Keeping Markets Fair: Considering Insider Trading Legislation (U.S. Senate Committee on Banking, Housing, and Urban Affairs)

Hearing	Keeping Markets Fair: Considering Insider Trading Legislation
Committee	U.S. Senate Committee on Banking, Housing, and Urban Affairs
Date	April 5, 2022

 

Hearing Takeaways:

• Insider Trading Policy and the Insider Trading Prohibition Act: The hearing mainly focused on how the U.S. currently prosecuted insider trading and the proposed Insider Trading Prohibition Act, which would codify some of the current insider trading case law. Committee Members and the hearing’s witnesses highlighted how the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice (DoJ) have prosecuted insider trading for decades using principles of fraud under the securities laws and mentioned how most of these principles have been developed without a standard defined by Congress. They further noted how different decisions across different federal courts have only added to the confusion surrounding what constitutes illegal insider trading. They called for the U.S. to develop clear and strict statutory rules for determining what exactly would constitute illegal insider trading. 
  • Inability to Prosecute Insider Trading Cases Against Hackers: Full Committee Chairman Sherrod Brown (D-OH) and Prof. Jackson highlighted how a party that hacked into a computer system in order to access material non-public information (MNPI) and then make trades based on said MNPI might not have actually committed illegal insider trading according to existing statutes and case law. Prof. Jackson explained that current insider trading laws currently did not cover NMPI obtained through cyberattacks because the federal government needed to demonstrate that NMPI was obtained through either the breach of a duty or deception in order for that activity to constitute illegal insider trading. He highlighted how many cyberattacks were not perpetrated via deception and were instead perpetrated via brute force tactics that overwhelmed the defenses of companies. Chairman Brown and Prof. Jackson expressed interest in working to define such cyberattacks as insider trading under federal statutes. 
  • Ability of Corporate Insiders at Foreign-Domiciled Companies Listed in the U.S. to Trade on Inside Information: Sen. Chris Van Hollen (D-MD) and Prof. Jackson expressed concerns with how corporate insiders at foreign-domiciled companies listed in the U.S. were not subject to prompt disclosure requirements for their trades in the stocks of their companies. They stated that this lack of a disclosure requirement posed risks that foreign firm insiders would be able to take advantage of ordinary investors. Sen. Van Hollen mentioned how he was working on legislation to address this topic.
  • Ability of Corporate Insiders to Take Advantage of Stock Buybacks: Sen. Mark Warner (D-VA) and Prof. Jackson raised concerns that companies could time their stock buybacks based on inside knowledge of impending downturns. Prof. Jackson called for requiring corporate executives to hold their shares when their companies engaged in stock buybacks.
  • Ability of Corporate Insiders to Trade on Information that Not Yet Been Publicly Released: Sen. Van Hollen and Prof. Jackson discussed how public companies were required to disclose significant corporate events to the public within four business days after the events had occurred and noted how corporate insiders often traded the stocks of their companies in the period between the events and the discourse. Sen. Van Hollen mentioned how he had introduced the 8-K Trading Gap Act of 2021 in order to prevent corporate insiders from trading the stocks of their companies during this period.
  • Ability of Members of Congress to Trade Based on MNPI: Sen. Elizabeth Warren (D-MA) remarked that Members of Congress were in a unique position to obtain information that they could then use to game the stock market. She asserted that the risks for insider trading among government officials were even higher than the risks for insider trading among corporate executives because government officials could use their positions to influence private outcomes and the values of the stocks that they hold or trade. She mentioned how she had introduced bipartisan legislation to ban Members of Congress from owning or trading individual stocks.
  • Concerns over the Insider Trading Prohibition Act’s Personal Benefit Requirements: A key areas of contention regarding the Insider Trading Prohibition Act was its reliance on a personal benefit requirement as grounds for prosecuting insider trading cases. Prof. Coffee called the personal benefit requirement “overly narrow” because it permitted the trading of insider information so long as the party providing the insider information did not receive direct compensation for said information. He stated that norms of reciprocity within the financial services industry meant that insider information could be traded without immediate or direct compensation, which could lead insider information tippers to evade prosecution for illegal insider trading. He suggested that the Insider Trading Prohibition Act adopt a wrongfulness standard in order to cover activities not covered under the personal benefit standard. However, Prof. Henderson argued that the Insider Trading Prohibition Act’s inclusion of the phrase ‘indirect personal benefit” was overly broad and could lead to excessive insider trading prosecutions. He contended that the legislation should more narrowly define a tipper as receiving a personal benefit when the tipper either receives something tangible in return for providing MNPI or provides some type of monetary benefit to a relative or friend as a result of their release of MNPI.
  • Concerns over the Insider Trading Prohibition Act’s Lack of an Exclusivity Provision: Prof. Henderson and Prof. Coffee highlighted how the Insider Trading Protection Act did not contain an exclusivity provision and stated that the absence of such a provision would allow for the U.S. government to use other laws (such as 18 U.S.C. 1348) to bring illegal insider trading cases. They commented that this lack of an exclusivity provision could ultimately render the legislation moot.
  • Concerns that the Insider Trading Prohibition Act Would Reduce Incentives for Stock Research: Prof. Henderson remarked that insider trading was considered illegal when a corporate insider deceptively takes MNPI that does not belong to them and uses the information to trade or when a corporate insider provides the MNPI to someone else in exchange for a benefit. He raised concerns that the Insider Trading Prohibition Act could have a chilling effect on the “necessary work” to ensure accurate stock prices. He commented that this legislation could result in the misallocation of capital and impose large compliance costs on investment funds.
  • Concerns that the Insider Trading Prohibition Act Would Impose Significant Compliance Burdens: Prof. Henderson contended that the costs of ensuring that investment professionals do not violate the Insider Trading Protection Act would fall disproportionately on smaller and mid-sized investment funds. He mentioned how these funds were more likely to be operated by women and minorities and more likely to be engaged in environmental, social, and corporate governance (ESG) strategies.
  • Concerns that the Insider Trading Prohibition Act Contained Overly Broad and Ill-Defined Provisions: Prof. Henderson discussed how the Insider Trading Protection Act stated that trading based on information obtained through theft and deception would lead to liability and contained a “very broad” provision relating to confidentiality. He asserted that this proposal was “ripe for abuse” and suggested that companies could theoretically prevent a party from trading their stocks through merely providing them with unwanted information. He further noted how the Insider Trading Protection Act would expand the type of traders that could be liable for insider trading beyond traders that acted with intent to violate the law. He indicated that the legislation would make it so individuals that were aware, consciously avoided being aware, or recklessly disregarded how information was obtained or communicated could have an insider trading case brought against them. He criticized the legislation for not defining the phrase “recklessly disregarded” and asserted that the absence of such a definition could subject innocent parties to insider trading cases. He stated that investors should be permitted to reveal a company’s MNPI if the NMPI involved fraud or illicit activity.
• Startup Access to Capital Issues: Committee Republicans, Prof. Henderson, and Mr. Burton expressed interest in working to support startup access to capital and to build upon the Jumpstart Our Business Startups (JOBS) Act. They raised concerns with how the number of public companies in the U.S. had declined by 40 percent since its peak in the late 1990s and contended that this decline would be even worse if the JOBS Act had not been enacted into law.
  • JOBS Act 4.0 Discussion Draft: Ful Committee Ranking Member Patrick Toomey (R-PA) mentioned how he had recently released a discussion draft of his JOBS Act 4.0 legislation, which contained proposals to encourage companies to go public (particularly during earlier growth stages), create special regulations for small businesses seeking to raise capital through private markets, enhance retail investor access to investment opportunities, and improve regulatory oversight. He indicated that he was soliciting feedback on the discussion draft over the next 60 days. Full Committee Chairman Sherrod Brown (D-OH) indicated that he would be meeting with Ranking Member Toomey later in the week to review the JOBS Act 4.0 draft legislation.
  • Increasing Investment Opportunities for Ordinary Americans: Sen. Tom Tillis (R-NC) mentioned how he had introduced the Equal Opportunity for All Investors Act, which would enable people to achieve accredited investor status through passing a test. Mr. Burton remarked that this legislation would provide clarification as to what constitutes a sophisticated investor under Regulation D. He commented that accredited investors were rare throughout much of the U.S. and stated that the legislation would help to address these shortages. Prof. Henderson remarked that Congress and the SEC ought to expand opportunities for investors to access private equity and other asset classes consistent with fiduciary duties under the Employee Retirement Income Security Act of 1974 (ERISA).
  • Concerns Regarding Proposed SEC Discourse Rules: Ranking Member Toomey and Mr. Burton raised concerns over how the SEC’s 23 recent proposals could further increase the costs of initial public offerings (IPOs) and could undermine the U.S.’s leadership in providing active and efficient capital markets. They criticized the SEC’s proposals to require companies to disclose facts that were not financially material in nature. They specifically highlighted proposed SEC disclosures related to climate change, diversity, equity, and inclusion (DEI), and human capital management practice.
  • Concerns Regarding Proposed SEC Rule on Special Purpose Acquisition Companies (SPACs): Ranking Member Toomey noted that while there had recently occurred an uptick in IPOs as a result of the advent of SPAC offerings, he stated that this uptick might be an aberration if SPACs turned out to be a temporary phenomenon. He raised concerns that the SEC’s recently proposed rule for SPACs could lead to the end of SPACs. He attributed investor demand for SPAC offerings to the fact that SPACs provided accessible growth stage investment opportunities to ordinary investors.

Hearing Witnesses:

1. The Hon. Robert J. Jackson Jr., Pierrepont Family Professor of Law, New York University School of Law
2. Prof. M. Todd Henderson, Michael J. Marks Professor of Law, University of Chicago Law School
3. Mr. David R. Burton, Senior Fellow in Economic Policy, Roe Institute for Economic Policy Studies, The Heritage Foundation
4. Professor John C. Coffee Jr., Adolf A. Berle Professor of Law, Director of The Center on Corporate Governance, Columbia Law School

Member Opening Statements:

Full Committee Chairman Sherrod Brown (D-OH):

• He asserted that the stock market was “detached” from the reality of most people’s lives and stated that the stock market disproportionately benefited wealthy Americans.
  • He referenced a U.S. Federal Reserve study that had found that the wealthiest one percent of Americans hold 53 percent of stock and mutual fund investments while the bottom 90 percent of Americans own less than 12 percent of these investments.
• He remarked that the aforementioned dynamics fostered distrust amongst the American public towards both financial markets and banks and contended that this distrust was justified.
• He stated that it was currently very easy for corporate insiders to exchange inside information without facing consequences.
• He discussed how the SEC and the DoJ have prosecuted insider trading for decades using principles of fraud under the securities laws and noted how most of these principles have been developed without a standard defined by Congress.
  • He called it surprising that the U.S. lacked laws that specifically outlined what constitutes illegal insider trading.
• He further noted how decisions from federal courts (including the U.S. Supreme Court) have only added to the confusion surrounding what constitutes illegal insider trading.
• He remarked that the U.S. needed clear and strict statutory rules for determining what exactly would constitute illegal insider trading.
  • He commented that such statutory rules would help to reduce uncertainty and inconsistency.
• He then discussed how there might exist limits on the U.S.’s ability to use insider trading case law to hold new varieties of improper trades accountable.
• He highlighted how a party that hacked into a computer system in order to access insider information and then make trades on said information might not have actually committed illegal insider trading according to existing statutes and case law.
  • He commented that the U.S. ought to consider this type of hacking and trading to be illegal insider trading.
• He applauded Rep. Jim Himes (D-CT) and Sen. Jack Reed (D-RI) for their work on legislation that would establish standards for what constitutes illegal insider trading.
• He remarked that a statutory definition of insider trading would capture abuses and misconduct that courts have found to be outside the concepts of “fraud” and “deception.”
  • He noted that the measures under consideration at the hearing would address these abuses (such as the aforementioned hacking example) by focusing on “wrongfully” acquired nonpublic information.
• He reiterated that the Committee must address illegal insider trading in order to instill public confidence in the financial markets.

Full Committee Ranking Member Patrick Toomey (R-PA):

• He first noted how the bipartisan Jumpstart Our Business Startups (JOBS) Act was signed into law exactly ten years ago and stated that this law’s streamlined pathway for startups to go public as emerging growth companies (EGCs) had accounted for 90 percent of the IPOs since 2014.
• He indicated however that the number of public companies was continuing to decrease and mentioned how the number of public companies had declined by 40 percent since its peak in the late 1990s.
  • He contended that this decline would be even worse if the JOBS Act had not been enacted into law.
• He remarked that the decrease in the number of public companies was hurting economic growth, limiting avenues for funding for American businesses, and reducing investment opportunities for average Americans.
• He noted that while there had recently occurred an uptick in IPOs as a result of the advent of SPAC offerings, he stated that this uptick might be an aberration if SPACs turned out to be a temporary phenomenon.
  • He commented that the SEC’s recently proposed rule for SPACs could lead to the end of SPACs.
• He attributed investor demand for SPAC offerings to the fact that SPACs provided growth stage investment opportunities in an accessible manner.
• He stated that the purpose of IPOs had shifted overtime from being a capital raising event to a liquidity event for investors, which led IPOs to become more expensive.
• He raised concerns that the SEC’s 23 recent proposals would further increase the costs of IPOs and could undermine the U.S.’s leadership in providing active and efficient capital markets.
  • He specifically mentioned how the SEC’s climate change risk disclosure proposal would nearly triple the external compliance costs for companies to prepare their annual 10-K statements according to the SEC’s own estimates.
• He mentioned how he had recently released a discussion draft of his JOBS Act 4.0 legislation, which contained proposals to encourage companies to go public (particularly during earlier growth stages), create special regulations for small businesses seeking to raise capital through private markets, enhance retail investor access to investment opportunities, and improve regulatory oversight.
  • He indicated that he was soliciting feedback on the discussion draft over the next 60 days.
• He remarked that his proposed JOBS Act 4.0 legislation would enable average Americans to access the same investment opportunities as union pensions, institutional investors, and high-net worth individuals.
• He then discussed the importance of providing market participants with incentives to use lawful means to discover information, conduct analysis, and develop investment hypotheses and to then use such efforts to make better decisions about market prices.
  • He stated that insider trading was problematic because it involved a person wrongfully obtaining or using MNPI in breach of a fiduciary duty or through misappropriation.
• He mentioned how federal courts had developed an extensive body of case law related to insider trading and asserted that Congress ought to codify what exactly constitutes illegal insider trading.
  • He stated however that Congress should be cautious in codifying what exactly constitutes illegal insider trading so as to not cause confusion, uncertainty, or unintended consequences (particularly in investment research).

Full Committee Chairman Sherrod Brown (D-OH):

• He indicated that he would be meeting with Full Committee Ranking Member Patrick Toomey (R-PA) later in the week to review the JOBS Act 4.0 draft legislation, as well as other policy topics.

Witness Opening Statements:

The Hon. Robert J. Jackson Jr. (New York University School of Law):

• He discussed how Congress had never codified insider trading rules and stated that this lack of codification exposed both defendants and ordinary investors to gaps in U.S. law.
• He mentioned how he had been part of the bipartisan Bharara Task Force on Insider Trading composed of prosecutors, defense counsel, legal academics, and judges to consider insider trading laws and noted that the Task Force had concluded that Congress ought to codify insider trading laws.
  • He expressed agreement with the Task Force’s conclusion.
• He expressed support for the Insider Trading Prohibition Act, which would focus liability on whether information was wrongfully taken, used, or communicated.
• He also remarked that current law allowed for hackers to profit from trading on their criminal activities and allowed for insiders at foreign firms listed in the U.S. to profit extensively from insider trading.
• He stated that illicit actors often hacked the computer networks of public companies in order to obtain NMPI that they would then use to inform their trading activities.
  • He commented that the use of this strategy resulted in public markets effectively being used to fund cyberattacks.
• He explained that current insider trading laws currently did not cover NMPI obtained through cyberattacks because the federal government needed to demonstrate that NMPI was obtained through either the breach of a duty or deception in order for that activity to constitute illegal insider trading.
  • He highlighted how many cyberattacks were not perpetrated via deception and were instead perpetrated via brute force tactics that overwhelmed the defenses of companies.
• He contended that the ability of hackers to evade prosecution for insider trading raised doubts about the fundamental fairness of public markets.
• He noted how the Insider Trading Prohibition Act would outlaw trading based on information obtained through cybersecurity attacks.
• He then discussed the problem of insider trading by executives at foreign firms listed within the U.S. and noted how insiders at foreign firms were not required to promptly disclose their trades in the stocks of their companies.
  • He commented that this lack of a disclosure requirement posed risks that foreign firm insiders would be able to take advantage of ordinary investors.
• He mentioned how he had co-authored a study that had found that foreign firm insiders were able to avoid substantial losses through selling shares in the stocks of their companies before these stock prices dropped.
  • He testified that this activity appeared to be concentrated in firms domiciled in just a few countries, including China and Russia.
• He called it unfair that insiders at foreign firms listed within the U.S. were being subjected to a different set of insider trading rules as compared to insiders at U.S. companies (who are required to promptly disclose their trades to investors).
  • He contended that the SEC should reconsider the exemption that foreign firms possess to insider trading disclosure rules under the Securities Exchange Act of 1934 (SEA).
• He concluded that the case law that has emerged regarding insider trading had created gaps that enabled corporate insiders to take advantage of ordinary investors and asserted that Congress must subject all market participants to the same set of rules.

Prof. M. Todd Henderson (University of Chicago Law School):

• He remarked that the costs of regulatory compliance for companies fell on all Americans and stated that the money that companies spent on regulatory compliance was being diverted away from employing workers, investing in research and development (R&D), and providing products and services.
  • He asserted that the goal of federal law ought to be to obligate companies to spend no more than absolutely necessary to protect investors and ensure robust capital markets.
• He contended that the current costs of corporate fundraising were too high and stated that the burdens of securities disclosure were “many times” higher than they were just a few decades ago.
• He further remarked that the risk of meritless securities fraud lawsuits remained high, despite Congressional efforts to eliminate such lawsuits.
  • He commented that these lawsuits had led to a “sharp” drop in the number of public companies.
• He noted how companies were resorting to new capital formation approaches, such as SPACs, as a work around for going public.
  • He asserted that the mere fact that SPACs were viewed as necessary for capital formation by investors and companies should give regulators pause when considering whether to impose additional regulations on companies seeking to go public.
• He criticized the SEC for issuing new rules that increased the costs associated with companies that wanted to go public and that prevented Americans from investing in private markets.
  • He stated that the ability of companies to access capital through private markets could help struggling companies to revive their businesses, adopt more appropriate governance approaches, and protect themselves from managers that might act in self-serving ways.
• He remarked that Congress and the SEC ought to expand opportunities for investors to access private equity and other asset classes consistent with fiduciary duties under the Employee Retirement Income Security Act of 1974 (ERISA).
• He then discussed the topic of insider trading and disputed the conventional wisdom that it was unlawful to trade equities based on MNPI.
  • He noted how investment advisors and stock market analysts made their livings seeking informational advantages for their clients.
• He stated that the absence of incentives to obtain NMPI would result in less information about stock prices, which would mean that stock prices would be less accurate.
  • He commented that this would result in inefficient capital allocations that would harm the entire economy.
• He remarked that insider trading based on informational advantages was only illegal when it resulted in a violation of the anti-fraud provisions of federal securities laws.
• He elaborated that insider trading was considered illegal when a corporate insider deceptively takes MNPI that does not belong to them and uses the information to trade or when a corporate insider provides the MNPI to someone else in exchange for a benefit.
  • He highlighted how the U.S. Supreme Court had provided this property-based approach to insider trading in their U.S. v. O’Hagan decision.
• He remarked that while the Insider Trading Protection Act purported to merely codify existing case law, he raised concerns that the legislation could have a chilling effect on the “necessary work” to ensure accurate stock prices.
  • He commented that this legislation could result in the misallocation of capital and impose large compliance costs on investment funds.
• He further stated that the costs of ensuring that investment professionals do not violate the Insider Trading Protection Act would fall disproportionately on smaller and mid-sized investment funds.
  • He mentioned how these funds were more likely to be operated by women and minorities and more likely to be engaged in ESG strategies.
• He noted that while the Insider Trading Protection Act purported to codify the existing personal benefit requirement for information tippers, he highlighted how the legislation includes the phrase “indirect personal benefit” (which he called overly broad).
• He contended that the Insider Trading Protection Act should more narrowly define a tipper as receiving a personal benefit when the tipper either receives something tangible in return for providing MNPI or provides some type of monetary benefit to a relative or friend as a result of their release of MNPI.
• He also discussed how the Insider Trading Protection Act stated that trading based on information obtained through theft and deception would lead to liability and contained a “very broad” provision relating to confidentiality.
  • He asserted that this proposal was “ripe for abuse” and suggested that companies could theoretically prevent a party from trading their stocks through merely providing them with unwanted information.
• He further noted how the Insider Trading Protection Act would expand the type of traders that could be liable for insider trading beyond traders that acted with intent to violate the law.
  • He indicated that the legislation would make it so individuals that were aware, consciously avoided being aware, or recklessly disregarded how information was obtained or communicated could have an insider trading case brought against them.
  • He criticized the legislation for not defining the phrase “recklessly disregarded” and asserted that the absence of such a definition could subject innocent parties to insider trading prosecution.
• He lastly criticized the Insider Trading Protection Act for not containing an exclusivity provision and stated that the absence of such a provision would allow for the U.S. government to use other laws (such as 18 U.S.C. 1348) to bring illegal insider trading cases.

Mr. David R. Burton (Roe Institute for Economic Policy Studies, The Heritage Foundation):

• He remarked that the JOBS Act had been very beneficial and had improved access to capital for entrepreneurs.
  • He noted how between 3 percent and 7 percent of the private capital raised annually in the U.S. was attributable to JOBS Act offerings.
• He discussed how the JOBS Act’s changes fell under five basic categories: smaller public EGCs, general solicitation under Regulation D, crowdfunding, an improved small issues exemption (i.e. Regulation A+), and changes to the registration threshold.
• He contended that Title I of the JOBS Act (which included the law’s EGC provisions) had played a key role in stopping the decline in IPOs.
• He stated that Title II of the JOBS Act (which permitted general solicitation under Regulation D) had helped companies raise between $65 billion and $200 billion annually.
  • He commented that this provision was a “major and underappreciated success.”
• He asserted however that the crowdfunding provisions under Title III of the JOBS Act have largely failed because of the underlying statute and the SEC’s subsequent actions.
  • He contended that both the tiny crowdfunding issuers and funding portals were “significantly” overregulated.
• He stated that while recent SEC revisions might help to reduce the aforementioned problems related to crowdfunding, he asserted that these revisions would not address the fundamental problems associated with the provision.
• He also called Title II of the JOBS Act (which established Regulation A+) a “modest success” and noted how it was currently used to raise about $1 billion annually.
  • He commented that there were potential reforms included in the JOBS Act 4.0 discussion draft that could make Regulation A+ a more important source for entrepreneurial capital formation.
• He then remarked that the legislative proposals included within the JOBS Act 4.0 discussion draft would “dramatically” improve access to capital for entrepreneurs and improve investor protections and returns.
  • He stated that the discussion draft would remove restrictions on secondary market sales, democratize access to private equity assets, and make “major” improvements to the rules governing EGCs, Regulation D, Regulation A, crowdfunding, micro-offerings, finders, exchanges, periodic disclosure requirements by issuers, business brokers, small broker-dealers, investment companies, and retirement plans.
• He further discussed several legislative proposals included within the JOBS Act 4.0 discussion draft that he believed would support capital formation efforts.
  • He highlighted how the Small Entrepreneurs’ Empowerment and Development (SEED) Act of 2021 would create a micro-offering exemption, which he commented would benefit small companies.
  • He expressed support for the Unlocking Capital for Small Businesses Act of 2022 and stated that the legislation would help small entrepreneurs to access capital found in money centers using finders and private placement brokers.
  • He noted how the Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act of 2021 would clarify the rules governing broker-dealers.
  • He stated that the Equal Opportunity for All Investors Act of 2021 would democratize access to private offerings.
  • He further noted how the discussion draft would make clear that ERISA fiduciaries that managed defined contribution plans would be able to invest in private equity and other assets.

Prof. John C. Coffee Jr. (The Center on Corporate Governance, Columbia Law School):

• He criticized the Insider Trading Prohibition Act for its establishment of a personal benefit requirement and asserted that this requirement could make it impossible to prosecute insider trading cases against sophisticated parties.
• He expressed support however for the Insider Trading Prohibition Act’s efforts to codify illegal insider trading and mentioned how insider trading was first defined by the SEC in 1961.
  • He noted how the SEC and federal courts had redefined what constitutes illegal insider trading activity over time without the involvement of Congress.
• He stated that Congress’s pattern of periodically raising the penalties for illegal insider trading demonstrated the body’s opposition to the practice.
• He remarked that the U.S.’s reliance on courts to develop and enforce insider trading penalties resulted in enforcement disparities as different federal circuit courts maintained different standards.
  • He noted how some federal circuit courts had a personal benefit requirement for insider trading cases while the U.S. Court of Appeals for the Second Circuit (which oversaw most of the U.S.’s trading activity) did not have such a requirement for insider trading cases.
• He asserted that the passage of the Insider Trading Prohibition Act would not address this issue of disparities because prosecutors could simply use other statutes (such as 18 U.S.C. 1348) to pursue insider trading cases.
• He noted that while Congress could address the aforementioned issue in the Insider Trading Prohibition Act through adopting an exclusivity provision in the law, he contended that such an approach would be rash in light of the current uncertainty surrounding the United States v. Blaszczak case.
• He remarked however that the absence of an exclusivity provision in the Insider Trading Prohibition Act would result in prosecutors choosing to bring cases under the easiest legal pathway.
  • He commented that 18 U.S.C. 1348 would constitute the easiest legal pathway.
• He then elaborated on his criticism of the Insider Trading Prohibition Act’s personal benefit requirement and stated that this requirement served as an obstacle to insider trading prosecutions.
• He noted how the Bharara Task Force on Insider Trading (which he had served on) had recommended that the U.S. move away from a personal benefit requirement for insider trading prosecutions and focus more broadly on a wrongfulness standard for such prosecutions.
• He lastly discussed how the practice of insider information tipping was common amongst hedge funds due to norms of reciprocity.
  • He commented that this dynamic had fostered insider trading amongst hedge funds as parties technically did not receive a personal benefit for the tipping of information (which meant that the parties could not be prosecuted for insider trading).

Congressional Question Period:

Full Committee Chairman Sherrod Brown (D-OH):

• Chairman Brown noted how the Insider Trading Prohibition Act would establish a framework that bans insider trading and would identify when sharing and trading on insider information would be wrongful. He asked Prof. Coffee to address why it was important for Congress to target wrongful conduct.
  • Prof. Coffee discussed how the wrongfulness requirement was the alternative to the personal benefit requirement. He called the personal benefit requirement “overly narrow” because it permitted the trading of insider information so long as the party providing the insider information did not receive compensation for said information. He stated that norms of reciprocity within the financial services industry meant that insider information could be traded without immediate or direct compensation, which could lead insider information tippers to evade prosecution for illegal insider trading. He recommended that Congress remove the current personal benefit requirement from the Insider Trading Prohibition Act and commented that he would support the legislation if such a change were made. He mentioned how the legislation’s personal benefit requirement was added only minutes prior to its passage in the U.S. House of Representatives.
• Chairman Brown then asked Prof. Jackson to discuss how disagreements across different federal circuit courts on insider trading matters had impacted the enforcement of insider trading.
  • Prof. Jackson remarked that the lack of clarity surrounding insider trading had caused “real problems” with regard to the application of the U.S.’s securities laws. He stated that market participants were often aware that this lack of clarity prevented certain insider trading cases from being brought, which led these market participants to engage in even more insider trading. He also remarked that the fact that federal circuit courts had addressed the issue of insider trading did not mean that Congress should not address the issue.
• Chairman Brown asked Prof. Jackson to identify the types of fact patterns that would suggest that a party was cognizant that they were wrongfully engaging in insider trading.
  • Prof. Jackson discussed how many parties engaged in insider trading will purchase short-dated out-of-the-money call options in order to maximize their profits. He noted that these parties often claimed that their successful short-dated out-of-the-money call options were the result of luck. He stated that the SEC and federal courts were very cognizant of this illegal strategy and that the SEC was fairly perceptive as to when illegal insider trading was occurring.
• Chairman Brown then noted how critics of the Insider Trading Prohibition Act had suggested that the legislation would criminalize normal activities (such as stock research and accidental communications of confidential information) and expand the scope of illegal insider trading beyond its current limits. He asked Prof. Coffee to indicate whether these critics had a realistic view of the legislation.
  • Prof. Coffee remarked that the Insider Trading Prohibition Act should be amended to include a wrongfulness requirement. He stated that the mere possession of MNPI should not create a duty for a party to abstain from trading. He asserted that parties that engaged in trading based on MNPI that they knew was wrongfully obtained should be subject to insider trading prosecution. He stated that the Insider Trading Prohibition Act’s current personal benefit requirement would enable bad actors to cleverly avoid breaking the law.
  • Prof. Jackson remarked that insider trading laws had failed to keep up with how markets actually function. He stated that it was often difficult for prosecutors to prove that a party engaged in insider trading received a personal benefit and highlighted how MNPI often was shared informally between market participants. He asserted that the law ought to impose penalties when the sharing of such MNPI was “wrongful.”

Full Committee Ranking Member Patrick Toomey (R-PA):

• Ranking Member Toomey commented that the crux of the hearing’s debate appeared to surround whether there would need to be either a direct or indirect personal benefit in order to prosecute insider trading cases. He asked Prof. Henderson to address why he believed that there should not exist an indirect personal benefit standard for insider trading cases. He also asked Prof. Henderson to project the adverse impacts that would materialize if the Insider Trading Prohibition Act were to become law.
  • Prof. Henderson expressed skepticism towards Prof. Jackson’s assertion that the SEC generally could perceive when wrongful insider trading activity was occurring. He discussed the Dirks v. Securities and Exchange Commission insider trading case, which involved the SEC trying to prosecute an individual for insider trading because the individual had received MNPI that the company whose stock he was trading was engaged in a Ponzi scheme. He noted that the individual in this case had repeatedly tried to tell the government that the company was engaged in a Ponzi scheme to no avail. He asserted that the individual in this case was not engaged in wrongful conduct, despite the SEC’s contention. He stated that the SEC’s long-standing approach had been to work to ensure information parity across all market participants. He called this approach problematic if it were to be used to determine wrongfulness. He expressed agreement with Prof. Coffee’s view that the stealing of MNPI for some financial gain (with the expectation of either immediate or future reward) was problematic. He remarked however that individuals seeking to reveal a company’s bad activity were not acting in a wrongful manner. He contended that a property rights approach to insider trading was not always correct. He stated that the government should instead need to prove that a person’s stealing of insider information was self-serving (either in the immediate-term or over the long-term).
• Ranking Member Toomey then discussed how the U.S. had experienced a large decline in its number of public companies, despite the overall growth in the U.S. economy. He asked Mr. Burton to provide an explanation for this decline in the number of U.S. public companies.
  • Mr. Burton first remarked that increased regulatory burdens for public companies were dissuading many companies from going public. He commented that the SEC’s current rules under consideration would only make these regulatory burdens worse. He also stated that there had occurred a “substantial” increase in litigation risk and the associated costs made companies less willing to go public.
• Ranking Member Toomey stated that the SEC was proposing to require companies to disclose facts that were not financially material in nature. He asked Mr. Burton to comment on the wisdom of these requirements.
  • Mr. Burton remarked that the SEC’s imposition of disclosure requirements for non-financially material information would constitute a “serious mistake.” He asserted that the SEC was trying to redefine traditional understandings of materiality. He noted how the SEC’s recently proposed climate change disclosure proposal would triple the cost of being a public company, which he commented would have “dramatic” effects. He further mentioned how the White House Office of Management and Budget (OMB) was currently reviewing a series of other proposed SEC disclosure requirements related to DEI and human capital management practices. He asserted that these practices had limited-to-no relationship to the financial outcomes of companies.
• Ranking Member Toomey commented that the SEC’s disclosure requirements under consideration would constitute a “complete” departure from historical norms.
  • Mr. Burton expressed agreement with Ranking Member Toomey’s comment and asserted that these disclosure requirements would undermine securities laws. He elaborated that these disclosure requirements were in variance with the historical purposes of these laws (which were to provide financially material information to investors).

Sen. Robert Menendez (D-NJ):

• Sen. Menendez mentioned how he had been working for several years on legislative efforts to codify insider trading prohibitions. He called the Insider Trading Prohibition Act currently under discussion a “common sense” proposal. He stated that there appeared to exist broad consensus that the practice of insider trading was unfair and contended that Congress should therefore ban the practice. He also asserted that insider trading did not constitute a victimless crime. He asked Prof. Jackson to discuss how insider trading negatively impacted markets, shareholders, and the broader public.
  • Prof. Jackson remarked that the U.S.’s inability to enforce insider trading laws and the court-developed nature of these policies had “very real costs” for ordinary Americans. He stated that the aforementioned issues undermined the fairness of the U.S.’s public equities markets, which disadvantaged ordinary investors.
• Sen. Menendez noted how a goal of the Insider Trading Prohibition Act was to resolve certain conflicts that had arisen across federal courts. He mentioned how the legislation would make it unlawful to trade securities based on information that the trader knows or has reason to know was wrongfully obtained. He asked Prof. Jackson to explain how different courts had reached different conclusions about a personal benefit requirement for insider trading. He also asked Prof. Jackson to address why the Insider Trading Prohibition Act’s clarification would be important for resolving the conflict.
  • Prof. Jackson discussed how courts had sought to identify the reason for why a tipper would provide MNPI to an outside party and had developed a personal benefit framework for determining whether the information tipping was unlawful. He stated that this framework was problematic in practice because MNPI was rarely traded directly for cash. He explained that people often tipped MNPI based on the expectation that they would receive MNPI at a later date as a form of reciprocity. He asserted that requiring the government to prove that MNPI was traded directly for cash would thus make it very difficult to bring insider trading cases in many instances, which would undermine the public’s trust in U.S. equities markets.
• Sen. Menendez then discussed how Congress was working on ways to apply traditional financial and regulatory frameworks to the digital assets space. He asked Prof. Coffee to indicate whether he had any concerns regarding the application of insider trading laws to digital assets.
  • Prof. Coffee noted how U.S. securities laws currently did not apply to cryptocurrencies. He indicated however that U.S. securities laws did apply to the IPOs of cryptocurrencies. He referred to the cryptocurrency space as the “wild west” and highlighted how cryptocurrencies were “extremely volatile.” He asserted that retail investors should not enter this space until cryptocurrencies were better regulated. He then emphasized that the Bharara Task Force on Insider Trading had found that merely using the personal benefit standard for prosecuting insider trading cases would enable sophisticated parties to evade prosecution. He noted that the Bharara Task Force on Insider Trading had thus recommended the adoption of a wrongfulness standard for prosecuting insider trading.

Sen. Thom Tillis (R-NC):

• Sen. Tillis discussed his efforts to make it easier for ordinary Americans to become early stage and accredited investors and mentioned how he had introduced the Equal Opportunity for All Investors Act to accomplish this goal. He asked Mr. Burton to indicate whether increasing access to EGC investment opportunities would help to democratize investing.
  • Mr. Burton answered affirmatively and expressed support for the Equal Opportunity for All Investors Act. He highlighted how the legislation enabled people to achieve accredited investor status through passing a test and commented that the creation of such a test would provide clarification as to what constitutes a sophisticated investor under Regulation D.
  • Prof. Jackson discussed how small and mid-sized companies that go public had historically and consistently given exactly 7 percent of their value to Wall Street investment banks as part of the IPO process. He called this situation suspicious given the supposedly competitive nature of Wall Street investment banks. He applauded the JOBS Act 4.0 discussion draft for its request that the SEC study this situation.
  • Mr. Burton expressed agreement with Prof. Jackson on the importance of having the SEC study the costs associated with IPOs. He stated that the SEC was sui generis among federal departments and agencies in its failure to release information publicly. He expressed support for having the SEC release more of this information to the public. He then remarked that the Equal Opportunity for All Investors Act would particularly help entrepreneurs in rural areas and smaller states to access capital. He commented that accredited investors were rare throughout much of the U.S. and stated that the legislation would help to address these shortages.
• Sen. Tillis then mentioned his work on the Reporting Requirements Reduction Act of 2022, which would shift several reporting requirements from a quarterly basis to a semiannual basis. He expressed interest in Mr. Burton’s view of this legislative proposal.
  • Mr. Burton indicated that while he was a supporter of scaled disclosure requirements, he expressed concerns that moving to semiannual disclosures would reduce the amount of information that was available to the marketplace. He commented that this reduced information could impact the accurate pricing of securities in secondary markets. He suggested that policymakers first limit this new disclosure approach to smaller companies in order to assess its effectiveness. He commented that this approach could then be expanded to more companies if it were proven to be effective.

Sen. Mark Warner (D-VA):

• Sen. Warner discussed how there had occurred a significant increase in cyberattacks and ransomware payments. He highlighted how Congress had recently passed a bipartisan law to require the reporting of cyber incidents by companies. He noted how many bad actors engaged in cyberattacks in order to manipulate stock prices. He asked Prof. Jackson to discuss the prevalence of this practice and to address whether state actors were engaging in this practice.
  • Prof. Jackson remarked that there was “significant evidence” that spikes in option trading activity surrounding a company’s stock tended to precede the disclosures of cyber incidents by a company. He stated that this dynamic suggested that parties were profiting both directly from cyberattacks and from trading activity related to cyberattacks. He commented that the dynamic meant that trading markets were effectively funding the perpetration of cyberattacks. He stated that the Insider Trading Prohibition Act would make clear that trading based on information obtained through cyberattacks would constitute a violation of federal law. He then discussed how insiders at Chinese-domiciled firms listed in the U.S. were trading ahead of very significant stock price declines. He called it “crucial” that the U.S. address these gaps in its insider trading laws.
• Sen. Warner asked Prof. Jackson to indicate whether he had been able to track the trading activity surrounding a given company during the period between a cyberattack on the company and the public reporting of said cyberattack.
  • Prof. Jackson mentioned how there was a study in the Harvard Business Law Review that looked at the spike in options trading immediately preceding the public disclosure of a cyberattack. He noted how the levered nature of option bets meant that the proceeds from such trading activity could be very substantial.
• Sen. Warner also expressed interest in looking into the trading activities of insiders at foreign-domiciled companies that were listed on U.S. exchanges. He then expressed interest in the connection between insider trading and stock buybacks. He raised concerns that companies could time their buybacks based on inside knowledge of impending downturns. He asked Prof. Jackson to discuss this issue.
  • Prof. Jackson remarked that insiders at public companies often increased their sales of stock in connection with a share buyback plan. He commented that these insider sales suggested that the companies did not believe that the stock buybacks were in their best interests. He called for requiring corporate executives to hold their shares when their companies engaged in stock buybacks.

Sen. Elizabeth Warren (D-MA):

• Sen. Warren remarked that insider trading was one of the biggest threats to a functioning market. She noted that while the hearing was mainly focused on corporate insiders that traded the stocks of their companies based on MNPI, she highlighted how government officials were often privy to upcoming policy changes that could heavily impact the stock of a given company. She posited a hypothetical scenario in which a U.S. Senator learned of a pending contract award and purchased stock in the company before this award was made public. She asked Prof. Jackson to indicate whether the U.S. Senator in this hypothetical scenario had engaged in insider trading.
  • Prof. Jackson answered affirmatively.
• Sen. Warren then posited a hypothetical scenario in which a U.S. Senator attended a top secret briefing and learned that a company was facing significant legal trouble. She posited that the U.S. Senator in this hypothetical scenario then sold their stock in the company before the information about this legal trouble became public. She asked Prof. Jackson to indicate whether the U.S. Senator in this hypothetical scenario had engaged in insider trading.
  • Prof. Jackson answered affirmatively.
• Sen. Warren then posited a hypothetical scenario in which a U.S. Senator attended a non-public session in which they learned of plans to significantly boost the budget for the U.S. Department of Defense (DoD). She posited that the U.S. Senator in this hypothetical scenario then purchased defense-related stocks before this planned budget increase was made public. She asked Prof. Jackson to indicate whether the U.S. Senator in this hypothetical scenario had engaged in insider trading.
  • Prof. Jackson answered affirmatively.
• Sen. Warren then posited a hypothetical scenario in which a U.S. Senator held the stocks of pharmaceutical companies and learned that a Committee would soon bring forward legislation to cut drug prices. She posited that the U.S. Senator in this hypothetical scenario then sold their pharmaceutical stocks. She asked Prof. Jackson to indicate whether the U.S. Senator in this hypothetical scenario had engaged in insider trading.
  • Prof. Jackson answered affirmatively.
• Sen. Warren remarked that Members of Congress were in a unique position to obtain information that they could then use to game the stock market. She asserted that the risks for insider trading among government officials were even higher than the risks for insider trading among corporate executives because government officials could use their positions to influence private outcomes and the values of the stocks that they hold or trade. She mentioned how Members of Congress and their spouses had traded more than $500 million in stocks and other investments in 2021. She raised concerns with the fact that Members of Congress tended to outperform the S&P 500 in their trading activities. She noted however that no Members of Congress had been criminally charged with insider trading in 2021. She asked Prof. Jackson to indicate whether the U.S. needed strong rules to prevent Members of Congress from engaging in insider trading.
  • Prof. Jackson answered affirmatively. He stated that there existed potential conflicts of interest when Members of Congress could make decisions that impacted companies while holding stock in those same companies.
  • Prof. Coffee remarked that Prof. Jackson’s previous statements were focused on Members of Congress who were covered under the Stop Trading on Congressional Knowledge (STOCK) Act. He stated however that Sec. 16 of the Insider Trading Prohibition Act could make it impossible to prosecute parties not covered under the STOCK Act for insider trading if a personal benefit was not received for the inside information. He then remarked that Congress might want to consider adopting prophylactic rules to combat Congressional insider trading. He suggested that it might be prudent to only permit Members of Congress to invest in diversified investment portfolios and to prohibit Members of Congress from investing in individual stocks.
• Sen. Warren mentioned how she had introduced bipartisan legislation with Sen. Steve Daines (R-MT) to ban Members of Congress from owning or trading individual stocks.

Sen. Chris Van Hollen (D-MD):

• Sen. Van Hollen mentioned how he had introduced the 8-K Trading Gap Act of 2021. He mentioned how public companies were required to disclose significant corporate events to the public within four business days after the event had occurred and noted how corporate insiders were uniquely aware of this MNPI during this four business day period. He asked Prof. Jackson to address whether corporate insiders with access to this MNPI were engaging in trading activity during this four business day period.
  • Prof. Jackson remarked that there did exist reason to believe that corporate insiders were engaging in trading activity during the four business day period between a significant event and its public disclosure. He expressed support for both the 8-K Trading Gap Act of 2021 and the Insider Trading Prohibition Act and commented that these legislative proposals would deter corporate insiders from engaging in insider trading activities.
• Sen. Van Hollen stated that while it was reasonable for companies to be provided with four business days to report significant corporate events, he asserted that there did not exist a justifiable reason to permit corporate insiders to trade during this four business day period.
  • Prof. Jackson expressed agreement with Sen. Van Hollen’s assertion.
• Sen. Van Hollen then mentioned how Congress had previously passed into law the Holding Foreign Companies Accountable Act. He explained that this law required all companies listed on U.S. exchanges (whether domiciled domestically or overseas) to comply with “simple” accounting and transparency rules. He noted how Prof. Jackson had recently written a paper on the issue of how foreign corporate insiders were not governed by the same sets of insider trading rules that applied within the U.S.
  • Prof. Jackson mentioned how he had co-authored a recent paper that documented how corporate insiders at foreign-domiciled firms listed in the U.S. were engaging in insider trading through selling the stocks of their companies before the stock prices fell. He noted how these foreign firms were exempted from the “straightforward” SEC insider trading disclosures that U.S. firms were subject to. He suggested that the SEC reconsider whether this exemption was still warranted. He also noted how the corporate insider trading disclosures that these foreign firms provided to the SEC were in paper form. He called for reforming SEC Rule 144 in order to modernize this disclosure system. He expressed his hope to work with the Committee and the SEC on reforming Rule 144.
• Sen. Van Hollen mentioned how he was working to develop legislation to address the problem of corporate insider trading at foreign-domiciled firms that were listed on U.S. exchanges. He indicated his intention to work with Prof. Jackson on this legislation.