The federal courts since the 1960s have imposed criminal sanctions for insider trading violations without a statute defining the prohibited conduct. They have done so based on a statute that authorizes criminal sanctions for violations of rules promulgated by the Securities and Exchange Commission and an SEC regulation that prohibits, without defining, conduct we have come generally to call “insider trading.” Yet, in 1812 the U.S. Supreme Court held, in United States v. Hudson, 11 U.S. (7 Cranch) 32 (1812), that federal courts lack constitutional authority to define criminal conduct and decide common-law criminal cases. It is time for the federal courts to adhere to Hudson and get out of the business of enforcing an administrative agency's rule as a crime. It is also time for Congress to perform its constitutional function, if it wishes to have continued criminal enforcement, and enact an insider trading statute.

On May 9, 2017, the U.S. Court of Appeals for the Second Circuit heard further argument in the case of Mathew Martoma, serving a nine-year sentence for insider trading. One of the issues that the court will consider is how much, if any, of its 2014 Newman personal-benefit standard (773 F.3d 438 (2d Cir. 2014)), a required element for insider trading conviction, survives the Supreme Court's 2016 ruling in Salman (137 S. Ct. 420 (2016)). That is an important issue. In deciding the Martoma appeal, the Court of Appeals may also want to consider the more fundamental issue of whether it even has the constitutional authority to decide an insider trading criminal case.

Background

In 1942, the SEC promulgated Rule 10b-5 to prohibit insider trading. The Rule neither mentions insider trading, much less defines the precise conduct (among the variety of insider trading acts) that is deemed wrongful. It adopts the language of §17(a) of the Securities Act of 1933, but places its authority on §10(b) of the Securities Exchange Act of 1934, a broad delegation to an agency without any statutory standards to guide its conduct. In structuring as it did Rule 10b-5, the SEC avoided the constraints imposed by Congress on §17(a) while benefiting from the unconstrained delegated authority of §10(b). Congress has never enacted a law defining insider trading and making the defined conduct a crime. Indeed, it has expressly declined even to define insider trading. As Louis Loss and Joel Seligman have said of this doctrine, “it is difficult to think of another instance in the entire corpus juris in which the interaction of the legislature, administrative rulemaking, and judicial processes has produced so much from so little.”1

With the acquiescence of Congress, and the statutory authority to enforce properly promulgated SEC regulations as crimes, the federal courts have enforced Rule 10b-5 with criminal sanctions by defining the elements of criminal insider trading. The courts have announced those elements in case-by-case adjudications, the typical common law methodology. Virtually all would agree that insider trading is a common-law crime. As defined by federal courts, the personal-benefit element of that crime has wreaked havoc in insider trading criminal cases. In 1983, the Supreme Court held in Dirks v. SEC, 463 U.S. 646 (1983), that a violation requires a corporate tipper-insider to breach a fiduciary duty by disclosing confidential information to a tippee-outsider, that disclosure must have been for a personal benefit to the tipper, and the tippee who trades based on the information must have had knowledge of both the breach of duty by, and the personal benefit to, the tipper. Moreover, the court stated that where tipper and tippee are “trading relative or friend,” it is sufficient that the tipper gave such information as a “gift” knowing the tippee will use it to trade. From 1983 to 2014, the lower federal courts have struggled to make sense of the precise nature and contours of the personal-benefit element announced in Dirks.2