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SBC Insider Trading Hearing

Senate Banking Committee

Keeping Markets Fair: Considering Insider Trading Legislation

Tuesday, April 5, 2022

Topline

  • The hearing focused on, among other issues, the personal benefit standard, the Insider Trading Prohibition Act, and tangentially on other legislation including the discussion draft JOBS Act 4.0, Sen. Tillis’ efforts on early growth companies, and Sen. Van Hollen’s 8-K Trading Gap Act.
  • Ranking Member Toomey and Burton discussed the SEC’s rulemaking agenda and climate risk proposal.

Witnesses

Opening Statements
Chairman Sherrod Brown (D- Ohio)

In his opening statement, Brown explained how the stock market is detached from the reality of most people’s lives and disproportionately benefits the wealthy, adding that it seems too easy for corporate insiders to get away with exchanging information about upcoming mergers and deals and engaging in suspicious trading. He highlighted Rep. Jim Himes’ (D-Conn.) and Sen. Jack Reed’s (D-R.I.) efforts to push legislation that would take away the uncertainty created by the courts and establish standards to address insider trading.

Ranking Member Patrick J. Toomey (R-Pa.)

In his opening statement, Toomy touted the JOBS Act, said the Securities and Exchange Commission (SEC) is taking disclosure policy in the wrong direction, and highlighted his roll out of the discussion draft for the JOBS Act 4.0. He recommended that Congress codify what insider trading law should entail but cautioned against legislation that could cause confusion, uncertainty, or unintended consequences.

Testimony
Robert J. Jackson Jr., Pierrepont Family Professor of Law, New York University School of Law

In his testimony, Jackson praised the Insider Trading Prohibition Act for addressing gaps in judge-made insider trading law by recognizing that information changes hands in today’s markets on the basis of more than direct payments, focusing liability on whether information was wrongfully taken, used, or communicated, and not purporting to be the sole source of liability for insider traders who violate other laws. He then highlighted two gaps in current law, including cyber hackers profiting from trading on their activities and insiders at foreign firms profiting extensively from their trading.

Professor M. Todd Henderson, Michael J. Marks Professor of Law, University of Chicago Law School

In his testimony, Henderson discussed the regulation of capital raising and insider trading and said the Insider Trading Protection Act would increase uncertainty for the analysts and traders that do the essential work of incorporating information into stock prices and suggested that Congress narrowly define “personal benefit,” drop the catchall provision as to how information can be wrongfully obtained or communicated, limit liability to individuals with actual knowledge of their wrongdoing, and make the Insider Trading Prohibition Act the exclusive basis for federal insider trading claims.

Mr. David R. Burton, Senior Fellow in Economic Policy, Roe Institute for Economic Policy Studies, The Heritage Foundation

In his testimony, Burton addressed (1) the JOBS Act, (2) the importance of entrepreneurial capital formation to the economy and the American people, (3) the impact of regulatory impediments to entrepreneurial capital formation, (4) legislative proposals that have been introduced in the 117th Congress that promote capital formation and which have been incorporated into the Senate Banking Committee Republicans’ JOBS Act 4.0 discussion draft, (5) additional statutory changes to improve entrepreneurs’ access to capital, and (6) securities law reforms to improve the regulatory environment for entrepreneurs and larger public companies and returns for investors.

Professor John C. Coffee Jr., Adolf A. Berle Professor Of Law, Director Of The Center On Corporate Governance, Columbia Law School

In his testimony, Coffee highlighted the problem of allowing insider trading law to develop through judicial decision-making and two updates relevant H.R. 2655, the Insider Trading Prohibition Act, including the downsizing of the provision to eliminate the personal benefit requirement and the current posture of United States v. Blaszczak. He then summarized the current statutory law on insider trading, discussed the personal benefit requirement, and suggested that Congress should bar the tipping of, or trading on, confidential government information. Lastly, Coffee suggested changes to H.R. 2655, including adding a new Section 16A and changing the Standard and Knowledge Requirement.

Question & Answer

Insider Trading

Brown asked why Congress should target wrongful conduct. Coffee, not directly answering Brown’s question, said changing three or four words in the Insider Trading Prohibition Act would warrant his support. Brown asked how court disagreements about tipees impact insider trading cases. Jackson said cases cannot be brought under these circumstances, empowering market participants to do more of the behavior that brought about the cases. Brown and Jackson discussed fact patterns related to insider trading, and Brown asked Coffee to counter criticisms of the Insider Trading Prohibition Act. Coffee explained that those who know they have wrongfully received information are criminally liable for taking the information and moving it along. Jackson added that insider trading law has not kept up with how markets work and that the law should capture that activity when it is unlawful.

Toomey highlighted disagreement between panelists on what constitutes liability and asked why the indirect benefit standard should or should not be the appropriate standard. Henderson cited Dirks v. SEC to show that the SEC’s attitude of creating parity of information between traders is a real problem.

Sen. Robert Menendez (D-N.J.) asked about the impact of insider trading on the public. Jackson said the enforceability of insider trading laws has real costs for Americans such as making them less sure that they are going to be on a level playing field against those with privileged information. Menendez asked what led to the conflict in courts over personal benefits. Jackson explained the courts understanding of the personal benefits approach and the discrepancy between that understanding and how the market works.

Sen. Chris Van Hollen (D-Md.) highlighted the 8-K Trading Gap Act and asked if executives with access to non-public material information may be trading within the 8-K gap before the information is made public. Jackson said there is significant trading within the 4-day gap and that announcements pending at the end of the 4-day period are material corporate events and expressed support for the 8-K Trading Gap Act. Van Hollen also asked about foreign insiders, their insider trading, and the difference in governance between their rules and U.S. insider trading rules. Jackson said foreign firms are exempted from the same disclosures that apply to U.S. companies and that foreign company disclosures are provided on paper filings.

SEC Rulemaking Agenda

Toomey asked why there are fewer public companies today than a decade ago. Burton cited the massive regulatory burden, which will get worse under the SEC’s current rulemaking proposals, and the increase in litigation risk. Toomey followed up regarding the SEC’s proposals, asking about disclosure of financially immaterial facts. Burton said that is a serious mistake and that the SEC is trying to redefine the understanding of materiality that has been in place for a decade, adding that the climate disclosure rule would triple the cost of being a public company and have dramatic effects that will make the going-private transactions associated with Sarbanes Oxley’s internal control reporting requirements look like child’s play.

Digital Assets

Menendez asked how insider trading interacts with digital assets. Coffee said insider trading does not apply to digital assets but that it applies to certain initial public offerings (IPO) of crypto assets.

Early Growth Companies

Sen. Thom Tillis (R-N.C.) asked if increasing access to early growth companies democratizes investment. Burton said yes, adding this would give less affluent investors access to high growth companies. Jackson highlighted the tax that small and mid-sized companies pay when going public and praised Tillis’ legislative efforts to address this.

Regulatory Tailoring

Tillis asked about regulatory tailoring. Burton promoted scale disclosure, shared Tillis’ concern with overregulation’s effect on entrepreneurs, and expressed reservations about replacing 10-Qs with semi-annual reporting of financial statements.

Cybersecurity

Sen. Mark Warner (D-Va.) asked about the prevalence of cyber-attacks affecting stocks. Jackson said individuals profit from trading on cyber-attacks, including before companies publicly announce that they have been attacked, and emphasized that the Insider Trading Prohibition Act would make trading on cyber hacked information a violation of federal law.

Stock Buybacks

Warner asked about stock buybacks. Jackson said insiders at public companies increase sales of stock in concert with the announcement of a share repurchase plan and suggested CEOs should be forced to hold their shares when engaged with a buyback.

Insider Trading in Congress

Sen. Elizabeth Warren (D-Mass.) asked if we need stronger rules to prevent insider trading in Congress. Jackson said yes, and Coffee said Congress should only invest in diversified portfolios like mutual funds and not individual stocks.

For more information on this hearing, please click here.

For an archive of past SIFMA hearing coverage, please click here.