Does insider trading pay?. An analysis of trading and tipping activities in insider trading litigation
Date | 01 April 2019 |
Pages | 647-664 |
Published date | 01 April 2019 |
DOI | https://doi.org/10.1108/JFC-07-2018-0068 |
Author | Aneta Spaic,Claire Angelique Nolasco,Lily Chi-Fang Tsai,Michael S. Vaughn |
Does insider trading pay?
An analysis of trading and tipping activities in
insider trading litigation
Aneta Spaic
Faculty of Law, University of Montenegro, Podgorica, Montenegro
Claire Angelique Nolasco
Department of Criminology and Criminal Justice,
Texas A&M University-San Antonio, San Antonio, Texas, USA
Lily Chi-Fang Tsai
Department of Criminal Justice, University of Maryland Eastern Shore,
Princess Anne, Maryland, USA, and
Michael S. Vaughn
Department of Criminal Justice, Sam Houston State University, Huntsville,
Texas, USA
Abstract
Purpose –This paper analyzestrading and tipping activities in insider trading litigationdecided by federal
courts from January1, 2012 to December 31, 2014.
Design/methodology/approach –Legal documents fromthe US Securities and Exchange Commission,
LexisNexis and Westlaw databases were coded to determine profile, patterns of trading and settlement
outcomes.
Findings –Results of statisticalanalysis indicate that a defendant in both civil and criminalcases is more
likely to trade on the information whenhe/she receives a direct, financial benefit from breaching his/her duty
of confidentiality. The defendant tipper is also more likely to pass on the information to a close personal
friend, business associate or family member. The average amount of profit of defendants in both civil and
criminalproceedings substantially exceeds the averageamount of their settlements.
Originality/value –This paper offerssupport for the rational choice model –insidertrading is often based
on rational calculations of benefits not only to the defendant but also to his/her family and associates.
Although the threat of civil enforcement and criminal proceedings may possibly deter him/her from
committing the crime, results indicatethat the amounts of settlement in both proceedings are considerably
lower thanthe amount of profits obtained from the offense.
Keywords Insider trading, Corporate insiders, Breach of fiduciary duty, Business law
Paper type Research paper
Introduction
The concept of insider trading
Insider trading is prohibited under Section10(b) of the Securities and Exchange Act of 1934
(2012) and its implementing rule, Rule 10b-5 (Code of Federal Regulations, 2014). The law
provides that:
(i)t shall be unlawful for any person, directly or indirectly, by the use of any means or
instrumentality of interstate commerce or of the mails, or of any facility of any national securities
Insider trading
litigation
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Journalof Financial Crime
Vol.26 No. 2, 2019
pp. 647-664
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-07-2018-0068
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exchange –(b) To use or employ, in connection with the purchase or sale of any security
registered on a national securities exchange or any security not so registered, or any securities-
based swap agreement[1] any manipulative or deceptive device or contrivance in contravention of
such rules and regulations as the Commission may prescribe as necessary or appropriate in the
public interest or for the protection of investors. (Securities and Exchange Act of 1934, 2012)
Although not explicitly defined in current statutes, various federal and state courts,
including the U.S. Securities and Exchange Commission (SEC), have developed and
expanded on the forms, legal standards, defenses and boundaries of insider trading
(Anderson, 2014;Kim,2014;Murdock, 2014;Yeager et al., 2014;Tsepelman, 2015).
Breach of duty
For insider trading to occur, the corporate insider must have breached a fiduciary duty to
the corporation by trading on material, nonpublic information (Acoba, 1999;Chiarella v.
USA, 1980; Dirks v. SEC, 1983;Malone, 2003;Silver, 1985). In one case, the Supreme Court
described what has become known as the majority rule, stating that a director owed a
fiduciary relationship solely to the corporation and not to the corporate shareholders
(Goodwin v. Agassiz, 1933).Special facts, however, sometimes create a fiduciary relationship
between a director and shareholders, legally obliging the director to disclose material facts
before trading on the information(Strong v. Repide, 1909). Special facts existed in Strong v.
Repide (1909) when the director and controlling shareholder of the company used deceit by
hiring an agent to personally approach and purchase the shares from another stockholder,
concealing his identity from the latter. Other courts espouse the minority rule, holding that
directors owed a fiduciary duty not only to the corporation but also to the shareholders and
hence, cannot profit by trading on inside information at the expense of shareholders
(Dawson v. National Life Ins. Co. of America, 1916; Hotchkiss v. Fischer, 1930; Oliver v.
Oliver, 1903;Smith,1921; Stewart v. Harris, 1904).
The law on insider trading was expanded to cover not only corporate insiders and
tippees but also misappropriators who use deceit in obtaining material nonpublic
information (i.e. externallawyers hired to assist corporate acquisitions and takeovers) (USA
v. O’Hagan, 1997) and fiduciaries who tradeon material nonpublic information confided to
them by family members (Securities and Exchange Commission v. Rocklage, 2006; USA v.
Evans, 2007). The Second Circuit Court of Appeals in Securities and Exchange Commission
v. Dorozhko (2009) further created a category of fraud by affirmative misrepresentation,
holding that breach of fiduciary duty is a necessary element of insider trading only when
deception is based on silence or nondisclosure but not when deceit is based on active
misrepresentation, such as computer hacking. The Second Circuit remanded the case,
saying that computer hacking couldbe considered a deceptive device prohibited by Section
10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 (Securities and Exchange
Commission v. Dorozhko,2009).
The case of USA v. Newman (2014) clarified the nature of the tipper’sbreach of duty, the
level of proof required to show suchbreach and the standard of criminal intent or mens rea
for the tippee liability (Malone, 2003;Silver, 1985;Strader, 2015). The insider or
misappropriator must knowingly act with the intent of depriving the owner of the
information for his/her personal gain (Beeson, 1996;Dessent, 1998;Strader, 2015). A tippee
or individual who trades basedon material nonpublic information received from an insider-
tipper is also liable under Section 10-b (Yeager et al., 2014). Within the context of tipper–
tippee liability, the tippermust disclose material, nonpublic confidentialinformation for his/
her personal benefit,“broadly defined to include not only pecuniary gain, but also, inter alia,
any reputational benefit that will translate into future earnings and the benefit one would
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