It’s a basic tenet of American criminal law that prosecutors must prove every element of the crime beyond a reasonable doubt. In practice, this means we sometimes allow guilty people to go free in order to minimize the chance of unjustly imprisoning the innocent.
It follows that before prosecutors can prove a crime, somebody - preferably the people who write our laws - must first define the nature of that crime. That may not seem like much to ask in most areas of the law. But not when it comes to insider trading.
There is no statutory definition of insider trading. Instead, prosecutors and regulators have relied on case law to determine the boundaries of who could be charged. And, at least until now, that was exactly how the people who bring insider trading cases wanted it. Then-Securities and Exchange Commission Chairman John Shad expressed the view in the late 1980s that it was sufficient for the courts to define the rough edges of insider trading, allowing prosecutors to do the rest - by bringing increasingly aggressive cases until the courts told them they went too far. And between then and now, prosecutors have done just that.
The courts recently said that prosecutors had once again gone too far. The common definition of insider trading proffered by the SEC and by federal prosecutors - trading on material nonpublic information - is wrong, or at least seriously incomplete, according to the 2nd U.S. Circuit Court of Appeals in New York. In a ruling that threw out two recent high-profile cases and threatens others, the court said it is not, in fact, illegal to trade on leaked information unless the person doing the trading is aware that the person doing the leaking received a tangible benefit for doing so.
This is a huge development. It is also not necessarily a good one, by a long shot. Suppose some mid-level attorney in a corporate general counsel’s office tips off an old frat buddy about a soon-to-be-announced merger. The frat buddy might be free to trade on the knowledge, if the leaker receives nothing in return for the tip. Such a leak could still harm the leaker’s company by driving up the target’s price; the leaker would surely be vulnerable to civil action. He might be vulnerable to criminal charges too, but not insider trading; you can’t bring an insider trading charge against someone who does not actually execute or benefit from a trade. Under the newly clarified rule, however, the frat buddy would also be in the clear.
Both those who support the decision and those who oppose it have observed that it will make insider trading prosecutions much more difficult in the future, especially for any traders who are more than one degree removed from the original leaker, as was true in both the cases the ruling threw out. As David Miller, a former New York federal prosecutor, said to The Wall Street Journal, “If the tippee doesn’t even know of the tipper, how can you prove they knew there was a benefit?” The new ruling establishes the principle that, for those trading on confidential information, ignorance is not only bliss, but protection.
The court did not see this as an inherent problem. “Although the government might like the law to be different, nothing in the law requires a symmetry of information in the nation’s securities markets,” U.S. Circuit Judge Barrington Parker wrote in the opinion. In other words, just because an act creates financial unfairness doesn’t mean it constitutes a crime. This conclusion was made possible by the very vagueness the SEC and prosecutors spent so long preserving.
Why haven’t the Justice Department and the SEC urged Congress to write a clear insider trading statute before now? Because they have assumed, probably correctly, that as soon as the boundaries of insider trading are clearly defined, the people doing the trading will find ways to skirt or push those boundaries. The authorities want to be the ones doing the boundary-pushing, in the other direction. Until now, that sort of flexibility has allowed prosecutors to chase challenging, hard-to-prove cases.
But it isn’t right. Nor should this vagueness be indefinitely tolerated under our system. Careers, businesses and lives are ruined by prosecutions that either fail in court, get reversed on appeal or pressure targets into accepting plea bargains rather than risk draconian punishments handed out by judges who too often seem to believe that “Wall Street” and those involved with it deserve pretty much any bad thing that happens to them. It is unclear how many of those who accepted such deals, or pled guilty in other cases, will see any sort of redress after the Court of Appeals’ ruling. If nothing else, the ruling has shown that a refusal to define a crime deters effective punishment just as much as, if not more than, it deters wrongdoing in the first place.
I am all for strict enforcement of rules against insider trading. First, we need to know what those rules are. Let’s not wait to write those rules until after some insider’s frat brother makes a bundle at the expense of the executive’s shareholders and then goes free.