On August 8^th, the Securities and Exchange Commission charged Congressman Christopher Collins with insider trading based upon telephone calls he made from an outdoor White House event. The same day, an Indictment based upon the same facts was unsealed. While no one can recall a sitting congressman being charged with insider trading, Congress did specifically target misuse of confidential information by such federal government employees in 2012. The SEC chose not to avail its civil action of the advantages levied by that legislation, relying instead on common law theories and anti-fraud catchalls. Accordingly, the pending case is a primer on the ironic limitations of federal statutes and regulations aimed at eradicating informational advantages obtained unlawfully.

The 'Collins' Allegations

In June 2017, Collins served on the Board of Innate Immunotherapeutics, Ltd. (“Innate”), a company listed on the Australian Stock Exchange (“ASE”). Collins owned over 16% of the outstanding shares of Innate stock, a position that had triggered a House ethics investigation. Collins' son and daughter also owned Innate shares.

The government alleges in parallel cases that, on June 22, 2017, while attending a Republican Party gathering on the White House lawn, Collins received an e-mail from the CEO of Innate. The e-mail allegedly revealed that a clinical trial of the company's leading drug had ended abysmally, a confidential fact that was sure to decrease Innate's stock price once made public. After responding to the e-mail, Collins allegedly called his son to share the negative news. There ensued a tipping chain of numerous individuals collectively selling over 1.7 million Innate shares, the price of which shrank from 45 cents a share to 3 cents on June 27th. Collins' son was alleged to have avoided a loss of over $570,000 through his early sales; the father of the son's girlfriend was similarly alleged to have avoided a loss of over $143,000. Collins did not sell his shares during this 4-day period.

Both the SEC and the Department of Justice brought charges in the SDNY. The SEC's complaint names Collins, his son and the girlfriend's father. The complaint seeks a variety of sanctions based upon violations of Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act. The DOJ Indictment names the same defendants and numbers 13 charges, including conspiracy to commit securities fraud, wire fraud and the making of false statements to the FBI. The Indictment asserts that Collins, knowing that any sale of his shares would be halted or suspected, instead tipped his son; for his part, Collins denies wrongdoing and highlights that his retention of shares forced him to incur a loss of “millions of dollars” he had invested in Innate.

The S.T.O.C.K. Act of 2012

The insider trading prohibition traces to a 1961 administrative decision. The resultant “abstain or disclose” theory was subsequently blessed by Supreme Court cases in 1983 and 1997. The rule of law applies Rule 10b-5 to defendants in view of their status as an insider, misappropriating outsider, or tipper/tippee. In all instances, insider trading must be tied to a duty to keep information confidential.

In 2012, in response to a request from the president, Congress expanded that duty exponentially. The “Stop Trading of Congressional Knowledge Act” was offered as a remedy for a loophole. Specifically, the act codified the duty of confidentiality of specified elected officials as running to “the Congress, the United States government, and the citizens of the United States” when material, non-public information has been obtained via position or ”gained from the performance of such person's official responsibilities.”

Regardless of any idyllic scope, the statute's operative terms preclude its application in the Collins case. First and foremost, Collins allegedly learned of the inside information by virtue of his membership on the Innate Board – not through the performance of his duties as a congressman. Second, even if that membership could be tied to his elected status, he simply did not trade for a profit: As alleged, he tipped another (who avoided a loss).

Other Congressional gestures since 1934 are similarly of unlikely assistance. The Exchange Act's Section16(b) – a private remedy that remains the only attempt by Congress to define insider trading – requires a profit by Collins on purchases and sales within a 180 day period. Even if Collins' transactions in Innate stock meet temporal requirements, SEC interpretation has only joined a director's profits with those of a wife or household family member.

Separately, while Section 20A of the Exchange Act generously affords all market counterparties (but not the SEC) a cause of action against insider traders, tipper liability is dependent upon a separately demonstrated act violation. Also, the commission's position is that damages are reduced when the SEC has already obtained disgorgement.

The SEC's Own Non-Starters

In 2000, the commission promulgated Regulation Fair Disclosure to combat the selective distribution of inside information to favored parties. Prompted by disclosures to analysts, the regulation requires remedial disclosure by issuers. However, the requirement applies to agents acting on the company's behalf, and it is doubtful that Collins' alleged disclosures to his son served any corporate purpose.

Also in 2000, the SEC adopted Rule 10b5-2 to ease the obligation of establishing a duty of confidentiality in outsider cases. However, the varied predicates for a finding of confidentiality - including the relationship of “parent” and “child” – are only to be utilized in cases of misappropriation. Such theft of information from father by son or others is nowhere indicated in either the SEC Complaint or DOJ Indictment.

Other SEC measures targeting specific circumstances do not apply. Rule 14e-3, although prohibiting dissemination of information by non-traders, applies only to tender offers. Meanwhile, Rule 10b5-1, which was adopted to lower the commission's burden of proof to establish the defendant's “awareness” of the inside information (as opposed to actual use) has been sidestepped in favor of the traditional “possession” standard.

Accordingly, the commission has charged Collins with violations of Section 17(a) and Section 10(b), in conjunction with a parallel criminal action. However, even the reliable tipper theory begets some insecurity. As an Innate director, Collins is said to have owed a duty to Innate shareholders “to safeguard” inside information amplified by Innate policy precluding a) trading, and b) sharing such information when the recipient is likely to trade upon it. Such dual bases reveal uncertainty in allegations against board members, namely, whether the duty not to tip comes with the job, or is dependent upon company policy. The Ninth Circuit's Talbot decision in 2008 resolutely linked the duty with the directorship, while SEC pleadings in other circuits have often relied on written notice from the company to its Board.

More importantly, any alleged duty requires a finding of materiality within the context of the elements of Rule 10b-5. That term, undefined by Congress and generally subject to a market impact test, requires (per case law) examination of the relevant timeline. While both the ASE and the OTC markets responded dramatically to news of the clinical failure, the stock's price had steadily decreased over 62% on the ASE in the six months prior thereto. The Bausch & Lomb case of 1977 clarified that bringing to court a short timeline may result in a judge labeling the SEC theory a “facile inference.”

Further, the element of scienter poses a challenge: Collins is not alleged to have attempted to sell any of his 16% position in Innate either before the ASE trading halt or during the period of several days before the public announcement of the clinical failure. Collins is essentially accused of knowingly not attempting to trade, an interesting supposition given that he stood to gain far more from Innate sales than did his son.

Finally, it bears noting that the commission's quest for both disgorgement and fines may prove quixotic. The strong suspicion of the commission's disgorgement tool raised by last year's Kokesh no doubt prompted the inclusion within the parallel Indictment of the harsh forfeiture and asset substitution provisions.

Conclusion

Agencies are called upon to animate Congressional intent pursuant to clearly intelligible guidance – a symbiosis labeled “interstitial rulemaking.” For nearly 60 years, the SEC has engineered theories that may convince a court that insider trading occurred. The commission has thus forcefully grown a prohibition that inspires imitation worldwide. In turn, the agency has earned adulation for its fearlessness in employing that ban against anyone, regardless of status.

Still, Congress increasingly appears to be an exhortatory bystander to the process, which more resembles a boundless law school hypothetical with each high profile case. The S.T.O.C.K. Act plays no role in assisting SEC Complaints against congressmen, Regulation FD has been invoked but a handful of times, and both the chase of “attempted” insider trading and disgorgement warrant SEC referral to the DOJ for use of generic criminal statutes. Moreover, the protocol by which cases elevate from civil to criminal has become increasingly opaque. Add to this uncertainty the newly provocative question of when news of a foreign exchange's trading halt qualifies as disclosure of negative news and one begins to appreciate the lure of a purely statutory prohibition – if the commission could be prodded to employ it.

Stated otherwise, fans of market “fairness” at any intellectual cost can rejoice that a difficult hodgepodge of statutes, regulations, and common law wizardry can be expediently cobbled together to charge those who appear to flaunt their privileged status. Yet, if the Collins allegations are true, Congress failed to reach by statute insider trading by one of their own transpiring but two miles down Pennsylvania Avenue. It was the Fourth Circuit that observed in 1995 that we were all becoming “pawns” in a strategy known only to the commission. To be sure, the government attorneys – having elevated the contest to criminal proceeding – shall likely have their hands full bringing that strategy to fruition should these cases proceed to trial.

A former regulator, Professor Colesanti has taught securities regulation at the Hofstra University Maurice A. Deane School of Law since 2002. His 2018 book, “Fairness, Inc.”, traces the history of the modern insider trading prohibition.