By JACK HOUGH
There's no statutory> definition of illegal insider trading. Congress considered creating one in 1984 when it sharply increased penalties for those who are found guilty. The Securities and Exchange Commission opposed the creation of a definition, arguing "existing law provides a sound legal framework for judicial analysis and review of new and unforeseeable trading devices and strategies." Some senators expressed concern about the complexity of a definition. Sen. Alfonse D'Amato of New York said he didn't want to delay passage of the new penalties to create one. So Congress didn't create one.
"A vague law is the prosecutor's best friend," says Stephen Bainbridge, a law professor at UCLA and member of the Bar Association's Committee on Corporate Laws. Without a strict definition, the SEC can shape and fit existing case law for each new prosecution, which increases its power, Bainbridge says.
William Wang, author of "Insider Trading," seems less critical. "If you create a strict definition, people will find loopholes," says the UC Hastings law professor and former member of the National Adjudicatory Council for FINRA, which regulates U.S. securities firms.
To explore the vagaries or lack thereof in insider trading law, I created five hypothetical scenarios and asked professors Bainbridge and Wang whether each constitutes insider trading. (I also asked the SEC to comment, but it declined.)
The SEC provides a useful recap of insider trading law here. To make a long story preposterously short, all investors (not just company insiders) are prohibited from trading on misappropriated information that is both material to securities returns and not available to the general public.
Question 1: A janitor notices that the typically quiet phones in his company's sales department are suddenly ringing wildly. He takes that to mean his company's new products have caught on with customers and he buys shares.
Bainbridge: No. It's not material information. If the janitor found a memo about a takeover, that would be clear, but the meaning behind phones ringing seems speculative.
Wang: Probably not. It's definitely non-public information but it's not necessarily material. The test is whether there's a substantial likelihood that a reasonable investor would consider it important. That's not a legal question so much as a question of fact for a jury.
Question 2: A chief executive tells a shareholder with a 6% stake that the company is planning a stock offering. Stock offerings tend to dilute the value of existing shares. The shareholder sells.
Bainbridge: I don't think so. I co-signed an amicus brief in support of [the defense in a similar case]. But I would be the first to concede it's a gray area.
Wang: I'd rather not comment. At one point I was consulted as an expert for the defense [on a similar case]. It's complicated.
Question 3: A Wall Street researcher, paid to opine on shares of Hypothetical Computer, calls overseas suppliers known to make components for Hypothetical and asks about sales. Upon learning that demand is strong, he urges clients to buy shares of Hypothetical.
Bainbridge: No. There's no quid pro quo between the analyst and supplier. The SEC takes the position that contractual obligations [between the supplier and Hypothetical] are enough, but there hasn't been a judicial decision that determines that.
Wang: It depends on whether the company has sworn its supplier to secrecy.
Question 4: A top lieutenant at an investment company buys shares of another company before pitching his boss on a takeover. The boss eventually agrees to the pitch and the takeover occurs at a large premium.
Bainbridge: I don't think so. There are questions about the materiality of the information. What's he trading on? His intentions. He intended to pitch the deal. Trading on your own intentions is not something for which we've ever assigned liability. When you're dealing with things like the possibility that a merger will occur, courts have generally required concrete signs: the hiring of lawyers and bankers, appraisals and so on. When the answer to those questions is no, I simply don't think the information is material.
Wang: My inclination is yes, if there's a company policy against it. This is more likely to be material than the earlier janitor example, but again, it's a fact-finding matter for a jury. They might have to look into the percentage of takeovers that the lieutenant pitched in the past that were done.
Question 5: A U.S. senator learns that Pretend Aerospace is about to get a big government contract. He buys shares. (Insider trading laws created for Wall Street don't apply to Congress. A bill introduced in 2006 would create insider trading laws for government workers. Previous such bills have failed.)
Bainbridge: It should be insider trading, but it's not. Congress has no fiduciary duty to the voters. (Some people disagree with me on that point.)
Wang: Yes, if there's an ethics policy that prohibits it. Some commentators have argued that there is.