Scholar argues that judges, rather than the legislature, should continue to regulate insider trading.
U.S. Representative Chris Collins (R-N.Y.) was arrested in 2018 on allegations of insider trading after acting on a tip to mitigate his losses from a failing stock. The high-profile arrest marked just one example of how access to privileged financial information can lead to allegedly nefarious activity.
Insider trading is more common than you might think: A 2014 study found that almost 25 percent of financial transactions involve some level of insider trading. In 2017, the U.S. Securities and Exchange Commission (SEC) brought over 40 civil enforcement actions related to insider trading in addition to criminal enforcement actions brought by the U.S. Department of Justice.
Former U.S. Attorney Preet Bharara and SEC Commissioner Robert Jackson have criticized the current model of insider trading regulation for being “hazy” and “outdated.” They believe that either Congress or the SEC should promulgate a clear definition of insider trading to provide needed certainty on proper conduct in the financial market and to promote healthy and legal information sharing.
But professor Jill Fisch of the University of Pennsylvania Law School disagrees. Fisch advocates for judicial action, rather than new regulations or legislation, to regulate insider trading, as courts are in a unique position both to control over enforcement and to modify standards with evolving business practices.
First, Fisch contends that judicial lawmaking benefits from being flexible and developing incrementally. Instead of being constrained to one concrete definition of insider trading, a judicial definition can be modified to accommodate new fact patterns as they arise. Furthermore Fisch argues that since the judicial definition of insider trading is refined over time, it produces fewer unforeseen consequences than a legislative hardline definition would.
Second, Fisch argues that the political insulation the judiciary enjoys benefits inside trading regulation. Fisch highlights legislators’ tendency to react hastily to high-profile events and to produce quick legislative solutions. This type of legislation, Fisch argues, harms markets and the overall economy. Political pressure can lead to over enforcement since regulators can succumb to pressure from Congress and the public to go after high-profile individuals. But, as Fisch contends, political isolation allows the judiciary to avoid these pressures.
In 2015, Fisch notes, members of Congress introduced three bills that would have redefined the scope of insider trading. None of the bills gained enough support to become law, but Fisch argues they provide helpful examples of the drawbacks of a legislative solution..
The Reed-Menendez Bill, for one, would have made any trading on the basis of material nonpublic information illegal. Even though a blanket ban would alleviate any uncertainty, Fisch argues that this broad prohibition would end up discouraging legitimate research. Fisch contends that some informational advantages should be permitted to help foster better trading efficiencies.
The second bill—the Himes Bill—would have only outlawed trading on the basis of information that was obtained wrongfully. This bill would require someone to obtain material non-public information, either recklessly or knowingly, and then trade on it before facing liability. But what counts as wrongful conduct under the Himes bill, Fisch argues, is no less ambiguous than under current judge-made law.
Lastly, the Lynch Bill would have provided a more precise definition of insider trading, prohibiting behavior that was “(1) “nonpublic and obtained ‘illegally’; (2) from an issuer with an ‘expectation of confidentiality’ or for use only for legitimate business purposes; or (3) ‘in violation of a fiduciary duty.’” Fisch argues that the language of the bill would have, again, created ambiguity similar to current judge-made law, therefore not solving any of the current issues.
Fisch claims that these three legislative approaches show the difficulty of codifying a clear legislative definition of insider trading. She contends that even though judge-made law may have its downsides, the current system is more beneficial to a healthy market than any of the recent legislative alternatives.
One downside of judge-made law, Fisch concedes, is that even though political insulation yields benefits, that insulation can also lead to a lack of accountability. The lack of accountability can, in turn, degrade public faith when courts reject expansive enforcement measures.
Furthermore, Fisch points out that the uncertainty created by shifting judicial opinions can have negative impacts on the financial market. Fear of liability, she contends, can at times impede the type of information gathering necessary for a healthy market to thrive.
Although judicial lawmaking may contribute to uncertainty in the financial markets, Fisch argues that uncertainty in the context of insider trading may still be beneficial. A hardline rule, Fisch maintains, could potentially open the path to fraud by allowing backdoor loopholes to develop. Instead, judicial lawmaking deters that type of opportunistic behavior and is able to evolve with changing business practices.
Fisch’s article appears in volume 71 of the Southern Methodist University Law Review.
