Practitioners, listen up! You need to unlearn much of what you think you know about the law of insider trading. That law is changing—and quickly. In addition, new legislation has passed the House by an overwhelming margin and could conceivably pass the Senate this year.

Since Dirks v. SEC, 463 U.S. 646 (1983), the black letter law of insider trading has required the prosecution to show not just that a purchase or sale of securities was based on material, non-public information, but also a breach of a fiduciary (or similar) duty that involved a personal benefit being received by the tipper from the tippee. This "personal benefit" test was overbroadly extended in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), which added some confusing language that made it more difficult (in fact, nearly impossible) to convict the remote tippee (who could seldom be shown to have known that the original tippee had received any personal benefit). As a result, many convictions, some after a jury trial, had to be overturned.

The New Case Law

Since Newman in 2014, the law has turned on its heels and eliminated some of these barriers to conviction. First, in Salman v. United States, 137 S. Ct. 420 (2016), the Supreme Court reversed much (but not all) of Newman. Even more importantly, in United States v. Martoma (Martoma II), 894 F.3d 64, 79 (2d Cir. 2018), another Second Circuit panel found an end run around Newman by seizing on language in Dirks that had said gifts of information by insiders to friends or relatives could also violate Rule 10b-5 on the theory that such gifts resembled trading by the insider and a follow-up gift of the proceeds by the insider to a friend or relative. Expanding on this relatively modest statement in Dirks, the Martoma II court generalized that Rule 10b-5 is violated whenever a "corporate insider receives a personal benefit … from deliberately disclosing valuable confidential information without a corporate purpose and with the expectation that the tippee will trade on it." See 894 F.3d 64, 79 (2d Cir. 2018).

This doctrinal move effectively eliminated the need to show a personal benefit paid by the tippee to the tipper because it could now be assumed that the insider/tipper had received a personal benefit from the satisfaction of knowing that his or her intended beneficiaries had received the gift. Whether other circuits will accept this significant change in the law (and its stealth overruling of Newman) is debatable, but because most insider trading prosecutions are brought in the Southern District or the Eastern District of New York, this may not really matter. The odds of a conviction being upheld have now gone up significantly.

The second and even more dramatic development that has changed insider trading law is United States v. Blaszczak, 947 F.3d 19 (2d Cir. 2019). Decided on Dec. 30, 2019, it upheld a conviction for insider trading based on both 18 U.S.C. §1348 and the wire fraud statute, expressly ruling that it was not necessary to satisfy the criteria set forth in Dirks when the prosecution was based on these statutes (rather than §10(b) of the Securities Exchange Act). 18 U.S.C. §1348 was passed as part of the Sarbanes-Oxley Act in 2002 and uses the same simple "scheme to defraud" language as do the mail and wire fraud charges.

Potentially, such a stripped down statute could easily result in overcriminalization. For example, prosecutors might consider it fraudulent if a defendant acquires material, non-public information and trades on it without disclosure of these facts. Should this alone be criminal? Let's consider two cases: First, an acquirer buys 10% or more of the target's stock in the open market in the days before the acquirer announces a hostile tender offer for control. It may disclose these purchases in compliance with the Williams Act, or it may not. Either way, can these purchases be deemed to constitute unlawful insider trading because the acquirer failed to disclose the material fact of its settled intention to make a tender offer? Under the securities laws, the answer is no, in part because the purchaser owes no fiduciary duty to the target shareholders and it cannot misappropriate the information from itself. But what about under §1348? If all that is required is a "scheme to defraud" (which is the operative language of §1348), such "schemes" may exist in the eye of the beholder.

Let's take another case: An aggressive hedge fund hires several leading medical scientists (including a Nobel Prize winner) to review a variety of drugs that may be used to develop a vaccine for the coronavirus. After much expensive research and testing, the scientists decide that a drug owned and patented by the little XYZ Drug Company is the most promising candidate. The hedge fund first buys $100 million worth of XYZ's stock and then issues a press release announcing why XYZ's drug is superior to all the other candidates. Assume that this press release is very bullish (and possibly even overstated somewhat). Can these purchases be called insider trading because no advance disclosure was made of the information the hedge fund acquired before it purchased the stock? Hopefully not! This is a case where the hedge fund profited from its own hard work and entrepreneurial efforts. But a skeptical prosecutor might imagine a "scheme to defraud" based on this combination of nondisclosure and aggressive promotion because the prosecutor knows that the prosecution no longer has to satisfy the Dirks standard when using these other statutes.

Fortunately, Blaszczak placed some important limitations on the scope of §1348. The hero of this story was the Southern District judge (Judge Lewis Kaplan) who essentially instructed the jury that a conviction for insider trading under §1348 required that the material information be "misappropriated" or "embezzled." Because one cannot misappropriate from oneself, this protects those who develop material information on their own, and such a requirement minimizes much of the potential for overcriminalization.

Still, there remain a number of gray areas under both Martoma II's new gift theory and §1348. For example, in the case of §1348, suppose the exact equivalent of the Dirks case arose tomorrow. A whistleblower who recognizes that his company was insolvent and had long engaged in a continuous fraud asks the equivalent of Ray Dirks to help him. Dirks does so, but also tells his institutional clients who trade before the scandal breaks. The case is prosecuted under §1348. Now the issue becomes whether Dirks misappropriated this information from the whistleblower. In its Dirks decision, the Supreme Court held that, under Rule 10b-5, the tippee stands in the shoes of the tipper. If the tipper had a legitimate motive for tipping (i.e., to end the fraud), then the tippee was safe because he owed no fiduciary duty to the shareholders and was not aiding and abetting a fraud by the tipper. But under §1348, the existence of a fiduciary duty is irrelevant. Arguably, Dirks has misappropriated information given him for a legitimate purpose by his whistleblowing tipper and used it for an improper personal purpose. This is probably the result that the SEC always wanted.

In the case of Martoma II's gift theory, other questions are equally open. In Newman, a low-level stockholder relations manager at Dell tipped some institutional investors that a major earnings decline was coming (and they quickly passed the information on). But the corporate employee received no benefit, and his purpose seemed to have been to placate important shareholders of his corporation. Although Martoma II found its gift theory to apply when a corporate insider discloses "valuable confidential information without a corporate purpose and with the expectation that the tippee will trade on it," it is not clear that this language easily fits these facts. Here, the low-level employee did indeed have a "corporate purpose" (to placate powerful shareholders), and he had no altruistic motive or a desire to benefit friends or family. These shareholders (large institutions) were not persons to whom he would likely give his own money. Remember too that Dirks focused on gifts in the context where the transaction resembled trading by the insider followed by the insider's gift of the proceeds to the friend or relative. The gains to the defendant on the Dell trades in Newman were over $70 million. If this low-level employee had made over $70 million, it is doubtful that he would have given that away to persons with whom he had no prior relationship.

Nor does tipping by a stockholder relations manager to institutional investors easily resemble a misappropriation or embezzlement; the investors were given the information with no restriction on its use. Finally, because there was no indication of any personal benefit paid to the employee, the standard "personal benefit" under Dirks is also seemingly not satisfied.

These two new decisions point in opposite directions. Martoma II focuses on "gifts", while Blaszczak requires a "misappropriation." These are virtually antithetical. Although both theories might be plead in the same indictment, it is hard to imagine the same conduct satisfying both. If the tipper gives the information to the tippee, the tippee cannot logically have stolen it.

How should the law deal with such gratuitous tipping that does not involve any personal benefit or gift? My own answer would begin from the fact that this tipping clearly seems to violate Regulation FD (17 C.F.R. §243.101(c)) (covering persons, such as the original tipper in Newman, "who regularly communicate with … holders of the issuer's securities"). Such a person could be sued by the SEC or, in an extreme case, indicted by the U.S. Attorney. Even through Regulation FD was widely seen as a lesser alternative to an insider trading violation—in effect a venial sin to the mortal sin of insider trading—all knowing and willful violations of SEC rules can be criminally prosecuted.

From this starting point, the recipients of information tipped in violation of Regulation FD could be viewed as aiders and abettors of such person's violations. Aiders and abettors can be sued by the SEC under §20(e) of the 1934 Act, or they can even be indicted under 18 U.S.C. §2. There is no zone of immunity if the conduct of the primary violator violates SEC rules.

New Legislation

The Insider Trading Prohibition Act (H.R. 2534) passed the House by a lopsided margin of 410 to 13 on Dec. 5, 2019. Sponsored by Congressman Jim Himes (D. Conn.), it was originally intended to codify the judicially created common law crime of insider trading and to eliminate the personal benefit test, which had effectively given legal immunity to remote tippees. However, a funny thing happened to that bill on its way to passage. On the eve of the vote, the Ranking Member of the House Financial Services Committee (Patrick McHenry (R-NC), made a motion to re-insert the personal benefit test back into the bill, which motion Congressman Himes agreed to support. Why? Congressman Himes's intention appears to have been to ease the bill's reception in the Senate (although its fate there remains uncertain).

The result is a strange mismatch of a bill that both expands and contracts the scope of the insider trading prohibition. Its most critical provision (§16A(c)) reads as follows:

"(c) STANDARD AND KNOWLEDGE REQUIREMENT ̶

"(1) STANDARD. ̶ For purposes of this section, trading while aware of material, nonpublic information under subsection (a) or communicating material nonpublic information under subsection (b) is wrongful only if the information has been obtained by, or its communication or use would constitute, directly or indirectly ̶

"(A) theft, bribery, misrepresentation, or espionage (through electronic or other means);

"(B) a violation of any Federal law protecting computer data or the intellectual property or privacy of computer users;

"(C) conversion, misappropriation, or other unauthorized and deceptive taking of such information; or

"(D) a breach of any fiduciary duty, a breach of a confidentiality agreement, a breach of contract, a breach of any code of conduct or ethics policy, or a breach of any other personal or other relationship of trust and confidence for a direct or indirect personal benefit (including pecuniary gain, reputational benefit, or a gift of confidential information to a trading relative or friend)."

Because receipt of a personal benefit is an element of subparagraph (c)(1)(D) above, a prosecutor who wanted to indict a corporate insider under subparagraph (c)(1)(D) would have to show a classic personal benefit or a "gift" of information by the insider to the tippee (in short, the same as before). Alternatively however, the prosecutor could simply allege a "misappropriation" under subparagraph (c)(1)(C). Thus, this subparagraph (c)(1)(C) seemingly produces the same result as Blaszczak and eliminates the need to prove a fiduciary breach. This trivializes what is said in subparagraph (c)(1)(D). Possibly, someone will notice this when the bill is considered by the Senate. Then again, maybe not.

Despite this amateur drafting, the Act does have its good side because it no longer requires that the material nonpublic information be acquired by fraud; rather, such information can be "wrongfully" obtained by other means, such as theft, extortion, or computer hacking. Such an extension hardly results in overcriminalization and is broadly consistent with the recent Report of the Bharara Task Force on Insider Trading. Still, the express retention of a "personal benefit" test is a step backward, even if it is a futile step because the proposed legislation states it both ways in its separate subparagraphs. Finally, prosecutors can simply ignore this legislation and continue to prosecute under §1348 and Blaszczak. Only if this proposed statute were made exclusive (as some conservatives want), would this legislation have real impact.

This is a serious issue, as arguably the statutes applying to insider trading should be read "in pari materia"—unless Congress clearly signals a contrary intent. Blaszczak felt that Congress had so indicated a contrary intent, but this is quite debatable. If Blaszczak is correct on this point, fiduciary duties will rapidly recede in our rear view mirror, as prosecutors will turn to other theories that do not rely on them.

Stay tuned! Anything could happen in an election year.

John C. Coffee Jr. is the Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance.