Newman/martoma: The Insider Trading Law's Impasse and the Promise of Congressional Action

By Park, Tai H. | Fordham Journal of Corporate & Financial Law, December 1, 2020 | Go to article overview

Newman/martoma: The Insider Trading Law's Impasse and the Promise of Congressional Action


Park, Tai H., Fordham Journal of Corporate & Financial Law


Introduction

In the late 2000s, when federal prosecutors in New York turned their sights to the hedge fund investor community, it was like shooting fish in a barrel. Within a few years, they had won insider trading convictions or guilty pleas from dozens of securities professionals.1 They then watched, however, as key prosecutions unraveled. In United States v. Newman, the Second Circuit determined that some of the defendants who had been convicted after a hard-fought trial were not guilty of any crime.2 The Court's ruling and interpretation of the law led to reversals of other convictions and other charges being dismissed, even as to some defendants who had pleaded guilty to insider trading.3

Three years later, a different panel of the Second Circuit in United States v. Martoma issued a ruling that flatly contradicted Newman 4 A dissenting judge disagreed, declaring that the majority's mistaken rule should be ignored as dicta.5 These concerning events have caught the attention of Congress. While Congress had in previous years considered, then abandoned, legislation, Congress may now enact a statute that defines the insider trading prohibition.6 The current draft of the House bill offers much needed clarity, but also seems incomplete. It remains to be seen how the Senate will react to it.

This Article suggests that the merits of the current bill cannot be understood without examining the evolution of the judge-made rule of insider trading, which culminated in the Newman/Martoma impasse. This Article will examine the judiciary's decades-long effort to define an insider trading law that only Congress had the power to enact under the separation of powers doctrine. It argues that the result has been a hopelessly vague law that violates the notice requirements of the Due Process clause. While Congress is now considering a bill that offers much needed clarity, this Article contends that the current draft may be problematic. It strongly embraces a "parity of information" vision for the securities market by prohibiting any trades while in possession of material nonpublic information ("MNPI") obtained through a breach of a confidentiality obligation. In so doing, the bill gives too little regard for the competing interest of market efficiency. It is the conflict between these two important interests that mired the courts in debate for decades. If passed, the bill's blanket prohibition could materially impact institutional investors' ability to investigate corporate information, a task that is vital to accurate securities valuations. This Article supports a deeper analysis in the Senate that may lead to a more balanced law regulating the flow of corporate information in the financial markets.

Part I summarizes the origin and evolution of the judge-made law of insider trading. While at its very inception, the law was heavily criticized for analytic flaws as well as its nature as a judge-made criminal law, Congress declined to act. Thus, after decades of the law evolving on a case-by-case basis in a "topsy turvy" fashion, the sharp disagreement between Newman and Martoma suggests that even judges of the Second Circuit cannot decide what precisely the law prohibits and why.7 The root cause of this ambiguity is disagreement about a policy question of great importance to the U.S. securities market: to what extent our interest in market efficiency should trump the competing interest in parity of market information.

In Dirks v. SEC, Justice Lewis Powell, writing for the majority, triggered this debate when he sought to prohibit abusive conduct in the securities market while simultaneously offering institutional analysts a "safe harbor" so they could continue to seek out nonpublic corporate information.8 Such activity was viewed as vital to the efficient and accurate pricing of securities. Thus, Dirks held insider trading to be fraudulent only if the insider engages in an intentional breach of its fiduciary duty, which in turn requires a personal benefit to the insider in exchange for disclosing MNPI. …

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