Possession versus use: Is there a causation element in the prohibition on insider trading?

Business Lawyer

Volumn 52, Issue 4, 1997, Pages 1235-1278

  Honvich, Allan ^a  

^a Schiff Hardin and Waite   (United States)

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EID: 21944443915     PISSN: 00076899     EISSN: None     Source Type: Journal    
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References (457)

1. See infra notes 84-85, 120-26 and accompanying text (for cases decided under federal law);
2. Infra notes 46-55 and accompanying text (for cases decided under common law).
3. See infra notes 192-207 and accompanying text.
4. 15 U. S. C. §78j (b) (1994).
5. 17 C. F. R. § 240.10b-5 (1997).
6. Criminal fines and prison sentences may be imposed under section 32 of the Exchange Act. 15 U. S. C. § 78ff (1994). Private claims are asserted as implied causes of action under rule 10b-5 standing alone or supported by section 20A (a) of the Exchange Act. Id.§ 78t-l (a).
7. Section 20A (d) expressly preserves any implied cause of action. Id.§ 78t-l (d).
8. Section 21A of the Exchange Act provides for recovery of a civil penalty from "any person [who] has violated any provision of [the Exchange Act] or the rules or regulations thereunder by purchasing or selling a security while in possession of material, nonpublic information" in specified types of transactions. Id.§ 78u-1 (a) (1). The choice of the term "possession" rather than "use" in that section is not dispositive of the issue addressed here.
9. See infra notes 133-48 and accompanying text.
10. See infra notes 18, 28.
11. The prohibition applies only with respect to material information. Material information is information that a "reasonable shareholder would consider... important" in making an investment decision; that is, when there is a "substantial likelihood" that the "reasonable investor" would view the information as "significantly alter[ing] the 'total mix' of information made available."
12. Basic Inc. v. Levinson, 485 U. S. 224, 231-32 (1988)
13. (quoting TSC Industries, Inc. v. Northway, Inc., 426 U. S. 438, 449 (1976)). The prohibition applies only to nonpublic, or inside, information. There are at least two schools of thought regarding when information is "public." Under one approach, information is public if it has been "effectively disclosed in a manner sufficient to insure its availability to the investing public."
14. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 854 (2d Cir. 1968). Under another approach, information is public for purposes of rule 10b-5 "even though there has been no public announcement" so long as the trading of those who do know the information has caused the information to be "fully impounded into the price of the particular stock. Once the information is fully impounded in price, such information can no longer be misused by trading because no further profit can be made."
15. 2 The scarcity of pertinent cases does not, however, mean that the question is merely of abstract interest. In reality, the issue frequendy arises in counseling both individual and institutional clients who may obtain inside information pending completion of a transaction or in the midst of a pre-established trading program.
16. Chiarella v. United States, 445 U. S. 222, 227-35 (1980).
17. Dirks v. SEC, 463 U. S. 646, 655 n. 14 (1983) ("Under certain circumstances, such as where corporate information is revealed legitimately to an underwriter, accountant, lawyer, or consultant working for the corporation, these outsiders may become fiduciaries of the shareholders.");
18. SEC v. Ingram, 694 F. Supp. 1437, 1439-40 (CD. Cal. 1988) (holding a consultant in merger negotiations liable as a temporary insider).
19. United States v. O'Hagan, 117 S. Ct. 2199 (1997)
20. Rev'g, 92 F.3d 612 (8th Cir. 1996). This decision resolved a split among several courts of appeals.
21. Compare United States v. Chestman, 947 F.2d 551, 566-71 (2d Cir. 1991) (en banc) (reversing a conviction under rule 10b-5)
22. SEC v. Cherif, 933 F.2d 403, 408-10 (7th Cir. 1991) (injunction affirmed)
23. SEC v. Clark, 915 F.2d 439, 443-53 (9th Cir. 1990) (civil liability affirmed)
24. With United States v. O'Hagan, 92 F.3d 612, 622 (8th Cir. 1996) ("the misappropriation theory is not a valid basis upon which to impose criminal liability under§ 10 (b) ")
25. Rev'd, 117 S. Ct. 2199 (1997)
26. United States v. Bryan, 58 F.3d 933 (4th Cir. 1995). On the first occasion when the misappropriation theory was squarely presented to it, the Court divided equally.
27. United States v. Carpenter, 791 F.2d 1024 (2d Cir. 1986)
28. Aff'd, 484 U. S. 19, 24 (1987) (affirming a conviction for mail fraud unanimously, but affirming by an equally divided Court on convictions under the securities laws).
29. O'Hagan, 117 S. Ct. at 2207.
30. See, e.g., United States v. Newman, 664 F.2d 12 (2d Cir. 1981) (employees of investment banker misappropriated information entrusted to employer by its clients in order to trade in securities of targets of the clients).
31. While it is easy to pose examples of an insider possessing nonpublic information but arguably not using it in making a trading decision, it is much more difficult to envision a plausible situation where someone first misappropriates information (an affirmative wrongful act) and then trades without using it. The issue becomes more plausible in the misappropriation context when the defendant is a tippee-a passive recipient of the information rather than the person who purloined it. In O'Hagan, the defendant was expressly charged with trading on the basis of nonpublic information.
32. O'Hagan, 117 S. Ct. at 2205 & n. 1
33. These prophylactic measures are predicated at least in part upon the assumption that possession of material inside information somewhere in the organization would preclude trading but for the information-blocking device which prevents use of the information by those trading. One purpose of this Article is to test that assumption.
34. See Broker Dealer Policies and Procedures Designed to Segment the Flow and Prevent the Misuse of Material Non-Public Information, [1989-1990 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶84, 520, at 80, 621 (Mar. 1990);
35. Louis Loss & Joel Seligman, Securities Regulation 3618-31 (3d ed. 1991);
36. Leo Herzel & Dale E. Colling, The Chinese Wall Revisited, 6 Corp. L. Rev. 116, 119 (1983);
37. Allan Horwich, Bank Fiduciaries with Material Inside Information: Responsibilities and Risks, 113 Banking L. J. 4, 8-9 (1996);
38. Martin Lipton & Robert B. Mazur, The Chinese Wall Solution to the Conflict Problems of Securities Firms, 50 N. Y. U. L. Rev. 459, 495-96 (1975);
39. Carlos E. Méndez-Peñate, The Bank "Chinese Wall": Resolving and Contending with Conflicts of Duties, 93 Banking L. J. 674, 686 (1976);
40. Marc I. Steinberg & John Fletcher, Compliance Programs for Insider Trading, 47 SMU L. Rev. 1783, 1803-04 (1994). The SEC recognized the legitimacy of these measures in rule 14e-3 (b) under the Exchange Act, which provides a Chinese Wall defense in connection with inside information regarding tender offers.
41. C. F. R. § 240. 14e-3 (b) (1997).
42. 40 S. E. C. 907 (Nov. 8, 1961).
43. Id.
44. Id. at 911. This analysis was based in part on the developing common-law rule to impose such a duty.
45. Id. at 911 n. 13.
46. Id. at 912.
47. Id.
48. Id. at 909-10.
49. Id. at 912 n. 15. The authorities cited by the SEC for this proposition are germane to the issue addressed in this Article. The cited passage from the legislative history in the House of Representatives states, in part, that insiders "must not use inside information for their own advantage."
50. H. R. Rep. No. 1383, 73d Cong., 2d Sess. 13 (1934) (emphasis added). The cited passage from the legislative history in the Senate condemned "speculating in the stock on the basis of information not available to others."
51. S. Rep. No. 792, 73d Cong., 2d Sess. 9 (1934) (emphasis added).
52. Both passages dealt with what became section 16 of the Exchange Act, which requires disclosure of stock ownership and transactions by officers, directors, and significant shareholders of publicly traded companies, and disgorgement of short-swing profits. 15 U. S. C. § 78p (1994).
53. Cody, Roberts, 40 S. E. G. at 914.
54. Id. at 916.
55. Id.
56. 445 U. S. 222 (1980).
57. Id. at 232-35.
58. Id. at 228-29
59. (quoting Speed v. Transamerica Corp., 99 F. Supp. 808, 829 (D. Del. 1951)).
60. As the SEC did in Cady, Roberts, the Court drew on common law precedents.
61. Id. at 228 nn. 9-10.
62. Id. at 230.
63. 8 Id. at 228 n. 10, 232-35. Thus, while following Cady, Roberts in large measure, Chiarella required something which Cady, Roberts arguably had not, namely, a breach of a fiduciary duty or similar relationship of trust and confidence by a person in whom the counter party has placed trust and confidence.
64. Id. at 232.
65. 463 U. S. 646 (1983).
66. Id. at 665-67.
67. Id. at 653-54.
68. Id.
69. Id. at 654
70. (quoting In re Merrill Lynch, Pierce, Fenner & Smith, Inc., 43 S. E. C. 933, 936 (Nov. 28, 1968)).
71. Id. at 654
72. (quoting In re Cady, Roberts & Co., 40 S. E. C. 907, 916 n. 31 (1961)).
73. See also infra notes 212-15 and accompanying text. The cited passages are not the only ones where the Court has spoken in terms of "use" of inside information.
74. See United States v. O'Hagan, 117 S. Ct. 2199, 2207 (1997) (unlawful misappropriation consists of "undisclosed, self-serving use of a principal's information");
75. Id. at 2209 (the fiduciary's fraud is consummated when he "uses the information to purchase or sell securities");
76. Dirks, 463 U. S. at 653 n. 10 (insiders have a duty "not to trade on inside information");
77. Id. at 658-60 (repeated use of phrase to "trade on" inside information);
78. Id. at 661 n. 21 (reference to "knowingly trading on inside information");
79. Chiarella v. United States, 445 U. S. 222, 227 n. 8 (1980) (Cady, Roberts held that "the insider could not use the information");
80. Id. at 229 (other federal courts have found violations where "corporate insiders used undisclosed information for their own benefit");
81. Id. at 230 n. 12 (tippees "have a duty not to profit from the use of inside information"). There are, on the other hand, a few passages which do not suggest an element of affirmative, conscious use of inside information.
82. See, e.g., Chiarella, 445 U. S. at 227-28 (the duty to disclose arises when one party has information the other party is entitled to know).
83. Scienter is a necessary element of an SEC or private civil action under rule 10b-5, as well as a criminal action.
84. Aaron v. SEC, 446 U. S. 680, 695 (1980);
85. Ernst & Ernst v. Hochfelder, 425 U. S. 185, 193 (1976). In Dirks, the Court held: "It is not enough that an insider's conduct results in harm to investors; rather, a violation may be found only where there is 'intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities.' "
86. Dirks, 463 U. S. at 663 n. 23
87. (quoting Hochfelder, 425 U. S. at 199).
88. See infra notes 86-106 and accompanying text.
89. See supra notes 18, 28. This is not to say that the law of insider trading under rule 10b- 5 is no broader than the broadest common-law prohibitions. As noted in Cady, Roberts, the prohibitions under the federal securities laws are often broader than the proscriptions at common law.
90. Cady, Roberts, 40 S. E. C. at 913-14.
91. See supra notes 16-25 and accompanying text.
92. There have been many extensive analyses of the development of the prohibition on insider trading at common law and the various forms it has taken. A full discussion of these issues is beyond the scope of this Article.
93. See, e.g., Stephen M. Bainbridge, Incorporating State Law Fiduciary Duties into the Federal Insider Trading Prohibition, 52 WASH. & LEE L. REV. 1189 (1995);
94. Douglas M. Branson, Choosing the Appropriate Default Rule-Insider Trading under State Law, 45 Ala. L. Rev. 753 (1994);
95. Gerard E. Wimberly, Jr., Corporate Recovery of Insider Trading Profits at Common Law, 8 CORP. L. Rev. 197 (1985). For an extensive summary of the case law of the common law of insider trading
96. See Bailey v. Vaughn, 359 S. E.2d 599 (W. Va. 1987).
97. 70 A.2d 5 (Del. Ch. 1949).
98. Id. at 8.
99. Id.
100. Diamond v. Oreamuno, 248 N. E.2d 910 (N. Y. 1969).
101. *5 (D. Nev. Mar. 28, 1991) (finding that the Nevada courts would follow Brophy);
102. General Acquisition, Inc. v. Gencorp Inc., 766 F. Supp. 1460, 1477 (S. D. Ohio 1990) (under Ohio law);
103. Katz Corp. v. T. H. Canty and Co., #.362 A.2d 975, 980 (Conn. 1975) (under Connecticut law) (citing Brophy and Diamond with approval in dictum). Some courts have acknowledged that use of inside information by a corporate fiduciary is wrongful, but have rejected a cause of action by or on behalf of the corporation unless the corporation can prove that it was damaged by the misuse of information.
104. Frankel v. Slotkin, 984 F.2d 1328, 1336-37 (2d Cir. 1993) (under New Jersey law);
105. Freeman v. Decio, 584 F.2d 186, 194-95 (7th Cir. 1978) (under Indiana law);
106. Schein v. Chasen, 13 So. 2d 739, 746 (Fla. 1975) (under Florida law).
107. 411 F. Supp. 698 (E. D. Mo. 1976)
108. qff'd, 552 F.2d 797 (8th Cir. 1977).
109. Id. at 704-05.
110. Id. at 705.
111. Polin, 552 F.2d at 811 (emphasis omitted) (quoting RESTATEMENT (SECOND) OF AGENCY§ 388 cmt. c (1958)). The text of the comment, with omissions and emphasis as in the court of appeals opinion, is: Use of confidential information. An agent who acquires confidential information in the course of his employment or in violation of his duties has a duty... to account for any profits made by the use of such information, although this does not harm the principal.... So, if [a corporate officer] has "inside" information that the corporation is about to purchase or sell securities, or to declare or to pass a dividend, profits made by him in stock transactions undertaken because of his knowledge are held in constructive trust for the principal. Id.
112. *1 (Del. Ch. May 20, 1982).
113. * 11.
114. Id. The case was ultimately settled. Tuckman v. Aerosonic Corp., No. 4094, 1983 WL 20291 (Del. Ch. Apr. 21, 1983).
115. No. 7047, 1985 WL 21137 (Del. Ch. Sept. 5, 1985).
116. * 6.
117. Id. (citing Polin v. Conductron Corp., 552 F.2d 797, 811 (8th Cir. 1977)).
118. *3 (Del. Ch. Oct. 16, 1989), where the court held that there must be a "causal link... between the confidential information the corporate insiders possess and any profits they accumulate."
119. [1994-1995 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 98, 382, at 90, 614 (Del. Ch. June 1, 1994).
120. Id. at 90, 617-18.
121. Id. at 90, 618-19.
122. Id.
123. 584 F.2d 186 (7th Cir. 1978).
124. Id. at 197 n. 44. While finding that there was no cause of action under Indiana law for a corporation to recover insider trading profits from officers and directors absent proof of damage to the corporation, the court also reviewed the district court's finding that summary judgment was properly granted to the defendants on the ground that the sales in question were not "based on material inside information. "
125. Id. at 196-200.
126. See infra notes 212-15 and accompanying text.
127. 44 S. E. C. 633 (1971). The SEC reviewed the case sua sponte.
128. Id. at 635.
129. Id. at 646-47 (emphasis added).
130. In re Investors Management Co., [1969-1970 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 77, 832, at 83, 959-61 (SEC Initial Decision June 26, 1970).
131. Investors Management Co., 44 S. E. C. at 647 n. 28.
132. Id. at 651 (Smith, Comm'r, concurring). Commissioner Smith elaborated: "I do not read [the majority's] requirement that the information be 'a factor' as, for instance, encompassing situations where a firm decision to effect a transaction had clearly been made prior to the receipt of the information and the information played no substantial role in the investment decision. "
133. Id. He also observed that, in prior litigation, the SEC had "accepted the burden of proving that the inside information was the motivating factor, and not just a factor, in the decision to effect the transaction." Id. at 650.
134. 494 F.2d 1301 (2d Cir. 1974).
135. Id. at 1307. While the defendant argued that he bought the stock when he did because it "was fairly priced, it was cheap," the same market conditions had existed for some time before the purchase, and before the receipt of inside information. Id.
136. 420 F. Supp. 1226 (S. D. N. Y. 1976)
137. qff'd, 565 F.2d 8 (2d Cir. 1977).
138. Id. at 1236-38.
139. Id. at 1244-46.
140. Id. at 1237-39.
141. Id. at 1239. The court stated: "It would not be unreasonable to infer that [the seller] sold on the strength of [the analyst's] appraisal independent of [the chairman's] disclosure or, quite as likely, that his sale was motivated by the entire mix of factors then present." Id.
142. Bausch & Lomb, 565 F.2d at 18-19.
143. Id. at 18. In a subsequent proceeding, one of the firms which sold based on Mac- Callum's change in recommendation sought to vacate its prior consent to entry of a permanent injunction. The district court observed that, apart from the fact that the conduct of that firm had not been adjudicated in the contested case involving BL and its chairman, the court also had not even resolved whether those defendants who had gone to trial had violated the securities laws.
144. SEC v. Bausch & Lomb, Inc., [1979 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 96, 807, at 95, 170 (S. D. N. Y. Mar. 21, 1979).
145. 53 F. R. D. 664 (E. D. N. Y. 1971)
146. qff'd, 464 F.2d 437 (2d Cir. 1972).
147. Id. at 680-84.
148. Dolgow was decided before Eisen v. Carlisle & Jacquelin, 417 U. S. 156 (1974), which is generally read as precluding an evaluation of the merits of the claim when determining whether to certify a case as a class action. For a recent analysis of this issue
149. See Bartlett H. McGuire, The Death Knell for Eisen: Why the Class Action Analysis Should Include an Assessment of the Merits, 168 F. R. D. 366 (1996).
150. 89 F. R. D. 87 (S. D. N. Y. 1981).
151. In order to certify a class under the Federal Rules of Civil Procedure, the court must first find that "the questions of law or fact common to the members of the class predominate over any questions affecting only individual members." Fed. R. Civ. P. 23 (b) (3).
152. Dura-Bill Corp., 89 F. R. D. at 95.
153. [1993-1994 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 98, 103 (S. D. N. Y. Nov. 16, 1993).
154. Id. at 98, 808.
155. [1995-1996 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 98, 956 (N. D. Ala. Oct. 24, 1995)
156. Appeal docketed, No. 96-6084 (11th Cir. 1996).
157. Id. at 93, 614.
158. See supra note 38.
159. 608 F.2d 55 (2d Cir. 1979).
160. Id. at 63.
161. Id. at 62.
162. 699 F.2d 47 (1st Cir. 1983) (en banc).
163. Id. at 50-51.
164. 570 F. Supp. 1397 (C. D. Cal. 1983).
165. Id. at 1402.
166. 886 F.2d 1109 (9th Cir. 1989).
167. See supra note 45;
168. See also supra note 61 and accompanying text.
169. Apple Computers, 886 F.2d at 1117
170. (citing Freeman v. Decio, 584 F.2d 186, 197 n. 44 (7th Cir. 1978)).
171. [1993-1994 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 98, 247 (E. D. Pa. May 23, 1994). The defendant in question eventually setded with the SEC.
172. SEC v. Shared Medical Systems Corp., Litigation Release No. 14130, 56 S. E. C. Docket 2624 (June 22, 1994).
173. Shared Medical Systems, [1993-1994 Transfer Binder] Fed. Sec. L. Rep. (CCH), at 99, 700.
174. 49 F.3d 1363 (9th Cir. 1994).
175. Id. at 1379-80.
176. [1989 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 94, 444 (D. Mass. Dec. 6, 1988).
177. Id. at 92, 853-54.
178. [1989-1990 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 94, 840 (S. D. N. Y. Dec. 6, 1989).
179. The indictment in this case was the same one in which the defendants in United States v. Tekher, 987 F.2d 112 (2d Cir. 1993), were charged with violations of the federal securities laws.
180. See infra notes 107-19 and accompanying text.
181. Id. at 94, 561-62.
182. Id. at 94, 561.
183. Id. at 94, 562. The corporate defendant's concern that finding possession to be sufficient "works dreadful damage" to Chinese Walls was rejected because no Chinese Wall defense had been advanced.
184. Id. at 94, 562-63.
185. See United States v. Teicher, 987 F.2d 112 (2d Cir. 1993).
186. Teicher, 987 F.2d at 121. The defendants mounted a challenge to a jury instruction which stated: "The government need not prove a causal relationship between the misappropriated material nonpublic information and the defendants' trading."
187. Id. at 119. The court, however, found it "unnecessary to determine whether proof of securities fraud requires a causal connection" because, taken as a whole, "any alleged defect in the instruction was harmless beyond doubt."
188. Id. at 121. Moreover, the tippee defendants had not been precluded from arguing to the jury that they never knowingly traded on inside information; instead, they had focused their argument to the jury on their contention that they did not know the information was material and nonpublic or did not know it was wrongfully acquired. Id. The government's response to the defendants' petition for a writ of certiorari on this issue was based in large measure on the character of the comments on the possession versus use issue as dicta. Brief for the United States in Opposition at 12-14, Teicher v. United States, 510 U. S. 976 (on petition for cert.) (cert, denied) (Oct. Term 1993) (No. 93-138). The government did, nevertheless, support a "knowing possession" test.
189. Id. at 14 n. 9.
190. Teicher, 987 F.2d at 120. This ignores the "requirement" applied by the SEC in Investors Management.
191. See supra notes 63-67 and accompanying text.
192. Teicher, 987 F.2d at 120.
193. Id. While the U. S. Supreme Court upheld the misappropriation theory in O'Hagan, the Court's emphasis on "willful [ness]" and "culpable intent" tends to support the conclusion that a transaction without conscious use would not support a conviction.
194. United States v. O'Hagan, 117 S. Ct. 2199, 2214 (1997).
195. Teicher, 987 F.2d at 120.
196. Id. at 120-21.
197. Id.
198. Id. at 20.
199. See supra note 30 and accompanying text.
200. Teicher, 987 F.2d at 121.
201. Id.
202. See, e.g., Ralph C. Ferrara & Herbert Thomas, Ferrara on Insider Trading and The Wall § 8.03 [1] (1996) ("the import of Teicher may reach far beyond these immediate facts"; "[q]uestions thought already answered will again have to be reviewed.");
203. Martin Flumenbaum & Brad S. Karp, Insider Trading; Similar Acts; Footnotes, N. Y. LJ., Mar. 24, 1993, at 3 (Teicher "may gready increase the scope of both criminal and civil liability for insider trading");
204. Harvey L. Pitt & Karl A. Groskaufmanis, Actual Use of Inside Information at Issue, NAT'L L J., June 21, 1993, at 20 ("The impact of the Teicher opinion will be felt most profoundly not in litigation but in the day-to-day efforts by market participants-from securities professionals to those associated with public companies of all sizes-to avoid trades that, in hindsight, cross the murky line into illegality"). Professor Langevoort, on the other hand, finds the dictum in
205. Teicher to be the better rule. DONALD C. LANGEVOORT, INSIDER Trading: Regulation, Enforcement, and Prevention § 3.04, at 3-22 to 3-23 (1996).
206. 35 F.3d 1407 (9th Cir. 1994).
207. Id. at 1427.
208. Id. at 1427-28.
209. Id. at 1428.
210. Id. See supra note 94 and accompanying text.
211. Worlds of Wonder, 35 F.3d at 1428.
212. See supra notes 60-61 and accompanying text.
213. See supra notes 107-19 and accompanying text.
214. 922 F. Supp. 867 (S. D. N. Y. 1996).
215. Id. at 891.
216. Id. at 891-92. Under these circumstances, if the tippee had traded after receiving the information, he would have done so with the requisite scienter.
217. Id. at 891.
218. Id. at 892-95.
219. Id.
220. Id. at 893.
221. Insider Trading Sanctions Act of 1984 (ITSA), Pub. L. No. 98-376, §5, 98 Stat. 1264, 1265 (1984)
222. (codified as amended at 15 U. S. C. § 78t (d) (1994)) (emphasis added).
223. Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA), Pub. L. No. 100-704, § 5, 102
224. Stat. 4677, 4680 (1988)
225. (codified as amended at 15 U. S. C. § 78t-l (a) (1994)) (emphasis added).
226. Id.§ 3 (a) (3), 102 Stat, at 4677
227. (codified as amended at 15 U. S. C. § 78u-1 (a) (1994)) (emphasis added).
228. See Jackson Nat'1 Life Ins. Co. v. Merrill Lynch & Co., 32 F.3d 697, 703 (2d Cir. 1994) ("to state a claim under§ 20A, a plaintiff must plead a predicate violation of the [Exchange] Act or its rules and regulations");
229. In re Verifone Sec. Litig., 784 F. Supp. 1471, 1488 (N. D. Cal. 1992) (section 20A is violated only where "an independent violation of another provision of the securities laws has occurred")
230. qff'd, 11 F.3d 865, 872 (9th Cir. 1993) (plaintiffs "concede that if they have failed to allege an actionable independent underlying violation of the [Exchange] Act, they similarly cannot maintain a claim under§ 20A");
231. T. Rowe Price New Horizons Fund, Inc. v. Preletz, 49 F. Supp. 705, 709 (D. Md. 1990) (section 20A, by its terms, applies only "if there has been an insider trading violation of another provision of the securities laws");
232. But see H. A. B. Assocs. v. Hines, [1990-1991 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 95, 665, at 98, 119-20 (S. D. N. Y. Oct. 26, 1990) (complaint under section 20A sufficient in alleging only possession).
233. See also the straightforward parsing of the grammar of what became ITSA in the House testimony of
234. Ted J. Fifiis. Hearings on H. R. 559 before the Subcom. on Telecommunications, Consumer Protection, and Finance of the House Comm. on Energy and Commerce, 98th Cong., 1st Sess. 236, 245 (Apr. 13, 1983) [hereinafter Hearings on H. R. 559].
235. While subsequent congressional commentary on a prior statute may be instructive, "the interpretation given by one Congress (or a committee or Member thereof) to an earlier statute is of little assistance in discerning the meaning of that statute."
236. Central Bank v. First Interstate Bank, 511 U. S. 164, 185 (1994)
237. (quoting Public Employees Retirement Sys. v. Betts, 492 U. S. 158, 168 (1989)) (rejecting an aiding and abetting cause of action under rule 10b-5).
238. The SEC General Counsel (Daniel L. Goelzer) and Director of the Division of Enforcement (John M. Fedders) maintained that possession, not "based on," is the test, although the SEC's Chairman, John S. R. Shad, expressed uncertainty that the SEC's position on that issue had always prevailed.
239. Hearings on H. R. 559, supra note 136, at 48-49. Perhaps Chairman Shad was thinking of the SEC's own decision in Investors Management.
240. See supra notes 63-67 and accompanying text. In response to a subsequent inquiry from the Chairman of the Subcommittee on Telecommunications, Consumer Protection and Finance, House Committee on Energy and Commerce, Chairman Shad unequivocally stated that existing law "prohibit [s] trading while in possession of material nonpublic information. "
241. H. R. Rep. No. 98-355, at 31 (1983)
242. Reprinted in 1984 U. S. C. C. A. N. 2274, 2304 (Letter from John S. R. Shad, June 29, 1983). Director Fedders emphasized that the proposed legislation "does not impact the 'based on, ' 'in possession of, ' or a 'knowing' standard at all."
243. Hearings on H. R. 559, supra note 136, at 49. Later, however, Mr. Goelzer discussed trading "based on" inside information.
244. Id. at 58. While acknowledging that scienter must be proven, Director Fedders emphasized that that did not entail proving that the trade was "based on" the information. Id. at 71. Virtually all other witnesses who addressed the issue, however, were proponents of the use test.
245. See id. at 196 (testimony and submissions of Arnold Jacobs);
246. Id. at 200 (testimony of The Association of the Bar of the City of New York) (asserting that a possession test would be a change in the law);
247. Id. at 208 (testimony of the Securities Industry Association) (with specific reference to multi-service financial firms);
248. Id. at 297 (testimony of the New York State Bar Association);
249. Id. at 316 (testimony of the Federal Regulation of Securities Committee of the Section of Corporation, Banking and Business Law and the Securities Litigation and Governmental Litigation Committees of the Section of Litigation of the American Bar Association) (the possession test, at least as applied to multi-service financial firms, is "erroneous and not supported by case law or prior [SEC] authority").
250. H. R. Rep. No. 98-355, at 2 (1983)
251. Reprinted in 1984 U. S. C. C. A. N. 2274, 2275. The Senate described "insider trading" in substantially identical terms in summarizing the legislation.
252. COXG. Rec. S8914 (daily ed. June 29, 1984). These descriptions parallel the language used by the SEC in its statement in support of its proposed bill.
253. H. R. Rep. No. 98-355, at 21 n. 33 (1984)
254. Reprinted in 1984 U. S. C. C. A. N. 2274, 2293 n. 33 (Memorandum of the Securities and Exchange commission in Support of the Insider Trading Sanctions Act of 1982) (" 'Insider trading' is the term commonly used to describe the act of purchasing or selling securities while in possession of material nonpublic information about an issuer or the trading market for an issuer's securities."). Upon introducing Senate Bill 910, Senator D'Amato said, "Market trading by an insider in possession of material nonpublic information violates a basic principle of our markets, namely that all investors have equal access to relevant information. "
255. CONG. Rec. 7, 037 (1983). During that colloquy, Senator Sarbanes, who also supported the original Senate version of the legislation, condemned "using such material information. "
256. COXG. Reg. 7, 039 (1983). The House Report, however, noted the underlying policy against "tak[ing] unfair advantage" of inside information, and cited the legislative history of the original statute which condemned those who "used their positions of trust and the confidential information which came to them."
257. H. R. REP. No. 98-355, at 3 (1983)
258. Reprinted in 1984 U. S. C. C. A. N. 2274, 2276 (quoting S. Rep. No. 73-1455, at 55 (1934)).
259. See also supra note 22.
260. H. R. Rep. No. 98-355, at 4 (1983)
261. Reprinkdin 1984 U. S. C. CA. N. 2274, 2277.
262. Id. at 9
263. Reprinkdin 1984 U. S. C. CA. N. at 2282. To the same effect
264. See the statement of Representative Wirth, Chairman of the Subcommittee on Telecommunications, Consumer Protection and Finance, of the House Committee on Energy and Commerce, in support of the legislation at 98 CoXG. Rec. H7012 (daily ed. Sept. 19, 1983) ("this bill does not change the substantive law governing the kind of trading activity that may be deemed to be violative of the antifraud provisions of the Federal securities laws").
265. 2 Alan R. Bromberg & Lewis D. Lowenfels, Securities Fraud & Commodities Fraud §.4 (610), at 7:160.4 (2d ed. 1996).
266. 5D Arnold S. Jacobs, Litigation and Practice under rule 10b-5 § 265, at 11-514 (1996).
267. See also Note, A Critique of the Insider Trading Sanctions Act of 1984, 71 Va. L. Rev. 455, 494-97 (1985).
268. Langevoort, supra note 119, § 3.04, at 3-23 to 3-24 (footnotes omitted) (emphasis added).
269. See also Donald C. Langevoort, The Insider Trading Sanctions Act of 1984 and Its Effect on Existing Law, 37 Vand. L. Rev. 1273, 1289-90 (1984).
270. Wiluam K. S. Wang & Marc I. Steinberg, Insider Tradlng§ 4.4.5, at 183-84 (1996) (footnote omitted).
271. See infra notes 192-207 and accompanying text.
272. In enacting section 15 (f) of the Exchange Act, Congress showed that it could employ "use" terminology in the insider trading context. Section 15 (f) requires brokers and dealers to enforce written procedures "reasonably designed... to prevent the misuse in violation of this chapter... of material, nonpublic information by such broker or dealer...."
273. U. S. C. § 780 (f) (1994). One could argue that the failure consistently to employ "possession" language in all provisions pertaining to insider trading reflects a conscious decision to impose liability under ITSA and ITSFEA for trading while in possession of inside information irrespective of any element of causation. In this example of brokers and dealers, consistent use of "possession" language would have been codified using a phrase such as, "enforce written procedures designed to prevent the purchase or sale of a security in violation of this tide by such broker or dealer while in possession of material, nonpublic information. "That argument might attribute excessive precision to the drafting of the legislation, but the difference in language might also have been designed to take information blocking devices into account so that a broker-dealer firin could lawfully purchase or sell securities while someone in the firm was in possession of inside information, so long as the information was not "misused."
274. See supra notes 14-15 and accompanying text.
275. Pub. L. No. 100-704, § 2 (3), 1988 U. S. C. C. A. N. 4677;
276. See also H. R. Rep. No. 100-910, at 7 (1988)
277. Reprinted in 1988 U. S. C. C. A. N. 6043.
278. Consideration of proposed legislation which was not enacted must take into account that "failed legislative proposals are 'a particularly dangerous ground on which to rest an interpretation of a prior statute.' "
279. Central Bank v. First Interstate Bank, 511 U. S. 164, 187 (1994)
280. (quoting Pension Benefit Guaranty Corp. v. LTV Corp., 496 U. S. 633, 650 (1990)).
281. Federal Sec. Code (1978).
282. Id. at vii-viii.
283. Id. § 1603 (a) (1980). The text was revised in 1981 to change "fact of special significance" to "material fact" and to add a defense not relevant to the possession versus use issue. Federal Sec. Code § 1603 (a) (Second Supplement 1981).
284. Federal Sec. Code § 1603 cmt. (1) (1980). The reporter for the ALI project was Professor Loss, whose pro-possession test views are discussed later in this Article.
285. See infra note 194 and accompanying text.
286. In the commentary on the Federal Securities Code on the possession versus use issue, there was no reference to the causation discussion in Investors Management.
287. See supra notes 63-67 and accompanying text.
288. For an extensive discussion of the Federal Securities Code and its fate
289. See 1 Loss and Seligman, supra note 15, at 278-85.
290. Committee on Fed. Regulation of Sec., ABA, Report of the Task Force on Regulation of Insider Trading Part I: Regulation Under the Anlifraud Provisions of the Securities Exchange Act of 1934, 41 Bus. Law. 223, 259 (1985) [hereinafter Report of the Task Force].
291. Id. at 260. The accompanying commentary on the possession versus use issue was unilluminating on the reason for the Task Force's adoption of a causation requirement.
292. Id. at 232-33.
293. See also id. at 232 n. 21 ("It is unclear whether the possession theory prohibits all trading while in possession of material, nonpublic information or prohibits trading only if it is on the basis of such information. ").
294. Id. at 264.
295. 133 CONG. Rec. S473 (daily ed. Jan. 6, 1987).
296. Senate Bill 230 would have made it unlawful for an insider to sell or buy a security if he sold with knowledge of material nonpublic information or for anyone to sell or buy knowing material nonpublic information which he misappropriated. S. 230, 100th Cong. (1987) (proposed section 16A (a) (l) - (2) of the Exchange Act). One affirmative defense would have been that "the purchase or sale was caused solely by factors other than the trading person's knowledge of the material fact."
297. Id. (proposed section 16A (b) (3)). Senate Bill 231 would have made it unlawful for any person to trade in securities "on the basis of material, nonpublic information." S. 231, 100th Cong. (1987) (proposed section 16A (a) of the Exchange Act).
298. S. 1380, 100th Cong., § 2 (1987) (proposing section 16A (b) (1) of the Exchange Act).
299. The remarks of Senator Riegle upon introducing the legislation appear at 133 CONG. Rec. S8, 246-47 (daily ed. June 17, 1987).
300. His proposal is discussed in John F. Olson et al., Recent Insider Trading Sanctions Developments: The Search for Clarity, 85 Nw. U. L. Rev. 715, 728-29 (1991).
301. S. 1380, § 2 (proposing section 16A (b) (2) of the Exchange Act).
302. Id.
303. The Brief Explanatory Memorandum of the ad hoc committee is reprinted at 133 CONG. Rec. S8249 (daily ed. June 17, 1987). The draftsmen observed: In a limited class of cases, it is possible that an individual who possesses material, nonpublic information should not be presumed to have used that information wrongfully- for example, where a pre-existing dividend reinvestment plan of many years' duration is not interrupted by an individual who obtains material, nonpublic information he or she cannot convert to his or her own use. It is anticipated that those situations are so limited that the general presumption that individuals have used such information should apply, but the SEC is expected to develop rules to exempt from the terms of the statute those situations in which the statute should not apply. Specific exemptive authority would be vested in the SEC to accomplish such a result.
304. Id. at S8251 n. 6.
305. See, e.g., H. R. Rep. No. 98-355, at 27 (1983)
306. Reprinted in 1984 U. S. C. C. A. N. 2274, 2299 (Letter from John S. R. Shad. June 29, 1983).
307. Text of Draft "Insider Trading Act of 1987" Submitted by SEC, 19 Sec. Reg. & L. Rep. (BNA) 1284 (Aug. 14, 1987).
308. Id.
309. Id. at 1285 (proposing section 16A (d) (2) of the Exchange Act).
310. The SEC described the proposed legislation as "not fundamentally alter[ing] the scope of prohibited conduct under present law" but found the legislation useful to "eliminate certain anomalies or ambiguities that have arguably been created by some judicial opinions." Memorandum of the SEC in Support of the Insider Trading Act of 1987 [1987 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 84, 152, at 88, 853 (Aug. 7, 1987). The SEC did not identify the "judicial opinions," nor did it expressly address the possession versus use issue.
311. SEC Compromise Proposal on Insider Trading Legislation, 19 Sec. Reg. & L. Rep. (BNA) 1819 (Nov. 27, 1987) (Letter from David S. Ruder, Chairman, SEC, to Senators Riegle and D'Amato (Nov. 18, 1987)). The proposal was submitted upon approval of only a majority of the SEC.
312. *.
313. Id. at 1819 (the proposed legislation "prohibits trading while 'in possession of' material, nonpublic information, rather than requiring the 'use' of such information for trading")
314. Id. at 1817.
315. Id. (proposing section 16A (b) (2) of the Exchange Act).
316. Proposed Language for Inclusion in Committee Report on Insider Trading Definition, 20 Sec. Reg. & L. Rep. (BNA) 279, 280 (Feb. 19, 1988).
317. H. R. REP. No. 100-910, at 11 (1988)
318. Reprinkdin 1988 U. S. C. C. A. N. 6043, 6048.
319. Cal. Corp. Code § 25402 (West 1977);
320. Iowa Code Ann. § 502. 402 (West 1991);
321. N. M. Stat. Ann. § 58-13B-32 (Michie 1991);
322. Pa. Stat. Ann. tit. 70, § 1-406 (West 1994);
323. S. D. CODIFIED Laws § 47-31 A-101 (b) (Michie 1991). Thus, in a case under the cited Pennsylvania statute, the court held that the "dispositive issue is not a question of subjective intent, but rather whether [the defendant] possessed [the material] information... when he purchased plaintiffs' stock."
324. Slemrod v. Yardley Sav. & Loan Ass'n, [1989-1990 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 94, 915, at 95, 053 (E. D. Pa. June 19, 1989);
325. But see Life Investors, Inc. v. AGO Holding, N. V., [1981-1982 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 98, 343, at 92, 107 n. 10 (N. D. Iowa Oct. 9, 1981) (construing the cited Iowa statute "in accordance With established federal law" (i.e., rule 10b-5, in the absence of a pertinent decision of the Iowa courts)). Further, the cited New Mexico statutes provides that "activities permitted under the [Exchange Act], its rules and regulations shall not constitute a violation of this section. "
326. N. M. Stat. Ann. § 58-13B-32 (C).
327. Section 52 of the British Criminal Justice Act of 1993 defines the "ofFence of insider dealing." British Criminal Justice Act, 1993, §52 (Eng.). Section 53 of mat act provides defenses to a charge of insider dealing, including that the trader "would have done what he did even if he had not had the information." Id. § 53 (1) (c).
328. Principles of Corporate Governance: Analysis and Recommendations (1992).
329. Id.§ 5.04 (a).
330. Id. cmt. d (2) (a).
331. Id.
332. The ALI opted in favor of a remedy in the absence of proof of harm. Id.§ 5.04 (c) and cmt. d (2) (a).
333. See supra notes 18, 28.
334. See supra notes 165-74 and accompanying text.
335. See supra notes 63-67 and accompanying text.
336. In re Sterling Drug, Inc., Exchange Act Release No. 14675, [1978 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 81, 570, at 80, 298 (Apr. 18, 1978) (citation omitted). No authority was cited for the stated position, nor was there any reference to the 1971 SEC decision in Investors Management. See supra notes 63-67 and accompanying text. In this connection, it is interesting that the report of the American Bar Association Task Force noted the inconsistency between Sterling Drug and Investors Management, but the report neither explained nor sought to harmonize that inconsistency.
337. Report of the Task Force, supra note 156, at 232 n. 21. This is somewhat surprising because the task force and its advisors and consultants included a former SEC Director of Enforcement (John M. Fedders) and two former SEC General Counsels (Ralph C. Ferrara and Daniel L. Goelzer), all of whom advocated the possession test.
338. *;
339. See also supra note 138
340. Infra note 206 and accompanying text.
341. Litigation Release No. 13850, 55 S. E. C. Docket (CCH) 823 (Oct. 27, 1993).
342. Id. at 823.
343. Id.
344. William R. McLucas & Alma M. Angotti, Insider Trading: Is It Back or Did It Ever Really Go Away?, INSIGHTS, Oct. 1995, at 2, 4-5. The article contains the standard disclaimer that the views expressed are those of the authors and not necessarily those of the SEC.
345. Id. at 2 n. a. The only authority cited was Teicher. For a discussion, see supra notes, 107-19 and accompanying text.
346. McLucas & Angotti, supra note 190, at 5.
347. See supra notes 63-67 and accompanying text.
348. Insider Trading and the Analyst, Fifth Annual Institute on Securities Regulation 1974, 261, at 276 (PLI Corp. Law & Practice Course Handbook Series, 1974) (Remarks of Richard Jennings). Professor Jennings was responding in part to Stanley Sporkin, then Director of the SEC Division of Enforcement, who contended that if one person has the inside information and the other does not and they deal with each other, "It is immaterial whether the sale resulted from his desire for a new home or a new pair of shoes. If he has the information, he cannot effect the transaction without disclosing it to the buyer or the seller, as the case may be."
349. Id. at 274. (To the extent this view was based on the parity of information theory, that is no longer valid.
350. See supra note 30 and accompanying text.) At the same time, Sporkin stated, "Obviously you cannot hold somebody responsible without fault." Id.
351. 7 LOSS & Seligman, supra note 15, at 3505 (footnotes omitted). The authors find the references to "use" in the cases unpersuasive, stating that a "number of cases use language that seems to look the other way. But mere seems to be no case that turns on the point."
352. Id. at 3504 (footnote omitted). This latter statement is not consistent with the recent cases previously discussed.
353. See supra notes 84-85, 120-26 and accompanying text. Their one sentence interpretation of ITSA and ITSFEA is not borne out by the analysis in this Article.
354. See supra notes 133-48 and accompanying text. In their 1996 supplement, they take note of but do not analyze Teicher and do not mention Worlds of Wonder. 1996 Supplement LOSS & SELIG- MAN
355. Supra note 15, at 850-51 (3d ed. 1996).
356. 2 BROMBERG & Lowenfels, supra note 142, § 7.4 (610), at 7:160.1. The cited passages were first published in 1984 and have not been substantively revised since. The authors find support for their position in the exclusive employment of "use" language and the absence of any reference to "possession" in leading misappropriation cases.
357. 'BROMBERG & Low- ENFELS, supra note 142, at NM:198. As previously explained, however, the distinction between possession and use is much less likely to arise in a misappropriation case, albeit Teicher is just such a case.
358. See supra note 13.
359. 2 Bromberg & Lowenfels, supra note 142, § 7.4 (610), at 7:160.1. At the same time, they find the numerous references to both "use" and "basis" in the cases to be dicta "since the courts were focussing on other aspects and were not forced to choose between use and possession, or because they were stating sufficient conditions rather than necessary conditions."
360. Id. § 7.4 (620), at 7-160.10-.13. Their discussion of Teicheris brief and does not seek to reconcile its dictum With the rest of their analysis. 5 BROMBERG & LOWENFELS, supra note 142, at NM: 196-97.
361. 2 Bromberg & Lowenfels, supra note 142, at 7-160.2.
362. Id.
363. Id. at 7-160.2 to.4.
364. Id § 7.4 (621), at 7 :160.14.
365. Id.
366. 5 C Jacobs, supra note 143, § 66. 02 [c], at 3-657. The cited passage, however, was published in 1992 and has not been updated. Thus, this section contains no discussion of Teicher.
367. 5C Jacobs, supra note 143, § 66.02[c], at 3-663 to -664 (footnotes omitted).
368. Id. at 3-663. No authority is cited for this conclusion.
369. See supra note 144 and accompanying text. His support for the theory is not without some reservation, however.
370. See infra note 243 and accompanying text.
371. FERRARA, supra note 119, § 8.03 [1].
372. Wang & Steinberg, supra note 145, § 4.4.5 at 178-84.
373. See supra notes 107-19 and accompanying text.
374. See supra notes 63-85, 120-26 and accompanying text.
375. See supra notes 41-62 and accompanying text.
376. See supra notes 133-48 and accompanying text.
377. See supra notes 20, 22, 28, 34, 59 and accompanying text.
378. Ludwig Wittgenstein, Philosophical Investigations § 340, at 109 (G. E. M. Anscombe trans., 3d ed. 1958).
379. See, e.g., Simon v. American Power Conversion Corp., 945 F. Supp. 416, 425 (D. R. I. 1996) (the rationale for the prohibition on insider trading is to prohibit insiders "from exploiting their informational advantage to profit at the expense of investors").
380. The American Heritage Dictionary of the English Language defines "take advantage of" to mean "1. To put to good use; avail oneself of: take advantage of all educational opportunities. 2. To profit selfishly; exploit; took advantage of the customer." THE AMERICAN HERITAGE DICTIONARY OF THE ENGLISH LANGUAGE 25 (3d ed. 1992).
381. Webster's Third New International Dictionary defines "take advantage of" to mean "to make use of for one's own benefit: use to advantage: profit by." Webster's Third New International Dictionary 2331 (Philip Babcock Gove ed. 1971).
382. The Oxford English Dictionary defines "to take advantage of" to mean "To use any favourable condition which it yields; to avail oneself of. Often in a bad sense: To seize an accidental or unintended opportunity of profiting, to overreach (a person)." 1 THE Ox- Ford ENGLISH DICTIONARY 184 (J. A. Simpson & E. S. C. Weiner eds., 2d ed. 1989). The "benefit," of course, is not "knowing the information;" rather, it is trading at a market price that does not reflect the inside information.
383. Restatement (Second) of Torts § 551 (1981).
384. Chiarella v. United States, 445 U. S. 222, 228 n. 9 (1980).
385. Restatement (Second) of Torts § 551 (2) (a), (c).
386. There is a duty to correct an historical statement that was believed to be true when made but has since been discovered to have been false. See, e.g., Stransky v. Cummins Engine Co., 51 F.3d 1329, 1331-32 (7th Cir. 1995). On the other hand, there may be no duty to correct a forward-looking statement which, at the time it was made, was made in good faith and with a reasonable basis but which has since proven to be wrong because of changing circumstances.
387. Id. at 1332-33 & n. 9.
388. See also section 21E (d) of the Exchange Act, 15 U. S. C. § 78u-5 (d) (Supp. I 1995), which provides that nothing in section 21E, establishing a safe harbor for forward-looking statements, "shall impose upon any person a duty to update a forward-looking statement." Id.
389. This implicates the complex issue of the extent to which there is a duty to correct prior statements, a full discussion of which is beyond the scope of this Article. See, e.g., 7 Loss & Seligman, supra note 15, at 3519-25
390. 1996 Supp. at 852-54.
391. See infra notes 222-45 and accompanying text.
392. See supra notes 107-19, 194 and accompanying text.
393. The "interest in certainty and simplicity" may be "outweighed by the interest in fairness." McDermott, Inc. v. AmClyde, 511 U. S. 202, 208 (1994).
394. See supra notes 114 and 190-91 and accompanying text.
395. See supra notes 120-26 and accompanying text.
396. Dirks v. SEC, 463 U. S. 646, 662 (1983).
397. Id. at 663.
398. Id. at 663-64.
399. This measure is recommended at Harvey L. Pitt et al., Lessons from the Government's Insider Trading Losses: Beyond Moran, Hoover, Adler, and Bryan, INSIGHTS, May 1996, 16, at 19-20 (discussing SEC v. Moran).
400. See supra notes 127-32 and accompanying text.
401. This, of course, is no real choice, because few individual insiders have the discretion or right to choose to disclose confidential material information about their employer.
402. 15 U. S. C. § 78u-l (1994).
403. Obviously, this argument cannot be extended to exonerate the insider who placed the trade using the inside information, even though he made the same profit or avoids the same loss. Here the deterrence factor can have an impact.
404. Embarking on this phase of the analysis brings to mind two arguably conflicting time-honored aphorisms of Justice Oliver Wendell Holmes, Jr.: "The life of the law has not been logic; it has been experience," THE COMMON Law 1 (1923), and "Great cases like hard cases make bad law."
405. Northern Securities Co. v. United States, 193 U. S. 197, 400 (1904) (Holmes, J., dissenting)).
406. See, e.g., Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d 876, 891 (2d Cir. 1972) ("A party does not, within the intendment of Rule 10b-5, use material inside information unfairly when he fulfills contractual commitments which were incurred by him previous to his acquisition of that information. ");
407. Loss & SELIGMAN, supra note 15, at 3509 n. 139. Moreover, an effort to breach a binding contract in order to avoid an arguable securities law violation would pose the problem of, in effect, tipping others of the existence of (undefined) inside information.
408. See infra notes 243-45 and accompanying text.
409. See 5 U. S. C. app. § 102 (f) (3) (1994) for the requirements of a blind trust in the public officeholder context. A significant difference between the wholly discretionary account and the true blind trust is that, in the latter, the beneficiary has no information about the holdings in the trust.
410. See also Saul Levmore, Securities and Secrets: Insider Trading and the Law of Contracts, 68 Va. L. Rev. 117, 129-32 (1982).
411. Under section 256 of the Restatement (Second) of Agency:
412. If a principal knows facts unknown to a servant or other agent and which are relevant to a transaction which the agent is authorized to conduct, and because of his justifiable ignorance, the agent makes a material misstatement of facts, the principal:
413. (a) is subject to liability for an intentional misrepresentation, if he believed the agent would make the statement, or for a negligent misrepresentation, if he had reason to know the agent would make the statement.
414. Restatement (Second) of Agency § 256 (a) (1958).
415. The executive/principal's inside information should not result in his liability for conduct of the broker/agent, because the broker should not be making any statements to the other party to the transaction and, in any event, the executive would not expect the broker to make any statements.
416. LANGEVOORT, supra note 119, § 3.04, at 3-24.
417. While every such action or declination to act reflects a decision, only conduct "in connection with" a purchase or sale of securities is actionable under rule 10b-5. Blue Chip Stamps v. Manor Drug Stores, 421 U. S. 723 (1975). Thus, a decision to cancel a sell order upon learning favorable inside information or to cancel a buy order upon learning unfavorable inside information is not actionable under rule 10b-5, even though it may be morally indistinguishable from using inside information in deciding to buy or sell securities.
418. See supra note 164 and accompanying text.
419. As previously noted, the individual executive seldom has the discretion to make disclosure of the information solely to facilitate her personal trading. See supra note 230.
420. See supra note 144 and accompanying text.
421. Langevoort, supra note 119, § 3.04, at 3-24.
422. Id. at 3-24 n. 10. To the same effect
423. See SEC v. Moron, 922 F. Supp. 867, 894-95 (S. D. N. Y. 1996) (employee of investment banker did not respond with a "no comment" because "that could be a signal to [the alleged tippee] that I was working on something, and I purposely avoiding signaling anything to him in any way"; if comment had been refused, the alleged tippee "might then have realized that there was some other aspect to consider").
424. Financial institutions, such as banks and investment banking firms, maintain restricted lists which identify those securities in which the firm may not trade for its own account, usually because the firm is in possession of material nonpublic information about the issuer. WANG & STEINBERG, supra note 145, § 13.5.3.2.a, at 870-71. The mere fact that an issuer is included on the list is highly sensitive information. (Indeed, the conviction in Teicher was based in part on defendants' misuse of a tipped restricted list.
425. See supra notes 107-19.) Thus, any action that has the effect of disclosing to outsiders that a particular security is on the list should be avoided.
426. Jonathan Eisenberg, Protecting Against Insider Trading liability, 22 Rev. Sec. & Commodities Reg. 87, 92 (1989) ("danger that placement of securities on a restricted list can act as a signal to sophisticated investors");
427. Edward D. Herlihy et al., Supervisory and Compliance Policies and Procedures for Broker-Dealers, Issuers and Law Firms, in SE- CURITIES Enforcement Institute 1989, at 511, 534
428. (PLI Corp. Law & Practice Course Handbook Series No. 648, 1989) ("placing securities on a restricted list has potential drawbacks. The restricted list has been criticized as constituting a signal that the firm is in possession of inside information");
429. Theodore A. Levine et al., Current Legal Developments Affecting Insider Trading Enforcement Actions and Litigation 1988-1989, in Id., at 335, 472-75 (problems with using the restricted list include that "[p]lacing a stock on the list may signal the market that the firm knows of a significant development");
430. Note, Conflicting Duties of Brokerage Firms, 88 HARV. L. Rev. 396, 415 (1974). An executive implicitly informing his broker that he cannot trade in his employer's securities is the same as disclosing that the security is included on a restricted list.
431. There should be no argument that canceling the order, without further disclosure, constitutes an unlawful tip. Tipping in violation of me classical theory occurs when the inside information is disclosed in breach of a duty for the improper purpose of gaining a personal advantage or benefit. See, e.g., Dirks v. SEC, 463 U. S. 646, 661-64 (1983);
432. SEC v. Maio, 51 F.3d 623, 632 (7th Cir. 1995). Where there is no unlawful tip under the classical theory, there is no derivative liability imposed on the tippee.
433. See, e.g., Wang & STEINBERG, supra note 145, § 5.3.4.1, at 347-49. At the same time, there is no "misappropriation," because the insider did not misappropriate the inside information by merely canceling the trade in order to avoid a charge of a rule 10b-5 violation. Therefore, the putative tippee, the broker, bears no liability for acting on or passing on what he inferred from the act of cancellation, or even from the "no comment." For a general discussion of tipper/tippee liability
434. See 8 LOSS & SELIGMAN, supra note 15, at 3603-18
435. Donald C. Langevoort, The Demise of Dirks: Shifting Standards for Tipper-Tippee Liability, INSIGHTS, June 1994, at 23, 23-25.
436. For the one significant caveat, see supra note 219 and accompanying text. Even in that situation-where the inside information is a corrective to prior, but still current, disclosures that turn out to have been false or is a revision to a still current forward looking statement-the lesser evil may be to proceed with the transaction in silence.
437. See supra notes 243-45 and accompanying text.
438. See supra notes 116-18, 208, 217-28 and accompanying text;
439. See also supra notes 109, 111.
440. See infra notes 250-58 and accompanying text.
441. Thus, the proposal that the SEC should be given the power to exempt transactions "in which the statute should not apply" places too much confidence in the SEC to act. See supra note 164. There have been many cases where the SEC has been granted exemptive authority which it has not exercised. Most pertinent, section 21A (c) of the Exchange Act grants the SEC authority to exempt transactions from the insider trading penalty provisions of section 21A.
442. U. S. C. § 78u-l (c) (1994). No rules have been promulgated under that section. Among recent examples where no implementing rule has been promulgated
443. See section 21D (g) (10) (D) of the Exchange Act (SEC to define the term "outside director" for purposes of the class action provisions of the Private Securities Litigation Reform Act of 1995). 15 U. S. C. § 78u-4 (g) (10) (D) (Supp. I 1995).
444. Musick, Peeler & Garrett v. Employers Insurance of Wausau, 508 U. S. 286, 292 (1993). The Court cited, among other decisions, Blue Chip Stamps v. Manor Drug Stores, where the Court held that the courts must "flesh out the portions of the law with respect to which neither the congressional enactment nor the administrative regulations offer conclusive guidance."
445. Blue Chip Stamps v. Manor Drug Stores, 421 U. S. 723, 737 (1975). In so doing, the courts are "not to assess the relative merits of the competing rules, but rather to attempt to infer how the 1934 Congress would have addressed the issue had the 10b-5 action been included as an express provision in the [Exchange] Act."
446. Musick, Peeler & Garrett, 504 U. S. at 294. The approach suggested here, applying a "use" test, is entirely in accord with the legislative intent of the Exchange Act.
447. See supra note 22.
448. Musick, Peeler & Garrett, 504 U. S. at 294.
449. See supra notes 226-28 and accompanying text.
450. See, e.g., supra notes 64, 81, 142, 200 and accompanying text (inference from possession);
451. See also supra note 162 and accompanying text (rebuttable presumption of use from inference, but only in the case of non-natural persons).
452. 15 U. S. C. § 78r (a) (1994).
453. Id § 78t (a).
454. Basic, Inc. v. Levinson, 485 U. S. 224, 241-49 (1988) (rebuttable presumption of reliance based on fraud-on-the-market);
455. See also Affiliated Ute Citizens v. United States, 406 U. S. 128, 153-54 (1972) (positive proof of reliance not required where there has been breach of duty to disclose).
456. Sandstrom v. Montana, 442 U. S. 510, 524 (1979).
457. 2 McCormick on Evidence § 347, at 489-90 (John William Strong ed., 4th ed. 1992).