Introduction
Summer Pike said-
“Well, we are against fraud, aren’t we?”
I remember the day in 1943 when I was working in the S.E.C building (Philadelphia), and I suddenly received a phone call from then Trading and Exchange division director. He claimed to be on call with Paul Rowen who was the regional administrator of S.E.C in Boston. The director also informed over the phone call that the president of a company is buying shares of their company through shareholders of his own at the rate of $4.00 per share and he had informed the shareholders that the company is not performing well. Whereas in reality, the company is performing well, and its earning have quadrupled and its share prices will sell at $2 per share in the coming year. The director wanted to know if there was anything that could be done in such a situation. As soon as he came upstairs, I called for my secretary and then took a look at section 10(b) and also section 17 and then put all the sections together. We had a discussion related to where the purchase or sale should be, and we finally decided that it should be at the end.
After the discussion, we decided to call the commission and also got on calendar, and I barely remember if we reached that place in the morning or after having our lunch. All the commissioners were passed a piece of paper. Once the commissioners read all the rules, they tossed the paper and approved the same. It was only Summer Pike who decided to speak up, and he said-
“We are against fraud, aren’t we?”
And that is how the conference happened on codification of the laws related to federal securities: Administrative procedures, 22 Bus. law, 793, 891, 922 (1967). The case of Milton V. Freeman. The quotation was decided to be taken from Mr. Freeman remarks in the discussion after his papers presented at the symposium of securities law. Lanza v. Drexel & Co., 479 F.2d 1277, 1290 n.32 (2d Cir. 1973)
Moreover, the extensive practices of common laws were developed after the establishment of the rule 10b-5. These practices of the common law were built on the pillars of Inc. v. Green, SEC v. Texas Sulfur Co., Basic Inc. v. Levinson, Santa Fe Industries and similar others. The first tool for securities fraud investigation was provided by the Securities act 1933, provision of 10b-5, which is often written as the provision of 10b5.
- History of 10b (the evolution of 10b to 10b5-1)
Before the inception of the rule 10b5-1, the supreme court of the US had defined insider trading as the trade that is made “on” or “based on” materials of non-public information before the inspection of the rule 10b5-1. In re Cady, Roderts Co., Chiarella, O’Hagan
The terms mentioned above were not interpreted uniformly by the Appeals federal courts. The same is evident from the fact that the “knowing profession” of the materials of non-public information was sufficient for the second circuitto be fulfilled. On the other hand, according to the ninth and eleventh circuit, the “use” of the material non-public information was required.
Along with that, the eleventh circuit highlighted that the evidence of possession of the material non-public information was a strong inference for “use.” However, the ninth circuit required the “use” to be proven only in criminal cases.
These disparities among the circuits caused the SEC to establish a new rule that is 10b5-1, to provide clarity through specification. According to the new rule, when a person making purchase or sales is “aware” of the use of materials of non-public information at the time of purchase or sales, then the trade is supposed to take place “on the basis of” of such informational material.
According to the rule a person is liable and prohibited from doing trade if they are merely “aware” of the materials of non-public information (although they are not “using” such information). The rule also provided affirmative defense to various entities or persons related to the rule 10b5-1 plan.
In the year 2000, rule 10b5-1 was promulgated by the SEC. This rule identifies when the liability of a trader arises in case of insider trading from either “knowing possession” or “use” of the materials of non-public information. According to this rule, whenever a person indulges in the purchase or sales of securities where they are aware of use of materials of non-public information, then they are said to be trading “based on” such information.
The term insider trading is used for defining some activities and connotations that encompasses both prohibited and legal activities. An insider trading becomes an illegal one when it involves buying or selling of security, after breaching a relationship of trust and confidence or the fiduciary duty while having the possession of materials of non-public information about a security while carrying out the trade. Therefore the rule introduced by SEC in the year 2000 helps in providing security concerning the securities fraud to the corporate employees such that they can buy and sell the securities fearlessly. According to the rule, insiders can prepare a plan to trade the shares of the company without having any inside information. Therefore this rule allows the corporate people to safely and fearlessly carry out the transactions in future even if they come to know about the materials of non-public information.
Moreover, some critics are of the belief that the business insiders maneuverer the rule and also engage in use of materials of non-public information. There are also critics according to the observers who claim a rise in concerns relating to the Rule 10b5-1, and there are certain critics who are also of the belief that certain insiders outperform shareholders even if they use Rule 10b5-1. According to the rule, the plans operate in a manner where the traders operate more consistently with the shareholders who do not possess all the materials of non-public information. Therefore it can be said that the rule 10b5-1 is an important function as it helps in providing more clarity about which trades are made based on materials of non-public information. It also helps in providing defence to the insider when the trades are done following their terms of the rule of SEC. According to the release done by the SEC for its rule 10b5-1, it was found out that the design of the revised defence was done for overcoming situations where people could demonstrate that the materials of non-public information was not a factor in the decision of trade. It is necessary to provide clarity to insider trading as it has an impact over the capital markets. Moreover, equity compensation is used for rewarding the executives and it also encourages performance, which gives the power to the receivers to sell their shares on appropriate terms.
The plan of 10b5-1 was adopted in the year 2000 to solve the challenging issue of excluding the fair insiders and the regular insiders from the scope of SEC investigation and for the purpose of reacting to the scandal of Enron with its plan. The plan of 10b5-1 was appropriate for overcoming the fears of insider trading allegation when many executives were kept from diversifying their holdings. Restrictions on insider trading can often act as a constant headache for the executives of companies and companies who are eligible for getting their portion in form of stocks. Therefore the plan was important in the year 2000 but not in the present day because two years ago, the legislative initiative or the Bill HR 6320 was not passed.
- Curbing the 10b5-1 plans abuses: Promotion of transparent standards for the activities related to corporate insiders
Some of the enforcement actions of SEC have alleged abuses for the rule of 10b5-1 plans since the time of its inception. Some of the most recent dates include January 2012. The facts collected from the two cases, that includes information against the CEO’s of the country and Enron Company is so egregious that it has limited utility in determining when the rule 10b5-1 will be challenged by the SEC. According to the facts gathered by SEC, the former CEO of the country has been engaged in preparing plans during the past three months although he was aware of the country’s poor performance and increasing credit risk of credit and they continued originating loans.
Similarly, according to the facts collected by SEC against the WellCare health plans incorporation’s former executive, it was highlighted that the executives were engaged in amending the plans in less than a year and with almost a year left on plans. According to the allegations of the SEC in enforcement of 10b5-1 rule, the fraction of overlapping plans and alteration of the plans before their actual termination could lead to drawing up of scrutiny. These actions are also viewed negatively by the courts.
The plaintiffs frequently pointed the stock sales by the insiders for supporting their claims that defendant acted knowingly to mislead the entire market with the help of the information possessed by him. That further helped him in taking advantage of the stock price movements. It has also been found out by the courts that the trades that have been made accordingly to the 10b5-1 rule “do not raise a strong inference of scienter.” In re Lululemon Sec. Litig., 14 F. Supp. 3d 553, 584–86 (S.D.N.Y. 2014); see also In are Aratana Therapeutics Inc. Sec. Litig., 315 F. Supp. 3d 737, 764 (S.D.N.Y. 2018).
Since the rule 10b5-1 has to be entered in good faith, the use of the rule as an affirmative defense “must be pled and proved” and “circumstantial evidence giving rise to an inference of bad faith and scienter . . . by showing that the corporate insider’s trades under a 10b5-1 plan are unusual or suspicious” may be presented by the plaintiff. Smilovits v. First Solar, Inc., 2019 WL 7282026, at *3 (D. Ariz. 2019) (citing In re Enron Corp. Sec., Derivative & ERISA Litig., 258 F. Supp. 2d 576, 593 (S.D. Tex. 2003). Therefore certain securities classes actions ruling the 10b5-1 started being ruled by the court and t does not provide defence to scienter when the securities were adopted during class period. See Freudenberg v. E*Trade Financial Corp., 712 F. Supp. 2d 171, 200–01 (S.D.N.Y. 2010) This situation is, however, counter-intuitive because there is no way of predicting the class period that can be used by the insiders in case of action litigations related to future class. The developments made in law may limit the rule 10b5-1 usefulness that is for the affirmative defense as the class periods are long.
It has also been found out by the courts that in case of amendments, creation, cancellation or modification of the rule, 10b5-1 plans can become an evidence of the scienter itself than the defense. See In re Countrywide Financial Corp. Derivative Litig., 554 F. Supp. 2d 1044, 1068–69 (C.D. Cal. 2008). For instance, the court identified an intent “to capitalize on insider knowledge” that was based on the plans timing when the rule 10n5-1 plan was entered before the negative event or the fraud and was modified during the period of alleged misconduct. In re Lululemon, 14 F. Supp. 3d at 585. Therefore according to the rule 10b5-1 plans, a scienter may arise because “a clever insider might ‘maximize’ their gain from knowledge of an impending price drop over an extended amount of time, and seek to disguise their conduct with a 10b5‐1 plan.” Freudenberg v. E-Trade Financial Corp., 712 F. Supp. 2d 171, 200 (S.D.N.Y. 2010) (internal citation omitted).
Therefore although the rule 10b5-1 plan includes an affirmative defense to all the allegations for insider trading, it is necessary for the advisors and the plan holders to be aware of it. The awareness is necessary because the courts might decide to look into several factors in determining if the trade was suspicious or not. Therefore the court will coniser a number of factors- the net profits, the number of sales by insiders, the amount of holdings sold, the change in the volume of the holdings by the insider, and identifying if a transaction occurred in a situation for taking advantage of the alleged misrepresentation to inflate of the stock prices. See Gagnon v. Alkermes PLC, 368 F. Supp. 3d 750, 772–73 (S.D.N.Y. 2019).
- Rule 10b5-1 Reformation
Soon after the implementation of the rule 10b5-1 plans, it was suggested by high profile news articles and different academic studies that the executives were misusing the plans and it was being used for covering the improper sales by making use of inside information. In May 2013, a request in form of a letter was submitted by the CIIT or The Council Of Institutional Investors (that is an association of union and corporate pension funds, public and other plans of employee benefits), to the SEC for it to reconsider its interpretive guidance or for making amendments to the rule 10b5-1. The letter aimed at placing certain limitations and restriction on the plans of 10b5-1. However, the SEC did not take any concrete action after the request. Again in the year 2018, a renewed appeal was placed by the CII to SEC, citing a sale of about $39 million stock by the CEO of Intel in the year 2017 following the taking plan that was recently revised by the CEO. Entire Intel’s’ stock was represented in the sale apart from the amount that intel was required to hold and this incident took place at least one month before Intel disclosed a significant flaw in its products and services. Various attempts have been made by congress to reform the rules plans. It was in the year 2018 when the house decided to pass the Corporate Insiders Act and the JOBS that contained provisions related to the rule that was more like the Corporate Insiders Act. The bill, however, failed in senate. The Corporate Insiders Act includes a standalone bill and has got the benefit of bipartisan support (vote included 413-3), that suggested a better fare in senate. Again in December 2019, the H.R 2534 was passed by the house that included the Insider Trading Prohibitions Act and was sent to the same committee of Senate as Corporate Insiders Act. Certain judicial precedent related to insider trading using the Insider Trading Prohibition Act, and that would help establishing liability. Two of these acts, therefore, stand for renewed efforts through prevention of corporate insiders abuses at the investors cost.
The House passed a Bipartisan Bill in the year 2019, that is the H.R. 624 for promotion of transparent standard for Corporate Insiders Act (“the Corporate Insiders Act”) that tracks the recommendations of CIII relation to reformation of the rule 10b5-1 plan that is discussed below. Moreover, the senate has been sent the bill, and the senate committee has also been referred on issues relating to housing, banking, and other urban affairs.
The Corporate Insiders Act requires consideration on part of the SEC during course of study of rule 10b5-1 plans, about the impacts of the amendments mentioned above- on existing prohibition of the insider trading, on the company’s ability for attracting executives, capital formation, the willingness of the company to operate as a public company and the protection of the investors.
There is much flexibility in design of the plans by the insiders who are wanting to establish plans along with their advisors. However, in case of choices related to modification, creation, and termination of the rules 10b5-1, there may be an increase in the SEC actions and greater skepticisms by courts that the plan has been entered in good faith. Moreover, the amendment made by the Corporate Insiders Act will help in imposing new requirements to avoid abuse of the plans.
“Good faith standard.”
Our legal system is rooted in The England Common Law tradition, and we have been dependent upon the courts for developing laws that prohibit insider trading. While it was made mandatory by Congress to protect investors by making the markets free from any frauds, it is the jurists albeit department of justice in the United States and commissions who have played a major role in defining the law related to insider trading. To overcome the abuses that caused crash in the stock market of the United Nations, The Securities Exchange Act of 1934 and the Securities Exchange Act 1933 were enacted by the congress. The insider trading was directly addressed by 1934 act through section 10(b) and section 16(b).
There are several arguments for and against regulations based upon the different belts concerning the impact of insider trading. From the proponents of the regulations related to insider trading, it is clear that insider trading reduces the efficiency of the market by increasing the cost of equity and volatility while decreasing the stock process and liquidity. According to the proponents, that regulations which lead to prohibitions of the insider trading in stock markets results in improved efficiency in the stock markets. On the other hand, the regulatory opponents believe that information is reflected more quickly and easily in the process in the stocks, and there is no negative effect of the insider trading on the liquidity of the stock markets. Therefore the opponents feel that the insider trading should not be considered as illegal and that regulations prohibiting the same needs to be reduced to improve the efficiency of the markets.
However there is no need for such regulations because the issues promulgated by Bill 624 have already been regulated by the (a) internal regulations of the issuers (as they want the trust of the investors and for other reasons related to economy), (b) rule 10b5-1 and (c) the case law.
Therefore it can be understood that SEC is trying to free itself from the high number of scrutinizing insiders that appear to be successful by reducing the insiders transactions scope to those who have either not filed or have filed with several imperfections. It cannot be done easily buy regulations. It is evident from the fact that if an officer committed or indulged in prima facie wrongdoing, there is an opportunity for complaining every case that is suspicious irrespective of the fact that it is in the plan or not. Therefore by not checking the insiders who adopted the plans, SEC allowed them to slip out. At this point of time, a bill was promulgated that does not add any value. Still, this action puts the insiders back into those times when executives were not capable of diversifying their investments the way they wanted.
The following cases indicate that judges have already developed a case law on this issue.
Local No. 38, 724 F. Supp. 2d at 458
Glaser v. The9, Ltd., 772 F. Supp. 2d 573, 576 (S.D.N.Y. 2011)
Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d 171, 200 (S.D.N.Y. 2010)
In re EVCI Colls. Holding Corp. Sec. Litig., 469 F. Supp. 2d 88, 99 (S.D.N.Y. 2006)
Therefore by looking at issues highlighted by the bill from the perspective of SEC, it becomes logical for adopting laws as it can help in making SEC’s job easier than before. The investors’ interest, however, will be under the same as they had been before the passing of the bill. The issuers will change no rules. Therefore the insiders who have got a good foresight will get an opportunity to adopt the plans much before any transaction are entered and therefore succeed in those plans. “[A] clever insider might ‘maximize’ their gain from knowledge of an impending price drop over an extended amount of time, and seek to disguise their conduct with a 10b5-1 plan.” Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d 171, 200 (S.D.N.Y. 2010).
Setting limitations on the officers or even the board members look more like a crackdown than an arrangement for solving problems.
Therefore some of the goals as set out by the SEC for its preliminary study includes-
(A) how such amendments can help in enhancing the existing prohibitions and also the clarifications against any insider trading
(B) the impact of such amendments on the issuers ability to attract persons to become an issuer insider
(C) the impact that such amendments may have on the formation of capital
(D) the impact of such amendments on the willingness of an issuer’s for operating as a public company
These perspectives barely help in bringing a positive effect on the existing state of things
| how such amendments can help in enhancing the existing prohibitions and also the clarifications against any insider trading | I’m working on it |
| the impact of such amendments on the issuers ability to attract persons to become an issuer insider | I’m still working on the same |
| the impact that such amendments may have on the formation of capital | I’m working on the same |
| the impact of such amendments on the willingness of an issuer’s for operating as a public company | What factors causes a company to become public? It is a relatively inexpensive way to access capital (as compared to banks) Is the Bill going to attract more capital to the selected company than it previously used to? No, most likely it is not, because, in several cases, the public company already has more strict bylaws as compared to the bill. It is, therefore in the company’s interest to be attractive and transparent to public. |
Therefore the only goal that the bill is aimed at solving includes- the ability of the SEC to exclude insiders from scrutiny even when they are not playing fair.
And in case the bill gets adopted, it will distill all those who have no chance of cheating, and at the same time, the SEC can keep an eye on others. There may still be some insiders who are not required to set plans too close to trading window and try to modify them or delay the execution consciously.
SEC may have forgotten about the issuer who came out economy-wise and for public capital and to use the capital most transparently and honestly. There are chances of the insiders switching to other companies after red-flagging because the officers were able to suspiciously establish the rule. Therefore, in other words, the market has its capability of regulating the issues that can barely be regulated by any other restrictions.
The proposition of the bill Caselaw
| Limiting the insiders ability for adopting the plan to a particular time when they will be allowed to trade | The common reasons that courts support the denial of a defendant’s motion to dismiss is that the defendant entered into the trading plan after the class period had started or at a time that is too close to the same Levy v. Gutierrez, No. 14-CV-443-JL, 2017 WL 219592, at *14 (D.N.H. May 4, 2017); Van Noppen v. InnerWorkings, Inc., 136 F. Supp. 3d 922, 944 (N.D. Ill. 2015); In re Intuitive Surgical S’holder Derivative Litig., 164 F. Supp. 3d 1106, 1120 (N.D. Cal. 2015); In re Mun. Mortg. & Equity, LLC, Sec. & Derivative Litig., 876 F. Supp. 2d 616, n.34 (D. Md. 2012) |
| Limiting the ability of the insiders to adopt multiple plans at the same time | Cases |
| establishing mandatory delays | It requires delaying transactions until the time of public disclosure, and it is sometimes also recommended that the plans of Rule 10b5-1 haveeffective dates such as at least 30 days after the public disclosure of the plans to shareholders. This decision helps in minimizing the adverse publicity risk and also helps combating any challenge related to “good faith” by SEC. Moreover, a plan can only be effective when it is adopted while the seller does not possess any inside information. And the seller’sdefense in case of this issue is strengthened if some time has passed before the sales that are made for the first time. + the Cases |
| Limiting frequency with which insiders modify the plans | Cases |
The provision of rule 10b5-1 is an effective tool in itself because it helps in inducing companies to adopt various internal rules that can encourage insiders in acting fairly. The rule 10b5-1 plans are self-sufficient. However, the only thing that needs to be improved is that plans need to be disclosed to principles of public pursuance that provides for open and easy access to material information. These improvements can also be done without making any changes in the law. Yet the alternative or solution for improving the protection of the investors is not there in Bill 624.
- Different approaches to become successful in “the war on insider trading.”
Enforcement of General Law Devises
In The United States, the civil enforcement done by Commission has turned out to be a powerful tool against any form of insider trading. The civil enforcement have become a powerful tool because the Commission has got a broad authority for investigating into possible violations of laws relating to federal securities, including the concept of insider trading. In the informal investigations carried out by the commission that the staff can even conduct without getting authorized by the commission, the staff may require information on voluntary basis. On the other hand, in case of formal investigations, the Commission’s power of subpoena can be used by the staff for compelling witnesses to produce records, books any other evidences and also testify the same.
The injunction ordered by the federal court that includes an order for prohibiting the law’s future violations has been one of the principal tools of enforcement for the commission. Therefore any type of conduct that results in the violation of the injunction may result in imprisonment or even fines. In case of injunctions seeking actions, the temporary restraining orders may be requested by commission, and it also includes the preliminary injunctions that can provide emergency relief to the ongoing violations. In case of emergency actions of the commission, they will request freezing of orders for preventing profits from any alleged insider trading from pending investigation, disappearing and enforcement effort. In case of additional sanctions in the actions related to civil activities, the Commissions seek orders requiring disgorgement of payment of civil penalties and also illegal profits.
Insider Trading Sanctions Act 1984 was enacted by the commission as a remedy to the “inadequate deterrent provided by enforcement remedies for insider trading,” observing “injunction. .serves only a remedial function and does not penalize a defendant for the illegal conduct [and] disgorgement . . . merely restores a defendant to his original position without extracting a real penalty for his illegal behavior.” The act penalizes to about three times of the profits gained by the insider or for the amount of the loss avoided by him, thereby providing a powerful deterrent to the violators.
Insider trading is considered as a crime by The United States and is therefore punishable by imprisonment and even monetary penalties. But the insider trading is also a type of a civil offense. Therefore the importance of insider trading as both a civil and a criminal offense has been illustrated by two recent U.S. decisions of the federal courts.
As had been mentioned, the Court of Appeals of the Ninth Circuit held in the year 1998, that includes the case- The United States v. Smith was a criminal case of insider trading. The government in such a situation had to prove that even defendant or the traditional insider (in fact, a misappropriate) made use of materials of non-public information in making trade decisions, thereby rejecting the position of the commission and also the Second Circuit’s position. The second circuit position expressed in earlier decisions that it was sufficient to show that defendant was possessing information by the court when he was trading. Few months ago, the court of appeals of the Eleventh Circuit had reached a similar decision as in the case of Commission v. Adler which was a civil case. However, the court decided to increase the difficulties of proof. It had adopted a rule which provided that although “use” is required and important element of the Rule 10b-5 related to the violation of insider trading, and when an insider buys or sells securities. At the same time, while possessing materials of non-public information, a strong inference arises that the insider used such an information for buying and selling of securities. Then the trader can rebut the inference by providing evidence that there was not any connection between the trade and the knowledge possessed by the trader. However, such inference remains unavailable in criminal context because the burden in such case remains on the government for proving each element of the offense beyond a doubt. Therefore these cases demonstrate the importance of criminal and civil prosecution available to regulator.
Restraining Companies’ from Insiders Identification
(Alternative Approach’s for controlling insider training)
Another major approach for resolving issues related to insider trading consists of the Commission’s focus on formation of anti-insider trading internal policies of companies. Therefore there are two main theories identified in this issue. The first theory includes that there should not be any bans on the insider’s trading, and it will depend upon the company to decide if insiders will be allowed to purchase and sell using materials of non-public informations. Proponents of the theory are dependent upon the self-governance and market effectiveness mechanics of economy. The proponents argue that insider trading is a compensation form the employees, providing lower salaries to the employees that further benefits shareholders. Therefore it provides for innovation, and some argue that by promising rewards for plan or product development, it will lead rise in stock. And the second theory on the other hand, prohibits insider trading. And even though the arguments about the first theory are strong, still the regulations of the government are against it.
The “blue sky laws” are taken advantage of by the corporate, and only the few regulation provisions of federal securities enable the issuers to indemnify the insider’s losses. Therefore the fact of its allowance supports liberal approach for helping insider trading by providing that it has room for the insider trading without any negative consequence. Therefore by indemnifying the insider losses, a company can help in boosting employee loyalty and productivity. In this case, the Commission can set various restrictions upon the internal policies.
Control over Internal policies of the company
The Commission needs to shift its focus and efforts from enforcing regulations to compelling the corporate government for overseeing and reinforcing its internal policies. There are more than 2,800 companies that are traded in New York Stock Exchange; however, this number is smaller than the insider’s number. There is lack of sufficient resources for the Commission to control them; however, it seems easier and feasible to work with issuers. The Commission can improve the main area, such as the Corporate trading regulations related to anti-trading. The commission can try to scatter the regulatory effect over the insiders by compelling all the companies to incorporate stricter corporate policies.
“Bullet-Dodging” and “Spring Loading” Strategies
Another major example of the alternative (to the Bill H.R. 624) regulations may include the direct prohibitions of “bullet-dodging” and “spring-loading” strategies that are initiated by the company from time-to-time for spoiling the employees. The compensation committee that is responsible for implementing‘spring loading strategies’ grants the same to the insiders before the material information is released that can reasonably be expected to drive the shares of options higher.” Spring loading is further related to other practice: “bullet-dodging.” When the bullet-dodging options are granted, it releases bad news before the issue of options. The Commission accepts the spring loading policy: as it has adopted regulations that cause the corporation to explain the spring loading to their shareholders. 28 See 17 C.F.R. § 229.402(b) (2012).
Whistle-blower Protection Act of 1989
The Whistle-blower Protection Act of 1989 is another way of looking after the sustainable internal corporate control. The Commission motivates the insiders to act fairly and effectively under other employees. A vivid example of such approach includes -The Whistle-blower Protection Act of 1989. The inner corporate control promulgated by this act is more effective than most other detective systems. Dodd-Frank and Sarbanes- Oxley have extended considerable whistle-blowers protection. The most famous whistle-blower, Sheron Watkins, wrote to the Commission –
“thanks to the bounty provisions of the Dodd-Frank law passed in 2010, that path is now clear, and I am a firm believer that having that path of reporting to the Commission is essential to helping the securities industry be a safer place of investment for shareholders.”
Alternative method of Data Gatherers and provision for Safe Harbor for Analysts, Legislative Initiative of 10b5-SH
An alternative idea was the introduction of the legislative initiative for defining clear boundaries, reducing uncertainty within the enforcement regime of trading, providing necessary incentives for analyst and information gatherers to develop innovative research strategies and methods by adding provisions for safe harbor. Moreover, the Supreme Court has also warned that the only protection that the market participants have to rely on is the Commission’s reasonableness, but that can also turn out to be hazardous.
Irrespective of the developments by the circuit courts, Supreme Court, and the Securities and Exchange Commission (Commission), the “insider trading laws are among the most amorphous and vague in the entire criminal code.” This legal uncertainty has been exacerbated in recent years by pursuing and developing novel theories related to liability for insider trading that have not previously been recognized by courts. The same has been compounded with the enforcement actions and litigation posture. As a result, there is lack of reliable guidelines that could effectively inform the innovative investors researchers about the legal boundaries
The Commission has targeted securities analysts irrespective of the fact that their efforts in disseminating, analyzing, and compiling information, and in the identification and preventing corporate fraud, is necessary for the efficient marketing functioning. The Supreme Court, along with the Congress, had recognized the important nature of analysts’ work long ago and have therefore emphasized the importance of protecting analysts in insider trading liability. Congress has supported the ability of analysts in generating profit from the information possessed by them, with an understanding that – without the pecuniary gain potential – analysts would have little incentive in undertaking their efforts. The Commission has also recognized that the efforts of the analysts can help in increasing the market efficiency and therefore help in benefiting the whole market. The impact directly comports with Commission’s mission portion that aims at enhancing the information flow. Nevertheless, the Commissions consequences on the legal uncertainties and the “war on insider trading,” are likely to harm the primary objectives of the commission with the help of inhibiting the flow of information and development of different market participants and analysts.
Instead of stifling the flow of information, the Commission needs to embrace and recognize the policy that supports the Intellectual Property law. Therefore this law includes the right and ability to benefit from the intellectual efforts of an individual that is required to be protected by the government to induce and reward individuals for bringing forward new and better knowledge. The Commission was therefore required to adopt a new safe harbor Rule 10b5-SH to carry out the policy. This new rule would incentivize and protect the research strategies and methods that are “replicable.”
Courts and congress have an understanding that analysts cannot perform their function unless they got the opportunity of earning profits from their efforts. This disconnect between the apparent agreement of the commission – efficient functioning of the markets are dependent upon the analysts. On the other hand, the Commission ‘s support for the rule of parity-of-information is a failure to acknowledge the impact of the rule on the analysts incentives to analyze and gather information. To bridge the gap, the Commission is required to look at the laws relating to intellectual property in The United States –“ the right to benefit from one’s intellectual efforts is deliberately projected by the government to induce and reward individuals to “bring forth new knowledge.” As Thomas Jefferson once wrote, “ingenuity should receive a liberal encouragement.” The encouragement of financial markets needs to take the form of a protected opportunity for profit earning within the regime of enforcement that also provides for reliable guidelines and also reduces the substantial risk associated with insider trading. And therefore, only the opportunity is to be guaranteed and not the rewards.
Conclusion
The Commission needs to realize that it is not feasible to set a market that is ideally fair. The market where there is an equal volume of the information for all is impossible; but, it does not necessarily mean that Commission should not set the goals for chasing perfect order.
A finance professor at California-Berkeley University agreed that it is necessary to have clear legal boundaries such that everyone can understand what is not permitted and what is. However, he argumented against too many restrictions on information flow, and he called all the people in the financial system as professionals. Therefore they will always know more than an investor and it should be in that way only. The professionals should not pay, but if the professional are unable to dig up more information than amateurs, they should certainly find another job.
On the other hand, Chairman Levitt observed that: “Individual investors think – and I passionately believe – that the proverbial little guy’ on Main Street should have the same fair chance as the big guys.'”
To boost the confidence of the domestic investors and attract the international investment community.
