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July 30 — It is time for Congress to step in and pass insider trading legislation, according to Judge Jed Rakoff of the U.S. District Court for the Southern District of New York.
The debate over what is required to prosecute insider trading cases has been sparked by the U.S. Court of Appeals for the Second Circuit's decision in United States v. Newman. In what has been referred to as a blow to insider trading enforcement, the court concluded that the government didn't prove beyond a reasonable doubt that the defendant downstream tippees knew that information was disclosed by an insider in exchange for a personal benefit. On July 30, U.S. Solicitor General Donald Verrilli asked the U.S. Supreme Court to review the decision.
This debate is essentially over judge made law, which “ is not a good thing,” Rakoff said at a July 30 Practising Law Institute webcast. The judge added that “it is unfortunate that Congress has not seen fit to pass a statute directed at defining specifically what constitutes as unlawful insider trading.”
During the webcast, the judge also opined that, as a policy matter, the Securities and Exchange Commission should not be bringing cases involving important legal issues and developing law, such as insider trading, before administrative law judges.
In agreement with Rakoff, Kenneth I. Schacter, a partner at Morgan Lewis & Bockius LLP, said that in general, the fact that insider trading has been prosecuted for more than 30 years without a meaningful statute “is really problematic.”
Attorneys are spending a lot of time poring over judicial decisions, which may or may not have meaning, and assigning them the same weight as they typically would assign to statutes, he said.
Antonia M. Apps, a partner at Milbank, Tweed, Hadley & McCloy LLP, criticized the Second Circuit's decision specifically, saying that it may have made it more difficult for law enforcement officials to hold more culpable participants accountable.
In her view, the court's decision has made it entirely unclear what constitutes a personal benefit. “We absolutely need a clear test and statute for insider trading law.”
Since the Second Circuit's decision, several bills have been introduced into Congress that would ban insider trading.
All of those bills are a a step forward because “it is more appropriate for Congress to be making this law,” Rakoff said during the webcast.
Despite not citing a bill, Rakoff said he favors one that would not require knowledge that a fiduciary duty was breached.
Instead, Rakoff recited a statute that he came up with on his subway ride to the event, stating: “‘Whoever trades in a security in interstate commerce while knowingly in possession of material non public information concerning that security violates the law.' Then the law would then go on to specify both civil and criminal penalties for that violation.”
Rakoff noted that his rule is quite broad and essentially overturns the U.S. Supreme Court's decision in Chiarella v. United States, 445 U.S. 222 (1980), a case that he worked on as an Assistant U.S. Attorney for the Southern District of New York.
However, he said it would avoid almost all the controversies that now exist in trying to shoehorn insider trading into the SEC's fraud rules.
During the webcast, Rakoff also commented that as a policy matter, the SEC should send cases that involve important legal issues or developing law to federal courts, instead of administrative law judges because ALJ are hired, paid and report to the commission. The commission has faced criticism and myriad lawsuits related to its increasing use of its administrative forum.
According to Rakoff, the more difficult problem with ALJs deciding cases such as insider trading is that they have both criminal and civil implications. Only a federal judge who has both a civil and criminal docket is aware of the competing concerns and tension that such cases raise, he said
The SEC is fundamentally devoted to fairness, and it is in their own long-term interest, as well as the public's, that cases involving the development of criminal and civil law be addressed to federal judges rather than ALJs, he said.
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