United States v. Newman Clarifies the Law of Insider Trading | Hacker News Reader

United States v. Newman Clarifies the Law of Insider Trading

casetext.com

69 pointsmisterbwong34 comments

It's good that the court somewhat clarified previously-fuzzier law. The underlying problem is that insider trading as a crime is so ad hoc to begin with. TFA notes the hodgepodge of agencies, laws, regulation, rulings, etc. that "define" insider trading today. I doubt if any legal thinker's interpretation of the current understanding were codified into a single bill, that that bill could pass in Congress. Codifying what currently exists would make obvious what a boon it is for powerful executives. A codification of what the public imagines exists, would never get past those executives' lobbyists.

Nearly all executives trade in the securities of the corporations that employ them. Very few are ever charged with insider trading. (I'm not suggesting they should be!) However, whenever company management catches wind of transactions that annoy them, they always have a friendly ear at the prosecutor's office.

Long before major stock [EDIT:] moves, many "insiders" knew what was coming. Perhaps some told themselves, like Madoff, that they could get everything turned around. Regardless, insiders know before the public knows. Insider trading prohibitions serve to prolong the public's ignorance, and so deepen the public's trading losses. No one is better placed to dance right up to the line concerning investment decisions and public disclosure, than the firm's executives are. That's why the majority of insider trading prosecutions that succeed, are against outsiders like Martha Stewart or the subjects of TFA. Insider trading is a crime because it's valuable for the executive class to punish early defectors.

Nearly all executives trade in the securities of the corporations that employ them.

Lots of executives exercise stock options and sell shares. I think executives buying securities on the open market is far less common.

The 'insider trading' issue with the timing of when executives sell shares is why SEC rule 10b5-1(c) exists: It allows executives to establish in advance plans for selling their shares, such that their future trades cannot be deemed to be the result of inside information.

are you sure Director buying is well reported the Investors chronicle has a weekly run down of which listed company's directors have brought/sold shares.

I didn't say it never happened. Just that it's less common.

You can read all about them at SEC EDGAR [0].

[0]: https://www.sec.gov/edgar/searchedgar/companysearch.html

Except that the executives usually have automatic sales, to shield themselves from illegal insider trading. This usually happens inside the trading windows, and mostly using pre-scheduled recurring sales. A public company normally has a lawyer that specifically deals with this compliance.

There seems to be a fundamental logical error in the explanation given here:

"As the court recognized, the reasoning of Dirks compels this conclusion. The Supreme Court ruled that to be liable a tippee must know that the insider leaked the information in breach of a duty. The Court in Dirks also held that breach of a duty was established if the insider received some personal benefit in exchange for the leak. Logically, therefore, proof the tippee knew there was a breach of duty means proof the tippee knew that the insider received some personal benefit."

It would have to be the case that a breach of a duty can only be established if the insider received some personal benefit in exchange for the leak, in order for the conclusion to hold.

That is an explicit conclusion of Dirks (at 662): "Absent some personal gain, there has been no breach of duty to stockholders."

That is true, but it still seems to not follow. I could "breach my duty" to shareholders simply by being negligent.

It seems that that would trigger a different set of problems - confidentiality issues, rather than conflict of interest. So yes, still bad, but a different rule-set, perhaps?

Yes, the author seems to assume that:

    proof_of_breach <-> proof_of_benefit

You are arguing that it could be the case that:

    proof_of_negligence -> proof_of_breach
    proof_of_negligence -> (proof_of_benefit v ~proof_of_benefit)

in which case there could be a contradiction.

However, there is probably an argument that:

    proof_of_negligence -> (proof_of_benefit v ~proof_of_benefit)

is wrong and that there actually is a rule:

    proof_of_breach -> proof_of_benefit

For example, if someone is negligent, we already know they received a personal benefit (eg. reduced cognitive load, received compensation for work not performed, etc.).

To show a logical incorrectness, you need to show an `x` where:

    proof_of_x -> (proof_of_breach ^ ~proof_of_benefit) v (~proof_of_breach ^ proof_of_benefit)

What are you trying to say here?

    proof_of_negligence -> (proof_of_benefit v ~proof_of_benefit)

easily simplifies to

    true

and therefore doesn't need a case to be made for it. It's always true.

I guess it should be an Exclusive OR, although I'm not sure that is allowed in propositional logic.

The argument made was that negligence could occur without benefit (ie. proof_of_negligence does not imply either proof_of_benefit or ~proof_of_benefit).

My argument is that `proof_of_benefit -> proof_of_negligence` and that `proof_of_negligence -> (proof_of_benefit v ~proof_of_benefit)` (or otherwise) is nonsense.

Surely, if there is no benefit, then ~proof_of_benefit obtains? Are you advocating against the law of the excluded middle? How could there be proof of a benefit if there was no benefit?

Exclusive or, being a logical relationship, is allowed in propositional logic. It is traditionally indicated, in mathy areas, by the symbol ⊕, but you can just compose it from the standard and, or, and not operations.

And (proof_of_benefit ⊕ ¬proof_of_benefit) still simplifies to true, unless you're a hardcore constructivist.

"Duty" in this context refers to corporate fiduciary duties. There is a "duty of care" but mere negligence (and usually even gross negligence, without something more) does not violate that duty. The conclusion of the Supreme Court in Dirks is that information is leaked in violation of some duty if and only if it has been leaked for personal gain.

Newman follows from that assumption: breach of duty requires personal gain, so you cannot know duty has been breached unless you know there was personal gain. If you don't know there was personal gain, you can't tell simple negligent disclosure apart from breach of duty. And if you don't know about the violation of the duty, you can't be held liable for violating it derivatively as a tipee.

Is this because of the "trading" element? Otherwise it would be divulging company secrets?

I'm not sure what to make of that out of context. Is it saying that if I, as a corporate officer, copy some sensitive information onto an unencrypted USB drive, in direct violation of explicit company policy, and accidentally drop it someplace, and someone picks it up and trades on the information, I have not committed a breach of duty? That would strike me as a counterintuitive conclusion.

I guess I should provide a fuller quote for context: "Whether disclosure is a breach of duty therefore depends in large part on the purpose of the disclosure. This standard was identified by the SEC itself in Cady, Roberts: a purpose of the securities laws was to eliminate 'use of inside information for personal advantage.' 40 S.E. C., at 912, n. 15. See n. 10, supra. Thus, the test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach."

There is a fiduciary duty of care, though that has mostly to with care in the execution of corporate policies and transactions. I do not know how that has been interpreted in the context of information security.

The reasoning of Dirks seems to be that the relevant duty is the duty of loyalty, because the purpose of the law is to eliminate the "use of insider information for personal gain." So while copying sensitive information into a USB may breach one's duty of care, it's not a breach of the duty of loyalty and not within the scope of the law.

This is a massive loophole that has been exploited for decades.

Here's how it plays out, from board rooms to halls of Congress: I breach my loyalty so that you make $1million profit. Your spouse buys my child a $50K car as a birthday present.

In the cloudy eyes of the law, I received no benefit from giving you the tip.

Indeed. Dirks v. SEC touches on loophole-creation in at least one place:

"The SEC argues that, if inside-trading liability does not exist when the information is transmitted for a proper purpose but is used for trading, it would be a rare situation when the parties could not fabricate some ostensibly legitimate business justification for transmitting the information. We think the SEC is unduly concerned."

The last sentence is not immediately followed by any argument in support, so at this point I have no idea why the majority would dismiss the SEC's concern, which looks plausible to me. Perhaps they think it is not a relevant concern, but if so, why not say so? Irrelevance would seem to offer a stronger counter-argument than a disagreement over the magnitude of an effect. Perhaps they are uninterested in considering this issue because they have already decided the case on what they think are logical grounds.

I see. So one might get fired, and maybe even sued, but it's not a matter for the SEC.

Thank you for pointing this out.

I think the argument leading up to that conclusion is also interesting:

"Whether disclosure is a breach of duty therefore depends in large part on the purpose of the disclosure. This standard was identified by the SEC itself in Cady, Roberts: a purpose of the securities laws was to eliminate 'use of inside information for personal advantage.' 40 S.E. C., at 912, n. 15. See n. 10, supra. Thus, the test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders." [1] (My emphasis.)

Surely the 'thus' is unjustified here, given that the quote from the SEC is a purpose of the laws, not the purpose; some other purpose of the law might establish additional tests for a breach of duty. Furthermore, the quote from the SEC does not limit the purpose of the law to situations where the leaker is the beneficiary, yet that is claimed to be part of the conclusion that follows from it.

For completeness, I will point out that the next sentence says "And absent a breach by the insider, there is no derivative breach." This cannot be used to establish that no breach has occurred, because it is predicated on that assumption.

[1] https://casetext.com/case/dirks-v-securities-and-exchange-co...

There was obviously a reason that the tippers (Dell & Nvidia insiders) leaked confidential information to the defendants, two hedge fund managers named Newman and Chiasson.

I don't see why it's material whether this reason was friendship/status-boosting or some sort of tangible, cash benefit. The hedge fund managers benefited a great deal from the information, and thus the tippers benefited by extension as they now had stronger ties to two successful hedge fund managers.

If the tippers benefited from leaking confidential information, they breached a fiduciary contract with their shareholders by using company property (information) for their own gain.

"In each case, Newman and Chiasson were several steps removed from the original leak, receiving the inside information only after it had been first relayed between at least two or three other people."

This is inconsequential. If I were a hedge fund manager looking for insider info, I wouldn't be dumb enough to go directly to people within the company, unless I was out golfing with the CEO and he let something slip in conversation.

I would hire an analyst with ties to any employees in the organization to ask around. Which is probably what happened here. What other reason would there be for the analysts to acquire information and then go to the hedge fund managers with it?

You can't wash your hands clean by proxy if you still know what you are doing is wrong.

"The judge also agreed with the government that it was required to show only that the defendants [Newman and Chiasson] knew that insiders had leaked the information in violation of their duties to the company – the government did not have to prove the defendants actually knew the insiders had received a personal benefit in exchange." - this was the original logic under which they were convicted, and I think it makes a lot more sense than the final ruling.

> There was obviously a reason that the tippers ... leaked confidential information to the defendants ...

> I don't see why it's material whether this reason was friendship/status-boosting or some sort of tangible, cash benefit.

Mainly because they're facing prison time.

I can think of other laws that make similar distinctions. For instance, the punishment for receiving stolen goods will depend on the value of the goods in question. Why should somebody get a lighter punishment for receiving, say, an iPod compared to a car? In both cases, they knew the person giving them the item wasn't the owner.

In this case, it isn't a question of how harsh the punishment is, but whether the people will be punished at all. However, if the SEC wishes to create lesser penalties to cover this kind of thing, it has the regulatory authority to do so. If that's not enough, Congress can always reconsider the law, but I can't imagine people getting all that worked up about it.

I would imagine that it would be in the interest of any shareholder of a publicly held company to be very concerned about insider trading laws.

I took some time a while back to look into why insider trading is considered bad. The situation turned out to be messy and undecided but interesting. Here's some links I came across in that search if you're curious.

[0] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=132529 [1] http://www.cato.org/publications/commentary/whats-wrong-abou... [2] http://dealbreaker.com/2012/07/everything-bad-is-insider-tra... [3] http://www.forbes.com/columnists/free_forbes/2003/0512/050.h...

This is interesting, I was under the impression that insider trading covered even things accidentally leaked from companies. Is that not the case? If someone used information hacked or found by another person would that fall under insider trading?

"“Dorozhko’s alleged ‘stealing and trading’ or ‘hacking and trading’ does not amount to a violation” of securities laws, Judge Naomi Reice Buchwald of United States District Court ruled last month. Although he may have broken laws by stealing the information, the judge concluded, “Dorozhko did not breach any fiduciary or similar duty ‘in connection with’ the purchase or sale of a security.” She ordered the S.E.C. to let him have his profits."

http://www.nytimes.com/2008/02/15/business/15norris.html

The Second Circuit reversed that ruling.

http://economix.blogs.nytimes.com/2010/03/29/common-sense-an...

"The attorney, as an outsider to the corporation, owes no fiduciary duty to the corporation’s shareholders so the classical theory would not apply. Under the misappropriation theory, the trade is unlawful because the attorney violated a duty to the client by using the client’s confidential information for the attorney’s own benefit."

The client is the corporation's shareholders, as management simply acts as an agent for those shareholders.

The client is the corporation, a distinct legal person from any of the managers or any of the shareholders.

Ah, right. Thanks

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