor Advisory Committee proposed extensive new restrictions on the use of 10b5-1(c) trading plans as an affirmative defense for insider trading. Meanwhile, prosecutors and regulators continue to employ novel theories of liability in insider trading enforcement actions. Criminal enforcement actions under 18 U.S.C. § 1348 and civil enforcement under the novel "shadow trading" theory of liability are just two examples. How will these and other impending changes affect compliance departments at public companies and in the financial industry? How should the lawyers in these and other organizations prepare? Should market participants welcome these potential changes to our insider trading laws, or are there grounds for concern? This discussion group is designed to address these and other related questions.

There may still be room for additional participants. If you are a law (or business law) professor who is interested in joining the discussion in sunny Florida, don't hesitate to reach out to me at [email protected].

December 10, 2021 in John Anderson, Securities Regulation, White Collar Crime | Permalink | Comments (0)

Friday, November 26, 2021

Presenting at the 16th Annual Meeting of the American College of Business Court Judges

I was recently honored to be invited to join a panel at the 16th Annual Meeting of the American College of Business Court Judges (ABCBJ), which was held in Jackson, Mississippi, on October 27-29. The meeting was hosted by Chancellor Denise Owens (the current president of the ACBCJ) in association with the Law & Economics Center (LEC) at George Mason University Antonin Scalia School of Law.

Chancellor Owens kicked off the event and introduced the keynote speaker, Haley Barbour (former Governor of Mississippi). Governor Barbour gave an excellent talk about the ways in which Mississippi's musical traditions have helped to improve race relations over the past century.

The meeting panels covered a broad array of topics, including:

  • Ownership, Transfer and Trading of Intellecual Property Rights.
  • The Cost of Truth, Can You Afford It?
  • Artificial Intelligence, Machine Learning, and Algorithms: Studies in Law, Economics, and Racial Bias
  • Thriving Post Pandemic - Private Practice and Expanding Regulatory Authority After COVID-19.

I joined Professors Todd Zywicki and Donald Kochan on a panel moderated by Judge Elihu Berle (Los Angeles Superior Court). The panel was entitled, Shareholder Wealth Maximization versus ESG and the Business Roundtable: The Growing Debate Over Corporate Purpose. I presented on the Securities and Exchange Commission's plans for a new mandatory climate-change-related disclosure regime. The prsentation drew from portions of a recent essay I coauthored with Professor George Mocsary, An Economic Climate Change?

The conference concluded with the tour of our new Civil Rights Museum in Jackson. It was a wonderful meeting, and I look forward to participating in future ABCBJ events!

November 26, 2021 in Business Associations, Conferences, John Anderson, Law and Economics, Securities Regulation | Permalink | Comments (0)

Monday, November 22, 2021

JP Morgan Sued Elon Musk’s Tesla For Breach Of Contract: How Did I Predict It? - Lécia Vicente (Guest Post)

Friend-of-the-BLPB Lécia Vicente sent along the following post, which I thought our readers might find interesting, especially in light of the blog's prior posts on Elon Musk and his conduct (including those from Ann and me, like this one--citing to many others--and that one).  Enjoy!  Comment, as desired.  I have my own comments, which I will share in due course.

And (in this week of giving thanks) I offer gratitude to Lécia for bringing this post to us!  (You may remember that she guest blogged with us last December--almost a year ago.  Where did the time go?)

+++++

On November 6th 2021, Elon Musk polled his Twitter followers to determine if he should sell 10% of his stake in his company, Tesla. He wrote, “[m]uch is made lately of unrealized gains being a means of tax avoidance, so I propose selling 10% of my Tesla stock. Do you support this?”

On November 8th 2021, two days after Musk’s tweet, I tweeted the following question, "[c]an Musk actually be sued if he doesn’t follow through on his pledge to sell?” Initially, I was more concerned about securities law. Based on Musk’s tweets, shareholders might be misled to sell, meaning that Musk could be sued for misrepresentation. Similar scenarios of securities fraud involving Tesla and Elon Musk have happened before. In addition, Musk’s tweets could trigger claims of breach of contractual duties. A week after my tweet, on November 15th 2021, JP Morgan filed a complaint against Tesla for breach of contractual duties. I guess I predicted it.

Specifically, in JP Morgan Chase Bank, National Association, London Branch v. Tesla, Inc, JP Morgan is suing for the Tesla CEO’s tweet on August 7th 2018 when he stated “Am considering taking Tesla private at $420. Funding secured.” This statement came from the chair of Tesla’s board of directors and controlling shareholder. While the tone and seriousness of the announcement is debatable, JP Morgan took it seriously. Seriously enough to sue.

On February 27th 2014 and March 28th 2014, JP Morgan entered a series of agreements with Tesla in which JP Morgan would buy Tesla stock warrants at a specified “strike price.” Additionally, the warrants maintained an adjustment clause in case of an announcement of a significant corporate transaction involving Tesla, such as an acquisition. The purpose of the adjustment clause was to protect the parties from adverse economic effects. The 2021 Warrants expired between June and July 2021.

As explained in the complaint, in a Form 8-K filed on November 5th 2013, Tesla identified Elon Musk’s personal Twitter account “as a source of material public information about the company” and encouraged investors to review that account. The complaint also stated that:

Because the tweet violated NASDAQ rules requiring at least 10 minutes’ advance notice before a listed corporation publicly disclosed a going-private transaction, NASDAQ temporarily halted trading in Tesla’s stock following Mr. Musk’s tweet, evidencing that the exchange considered the tweet to constitute an announcement by the company itself.

After Mr. Musk’s tweet, Tesla’s Chief Financial Officer, its head of communications, and its General Counsel drafted an email—attributed to Mr. Musk—detailing the going-private plan. The email was sent to Tesla employees and published the same day on both Mr. Musk’s Twitter account and Tesla’s blog (which Tesla had also designated as a source of material public information about the company). In the email, and in a series of tweets responding to his Twitter followers, Mr. Musk elaborated on his plans to take Tesla private. He concluded in a tweet that “Investor support is confirmed. Only reason why this is not certain is that it’s contingent on a shareholder vote.”

That same day, in response to various inquiries from research analysts, Tesla’s head of investor relations confirmed that Mr. Musk’s tweet signified a “firm offer” to take Tesla private that was “as firm as it gets.” Specifically, she wrote in response to press inquiries about the tweet:

  • “I can only say that the first Tweet clearly stated that ‘financing is secured.’ Yes, there is a firm offer.”
  • “[A]part from what has been tweeted and what was written in a blog post, we can’t add anything else. I only wanted to stress that Elon’s first tweet, which mentioned ‘financing secured’ is correct.”
  • “The very first tweet simply mentioned ‘Funding secured’ which means there is a firm offer. Elon did not disclose details of who the buyer is . . . .  I actually don’t know [whether there is a commitment letter or a verbal agreement], but I would assume that given we went full-on public with this, the offer is as firm as it gets.”

It turns out that Elon Musk’s announcement of an acquisition was false. However, JP Morgan and all the banks that had entered similar contracts with Tesla, namely Goldman Sachs, did not know that at the time of the announcement. Still, JP Morgan adjusted the terms of the 2021 Warrants as a result of Tesla’s announcement of acquisition and, later, its abandonment of the transaction on August 24th 2018. JP Morgan considered that such adjustments were contractually required. Tesla refused to settle and pay in full what JP Morgan claimed Tesla owed as a result of the adjustments. JP Morgan ended up suing Tesla for $162,216,628.81, to be precise, for breach of contractual duties.

So, did Elon Musk’s tweet on August 7th 2018 constitute an announcement of an acquisition? Was it a “firm offer” to enter into a contract?”

Interestingly, JP Morgan’s complaint resonates with Johnson v. Capital City Ford, a case decided by the Louisiana Court of Appeal, in 1955. In Johnson v. Capital City Ford Co., the Court had to determine whether a unilateral declaration of will like an advertisement constituted a firm offer. Capital City Ford found itself with a surplus of 1954 Fords. To get rid of them, the company placed an advertisement in the local newspaper, the gist of which was “[c]ome in, buy a 1954 Ford and, when the new models come in, we will let you trade in the 1954 model for a 1955 model at no extra charge.”

In response to the announcement, Johnson went to Capital City’s lot, picked out a 1954 model, and bought it. When the new models arrived a short time later, Johnson returned to the Capital City lot and demanded a trade. Capital City refused, claiming that the advertisements “were not intended as offers, but merely as invitations to come in and bargain.”

The Court advanced the following major premises: (1) A newspaper advertisement may constitute an offer, acceptance of which will consummate a contract and create an obligation in the offeror to perform according to the terms of the published offer. (2) An offer to be effective, need not be addressed to determinate offerees; it can, instead, be addressed to the public at large. (3) Whether a particular advertisement is an offer, rather than an invitation to make an offer or enter negotiations, depends on “the legal intention of the parties and the surrounding circumstances.” (4) If the meaning of a declaration of will is doubtful or uncertain due to “want of explanation” that the declarer should have given or from “any other negligence of fault of his,” then “the construction most favorable to the other party shall be adopted.”

The Court held the advertisement was an offer. To a reader, the wording of the advertisement denoted a bona fide offer, and it was certain and definite enough to constitute a legal offer. If Capital City Ford really intended the advertisement not as an offer but as an invitation to make an offer, it should have said something to that effect. The advertisement created a risk of uncertainty through its ambiguous statements. Therefore, the onus was on Capital City Ford to clear up the ambiguity. Since the company did not do so, the Court construed the advertisement against Capital City.

In Johnson v. Capital City Ford, the Court applied another case R. E. Crummer & Co v. Nuveen et al. (1945). In Crummer & Co v. Nuveen, the US Court of Appeals for the Seventh Circuit had to decide if a notice published in a regular paper circulated among municipal bond dealers was a mere solicitation for offers to sell the bonds or an offer to purchase them. The notice reads as follows:

For the convenience of bondholders who may wish to surrender their bonds, the Board […] has arranged to provide funds for the purchase of the above described bonds at par and interest to December 1, 1941. Holders may send their bonds to the Manufacturers Trust Company for surrender pursuant to such terms.

The plaintiff was the owner and holder of $458,829 principal amount of the bonds, dated June 1st 1940 and due June 1st 1970. The defendants arranged with the Manufacturers Bank of New York (“Bank”) to deposit funds necessary to cover all such bonds presented for payment pursuant to the terms of the notice. The plaintiff, in reliance on the notice, delivered its bonds to the Bank on December 11th 1941. However, the Bank refused to pay the principal amount as provided by the notice. The plaintiff attempted to sell the bonds to other parties at par, but the bid for them was substantially less than par resulting in damages of $35,000. The defendants moved to dismiss the complaint on the grounds that the notice was merely a solicitation for offers to sell the bonds and not an offer to purchase them.

The US Court of Appeals maintained:

We cannot believe that the ordinary business man could be expected to read the advertisement as an invitation to send bonds from wherever he might be to New York on the chance that when they got there the advertiser would accept his offer to enter into negotiations for the purchase of the bonds. Rather, we think the wording of the advertisement is such as to show "an intent to assume legal liability thereby." [emphasis added].

In other words, the US Court of Appeals considered the notice as an offer to purchase bonds and not a mere solicitation for offers to negotiate the sale of bonds.

The agreements JP Morgan entered with Tesla included an announcement event protection clause. An “announcement event” is contractually defined in the agreements as follows:

(i)        The public announcement of any Merger Event or Tender Offer or the announcement by the Issuer of any intention to enter into a Merger Event or Tender Offer,

(ii)       the public announcement by Issuer of an intention to solicit or enter into, or to explore strategic alternatives or other similar undertaking that may include, a Merger Event or Tender Offer or

(iii)      any subsequent public announcement of a change to a transaction or intention that is the subject of an announcement of the type described in clause (i) or (ii) of this sentence (including, without limitation, a new announcement relating to such a transaction or intention or the announcement of a withdrawal from, or the abandonment or discontinuation of, such a transaction or intention) (in each case, whether such announcement is made by Issuer or a third party);

provided that, for the avoidance of doubt, the occurrence of an Announcement Event with respect to any transaction or intention shall not preclude the occurrence of a later Announcement Event with respect to such transaction or intention. 

Did Tesla’s CEO manifest a plain and clear intention to make a firm offer to sell his stock? Were his tweets mere invitations to negotiate rather than firm offers? Was there consideration or any sort of reward if the potential offerees satisfied specified requirements? Was his August 7th 2018 tweet a promise to enter contracts to sell stock?

Potentially, Musk's tweet could be seen as an offer to sell his stock to his Twitter followers if it gave the public the right to acquire Tesla’s stock when Tesla sold them. In this scenario, if those who accepted the offer paid for the stock when it was sold, then a contract would have been formed. In addition, Musk’s tweet could be seen as a promise to sell stock. In this case, offerees have a right to demand that Musk sell the stock. If this is a promise Musk did not intend to keep, then the SEC can understandably view it as a false statement.

More important than Elon Musk’s behavior is the actions as a result from his tweet on August 7th 2018. Why did he do it? It is doubtful that the tweet was originally intended as an offer to sell stock. It is not clear if Tesla’s CEO’s intention was to have his Twitter followers contact him with an acceptance and form a contract. That investors feel strongly about Elon Musk’s tweets is not surprising. As Jeremy Grantham said in a 2019 interview to CNBC news channel, Tesla “is an extreme demonstration of growth.”

The bottom line is that there is space to explore what substantiates an offer-via-tweet in the context of corporate transactions such as initial public offerings, takeovers, mergers and acquisitions. Even if one concludes Musk did not provide a firm offer, the contractual terms of JP Morgan and Tesla’s 2021 Warrants help expand this interesting area of contract law.

*           *           *

Thank you to Nathan B. Oman, Rollins Professor of Law and Co-Director of the Center for the Study of Law and Markets at William and Mary Law for comments and fruitful interaction on this issue via Twitter.

November 22, 2021 in Ann Lipton, Contracts, Joan Heminway, Securities Regulation | Permalink | Comments (0)

Friday, November 12, 2021

Weighing the Costs, Benefits, and Authority for Mandatory SEC Climate-Related Disclosure Rules

According to SEC Chair, Gary Gensler, “[w]hen it comes to climate risk disclosures, investors are raising their hands and asking for more.” He has therefore asked his staff to prepare recommendations on new mandatory climate-change-related disclosure rules.

There appear to be two principal policy goals behind this proposed mandatory climate-related disclosure regime. First, to advise current and prospective investors of previously undisclosed physical and transitional climate-related risks through reliable, consistent, and comparable disclosures. Second, to structure the disclosure requirements to highlight “bad actors” and incentivize changes in the climate-related behavior of publicly traded companies.

Not everyone is, however, convinced that new, mandatory climate disclosures are necessary or even wise. For example, two of the five current SEC Commissioners have questioned the wisdom and/or need for new climate disclosure rules. In addition, Professor Stephen Bainbridge and Professors Paul and Julia Mahoney have expressed concern over the costs of a new climate-disclosure regime, as well as skepticism over the claim that climate disclosures are important to the average investor.

In our recent essay, An Economic Climate Change?, my coauthor George Mocsary and I weigh into the debate over the wisdom of new mandatory climate-change disclosure rules for issuers by asking: (1) Are the goals behind the proposed reforms worthy and appropriate for an SEC disclosure regime (the mission of which is to maintain efficient markets and facilitate capital formation)? (2) Can these goals be accomplished under the existing regime? (3) What would a new disclosure requirement cost, both directly and indirectly? (4) Would any benefits from increased disclosure outweigh those costs?

We conclude that, with respect to disclosure of transitional climate-related risks (risks to issuers from current or prospective regulatory demands and broader market trends toward a carbon-neutral world), new disclosure rules would be either redundant or outside the scope the SEC’s statutory authority.

Concerning mandatory disclosure of physical risk (a company’s risk to physical assets, markets, and supply chain due to climate-related extreme weather events), we express concern that the unreliability of the nascent discipline of “event attribution science” (which strives to identify causal links from human-influenced climate change to extreme weather events) would force issuers into rampant speculation that would be of little use to investors. It is not consistent with the SEC’s mission (and is likely outside its current statutory authority) to mandate disclosures that would be of little or no use to investors.

Finally, we conclude by highlighting the potential for some unintended consequences of mandatory disclosures in this area. For example, the burden of such disclosures may force some currently public companies to go private. This would have the result of further reducing the already decreasing number of investment opportunities for Main Street investors. Moreover, capital may shift abroad to markets that do not require climate-related disclosures, making U.S. markets less competitive. And perhaps most concerning, new climate disclosure rules may force larger, more eco-friendly companies to reduce their carbon footprint by selling off fossil-fuel-based assets and business lines. These assets may be purchased by private or foreign companies that are less concerned about the environment. This may actually result in a net increase in carbon emissions.

November 12, 2021 in John Anderson, Securities Regulation | Permalink | Comments (0)

Friday, October 15, 2021

Meme Stocks, Hypermateriality, and Insider Trading

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, Expressive Trading, Hypermateriality, and Insider 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.

October 15, 2021 in John Anderson, Securities Regulation, White Collar Crime | Permalink | Comments (0)

Friday, October 1, 2021

Douglas on "Creepy" Concepts and Insider Trading Reform

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.

October 1, 2021 in John Anderson, Securities Regulation, White Collar Crime | Permalink | Comments (0)

Friday, September 24, 2021

Ten Ethical Traps for Business Lawyers

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:

  1. 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?
  2. 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?
  3. 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?
  4. 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?
  5. 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?
  6. 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?
  7. What social media practices run afoul of ethical rules and why? How have things changed with the explosion of lawyers on Instagram and TikTok?
  8. 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?
  9. When should lawyers barter with or take an equity stake in a client? How does a lawyer properly disclose potential conflicts?
  10. 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 SEC Can't Have Its Cake and Eat It Too: Some Concerns for Proposed Trading Plan Reforms

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!

September 17, 2021 in Ethics, John Anderson, Law and Economics, Securities Regulation, White Collar Crime | Permalink | Comments (0)

Friday, September 3, 2021

Testing Our Intuitions About Insider Trading - Part III

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.

September 3, 2021 in Business Associations, Corporations, Ethics, John Anderson, Law and Economics, Philosophy, Securities Regulation, White Collar Crime | Permalink | Comments (0)

Friday, August 20, 2021

Testing Our Intuitions About Insider Trading - Part II

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!

August 20, 2021 in Business Associations, Ethics, John Anderson, Law and Economics, Philosophy, Securities Regulation, White Collar Crime | Permalink | Comments (0)

Friday, August 6, 2021

SEC Approves Nasdaq Board Diversity Rule Amendments

The SEC's order is available here.  Chairman Gensler's comments on the new rules are available here.  In pertinent part, Chairman Gensler offers the following observations:

These rules will allow investors to gain a better understanding of Nasdaq-listed companies’ approach to board diversity, while ensuring that those companies have the flexibility to make decisions that best serve their shareholders. . . .  

 . . . These rules reflect calls from investors for greater transparency about the people who lead public companies, and a broad cross-section of commenters supported the proposed board diversity disclosure rule. Investors are looking for consistent and comparable data when making decisions about their investments. I believe that our markets work best when investors have access to such information.

The focus on standardized disclosures in this commentary is of particular interest to me. 

The order is lengthy and includes copious footnotes with references to the many comment letters received on the Nasdaq rule-making proposal.  For those (like me) who research and write in the area, this SEC order is a "must read."  I look forward to spending time with it in the near future.

August 6, 2021 in Corporate Governance, Current Affairs, Joan Heminway, Securities Regulation | Permalink | Comments (0)

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.

August 6, 2021 in Ethics, Financial Markets, John Anderson, M&A, Securities Regulation, White Collar Crime | Permalink | Comments (2)

Friday, July 23, 2021

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!

July 23, 2021 in Corporations, Current Affairs, Ethics, Financial Markets, John Anderson, Law and Economics, Securities Regulation, Web/Tech | Permalink | Comments (0)

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.

June 25, 2021 in John Anderson, Securities Regulation, White Collar Crime | Permalink | Comments (1)

Monday, June 21, 2021

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

 

June 21, 2021 in Conferences, Joan Heminway, Securities Regulation, Wellness | Permalink | Comments (0)

Friday, April 30, 2021

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.

April 30, 2021 in John Anderson, Securities Regulation | Permalink | Comments (0)

Monday, April 26, 2021

More On "Insider Giving"

Ten days ago, co-blogger John Anderson posted about a new insider trading paper co-authored by  Sureyya Burcu AvciCindy SchipaniNejat 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?

April 26, 2021 in Joan Heminway, John Anderson, Securities Regulation | Permalink | Comments (0)