THE AMBIGUITY OF INSIDER TRADING LAWS 1

The Ambiguity of Insider Trading Laws

Dawson Xiao

Legal Studies Academy First Colonial High School

THE AMBIGUITY OF INSIDER TRADING LAWS 2

Abstract

This paper explores the ambiguity of insider trading laws and how it affects the market system.

There are ethical proponents that explains why insider trading is illegal. The SEC is clarified to

address its importance in the market system. Recent and past case laws and insider trading

incidents illustrates the current issues of the crime. A task force lead by a former U.S. attorney

hopes to solve the issue with the cooperation of the SEC.

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The Ambiguity of Insider Trading Laws

Ever since the meltdown of the US stock market during the crash of 1929, the United

States government has attempted protect investors and ensure long-lasting trustworthiness in its

free-market trade system. With the creation of the government agency known as the Securities

Exchange Commision (SEC), regulations and laws have been put in place to create a strong

booming market system and one where investors can trust its honesty. One important aspect of a

fair market trading system is that all investors can trust that companies listed on the market are as

transparent as possible regarding all information about their company, their markets, and future

prospects for the company. Insider trading laws should be re-identified and clarified by the

government to avoid confusion and allow the market system to re-establish confidence in the

market and trustworthiness in the SEC.

Introduction to Insider Trading

Insider Trading

In order to understand the basis of insider trading, it’s important to examine how the

governing agency, the SEC, defines it before it takes legal action. According to the SEC, insider

trading is defined as, ‘buying or selling a security, in breach of a fiduciary duty or other

relationship of trust and confidence, on the basis of material, nonpublic information about the

security’ (SEC, 2016). However, this definition is not officially instated into the federal law. As

a result, numerous cases of insider trading make their way into the headlines as the crime itself at

times, runs rampant throughout the market system. In other words, there are countless cases of

insider trading occurring all the time, with many going undetected and with no legal

consequences whatsoever. The reason for this issue lies directly to the definition of insider

trading. The problem is because the term “insider trading” is defined by an independent agency;
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however, the crime itself lacks clarification and its vagueness causes consequences. Additionally,

it is extremely difficult to prove that a person committed the crime unless there is a critical

investigation with explicit evidence (MacDonald, 2011). However, these investigations are

extensive, time-consuming, and still provide difficulty today in the legal system. Due to this

factor, the ethical portion of insider trading is not made clear to those involved. Furthermore,

controversies about the crime itself have created a small portion of business investors who

believed it shouldn't be illegal at all. The law should be clearly written and enforced so that

everyone involved understands the crime and the consequences. With the creation of the SEC

(Securities and Exchange Commission), it was hoped that trust and honesty would be re-installed

upon the market as this agency’s charter was to provide oversight and enforcement of securities

laws. The goal of the SEC is to uphold laws and keep out malpractices and unfairness. Insider

trading is trading based on material, nonpublic information associated with a breach of duty

(Bharara & Jackson Jr., 2018). What this means is there is no official statute regarding its

consequences and the crime itself can vary due to various circumstances. Furthermore, the laws

in the United States are based on a common law court system and therefore interpretation of the

law heavily relies on judges. Therefore, insider trading laws can be manipulative where everyone

can potentially be subject to prison. As a result, those accused, tried, and convicted are being

treated unfairly due to the ambiguity and vagueness of the law. However, if it is clarified,

meaning an official statute regarding insider trading, then it would allow an even playing field

for those involved with a concrete understanding of the law, firm parameters on how it applies,

and less ambiguity on how the law is applied.

Not All Insider Trading is Illegal

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Insider trading isn't always illegal. In its most basic term, the legal part means an insider

buying or selling its own company stock as a result of knowledge, information, or insights which

are not known by the rest of the market or other investors. However, there are several elements

to it that are legal, but the insider must follow a certain procedure before making a trade. Legal

insider trading happens on a weekly basis (Chen,2018). The SEC considers company directors,

officials, or any individual with a stake of 10% or more in the company to be corporate insiders.

To provide transparency to other investors and to the market as a whole, corporate insiders are

required to notify the SEC and report any future transactions (buying or selling) within two

business days of the date the upcoming transaction (before the 2002 Sarbanes-Oxley Act

reporting of insider trading needed to be reported by the 10th day of the following month

(Chen,2018). This notification of a company insider about to make a trade of company stock is

valuable information to ‘outside’ investors and the market because it's assumed these corporate

insiders are making decisions based on their knowledge of the company. Stocks can be sold for

any reason however, it is only bought when insiders believe that it can be profited in the long

run. As a result, this type of action has several restrictions. For example, insiders are prevented

from buying and selling of the stock for the next 6 months. (Chen,2018)

Industry Research on Insider Trading

In a study conducted by New York University’s Stern School of Business and McGill

University, an analysis of all corporate merger and acquisition transactions (a total of 1,859

transactions) covering the time period from the beginning of 1996 to the end of 2012, indicated

that a quarter of all of these public M&A transactions may have included some form of insider

trading. And of these 1,859 transaction, fewer than 5% were actually litigated by the SEC, a clear

indication that the statues of insider trading are infrequently applied and prosecuted (Huddleston,
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2014). In addition, another study conducted by the University of Cambridge and Stanford cites

that corporate insiders at major US banks strongly profited during the US financial crisis of 2009

due to their close-ties and well-informed connections at US government agencies. The

researchers found strong evidence of a relationship between political connections and informed

insider trading. These government friends provided advanced knowledge about government

programs, especially during the period in which Troubled Asset Relief Program (TARP) funders

were distributed (Franck, 2018). The ambiguity of the law has cause inconsistency with the SEC

operations and it has allow insiders to take advantages in earning more money at the cause of

other shareholders.

Ethical Concern

To fully understand the basis of insider trading and why it was an issue, the ethical

history of the crime must be understood. The average citizen believes that insider trading is bad;

and the mainstream media flashes images of an executive or an official obtaining non-public,

confidential information and earning a fortune overnight. While big infamous prosecutions for

insider trading tend to be infrequently, when they are, they are portrayed by the media as the

quintessential poster of greed. For many people, insider trading is the black plague of Wall

Street business people and politicians. With such a widespread practice, influencing thousands of

investors, the crime itself is oddly overlooked and lacks examination and research (Moore,

1990). While most people believe the crime is based upon unfairness, there are further concerns

that demonstrate why insider trading is unethical.

Fairness

The first ethical component of insider trading is fairness. The common ethical concern for

insider training is that one ‘stock investor’ has an informational advantage over another.
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Additionally, the ethical issue of fairness can be broken into two parts: the first which argues that

insider trading is unfair because both parties do not have equal information; the second argues

that insider trading is unfair because both parties do not have equal access to the information

(Moore, 1990). Both sound relatively reasonable but how do they applied to insider trading? For

example, if one person buys an antique, and they pay one hundred dollars, but know they could

resell it for one thousand dollars, are they obliged to disclose that to the original owner?

Therefore, is it unethical for the buyer to perform this type of action since he has an

informational advantage (Moore, 1990)? Under typical human interactions, this type of action

does not equate to a crime even though both parties do not have equal information. The first

buyer is not obligated to reveal information that is not of interest to the seller. However, lying

and deception are unethical behaviors. If the buyer told the seller that the item is worth less than

fifty cents and the seller believes that and sold it, then that action is morally wrong. Therefore,

the only time one must tell the truth and not lie is when both parties are in a contract, or owing a

duty towards one another. It is only when there is a breach of contract or deception, that a crime

is done (Moore, 1990). This analysis doesn’t focus on the wrongness of insider trading itself, but

rather the breach of fiduciary duty. A dysfunctional system filled with deception and distrust will

never operate to its fullest potential and will slowly destroy itself.

The second part of the component is the lack of equal access to the information. The

issue with this concept is that all people can never reach a state of equal position. In order for a

society to function people must perform different roles. As a result, some roles have an easier

time obtaining information based on their title or position. For example, corporate executives

will also have easier access to information and thus know more than ‘outside’ shareholders, or

other potential investors. Although shareholders do take an ownership interest in a company they
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only own shares of the company and are not privy to inside corporate insights or knowledge.

This aspect makes it unethical because due to their position, the insiders have an advantage over

others.

The SEC

The charter for the SEC is to regulate and monitor the stock market and prosecute

criminal actions, especially insider trading. Though the term “insider trading” wasn’t even a

word when the world’s first legal stock market exchange system was founded in Pennsylvania

under Philadephia Stock Exchange in 1790 (“Timeline”, 2016). However, with emergence of

successful stock markets such as the New York Stock Exchange (NYSE), the global trade system

took off as a result of the industrial revolution . For the next several decades, stock exchanges

went through successful and rough times with multiple crashes and economic booms. However,

it wasn’t until the Stock Market Crash of 1929 when the government decided that there must be

an independent agency to monitor the market.

The Emergence of the SEC

The US economy of 1929 was a roaring, energetic, and successful time with businesses

doing extremely well and stock market investors enjoying strong gains. Securities, which are

financial instruments that hold monetary value such as bonds and stocks were offered from left

to right. An estimate of 50 billion dollars worth of securities were offered, but due to fraud and

deception by listed businesses and brokers, and the unregulated use of margin buying (buying

stocks on credit) rendered much of these investments with little real value. However, with the

stock market crash of the 1929, one of the largest economic recessions in history, the economy of

the nation came pouring down. Without a strong market system, the economy of any nation will

never restore, let alone grow. However, the stock market crash led to deceptive investors, fraud,
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distrust and disbondment between businessman in the market system. In order to restore faith,

confidence, and trust in the market system, the US Congress passed and installed the Securities

Act of 1933 and also The Securities Exchange Act of 1934 (Kennon, 2018). In order to regulate

business and avoid deception, businesses were now obligated to reveal their full business plan,

rules, and confidential information.

SEC Operations

The mission of the SEC is to protect investors, maintain fair, orderly, and efficient

markets, and facilitate capital formation (U.S. Securities and Exchange Commision, 2017). The

current chairman of the SEC is Jay Clayton after being appointed by the Trump Administration

in 2017. The agency is organized into five divisions and 25 offices with numerous employee. In

FY 2017, the SEC employed 4,794 full-time equivalents (FTE), including 4,672 permanent and

122 other than permanent FTEs (U.S. Securities and Exchange Commision, 2017). Within each

office officials and professional are separated by their specialization. These titles include insider

trading, accounting fraud, and financial misinformation. Federal securities law require

companies to publish their information including statements, sales, stock prices, and any other

data that is non-confidential. Then the SEC employees perform an analysis of the data, determine

the validity, and finally record in their own reports. This is because as there are numerous

companies and only so many employees from the SEC. Thus, there must be a mutual,

trustworthy relationship between the two groups to ensure an honest and functional system in the

market.
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Recent News

Numerous amounts of people are being charged with insider trading in recent news. They

include athletes, doctors, and even politicians. The following are some of the most recent insider

cases. NFL Cleveland Browns linebacker, Mychal Kendrick, and former Goldman Sachs Banker,

Damilare Sonoiki, are found guilty of insider trading with nearly $1.2 million dollars in profit.

This scheme began four years ago where Mychal decides to trust Damilare Sonoiki. In exchange

for NFL tickets, apparels, cash,and other incentives, Solnoki would exchange corporation stock

information. These two individuals faced one count of securities fraud as well as one count of

conspiracy to commit securities fraud each (Hale, 2018). Dr. Edward J.Kosinski, a doctor,

invested upwards to 40,000 shares in Regado Biosciences. However, he was leaked an small

piece of intel that the drugs developed by Regado results in side-effects to patients such as

allergic reactions. Consequently, the company lost 30% in stock pricing which was avoided by

Kosinski (Soule, 2018). His greed ultimately lead to an investigation leading to his arrest. He

faces 6 months in prison. Additionally, he faces another civil lawsuit with the U.S. Securities and

Exchange Commision. Lastly, Chris Collins, a U.S. Representative for Buffalo, NY, was

indicted for insider trading in June 2018. He and his family had purchased a large sum of shares

of Australian pharmaceutical company called Innate Immunotherapeutics (Mangan, 2018).

However, right before the stocks plummeted due to a drug test failure, Collins and his family

sold off hundreds of thousands of worth of shares. He decided to halter his political campaign

after this incident. Each of these incidents resulted in stiff penalties which “is disconcerting for

an area of law desperately in need of clarification, where liability is easy to find, and sometimes

based on nothing more than a simple conversation between friends or family members”

(DeWhitt, 2018). Perhaps the most infamous case in the past decade is Raj Rajaratnam. Raj is a
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high profile investor who was well known in the market with numerous connections. He

allegedly made over $60 million dollars in profit by trading with over 40 insiders for

information. On September 23, 2008, Warren Buffet agreed to pay $5 billion for preferred shares

of Goldman Sachs. However, these details were not publicize to shareholders. Strangely, Raj

purchase around 170,000 shares of Goldman Sach (Huneke, n.d.). He then later on earned over

$900,000 dollars but was prosecuted by U.S. attorney Preet Bharara. This incident along with his

numerous other avaricious acts has cause him to be a danger to the market system. Evidently, the

actions of these criminals has caused danger to the market system at the cost of other

shareholders.

While most ambiguity in the law potentially could aid the defendant, the case is not the

same for insider trading. In the minds of the public, these cases could go in all types of directions

where people could cheer for the defendant or oppose his/her action without complete

knowledge about the crime. Insider trading cases are usually decided with the opinion of the

court. As a result, the law itself could never really define insider trading and could be shaped and

molded into different types of forms. The law is usually the supreme rule of the land, but in this

case, it could potentially be the court. Unless the crime itself is completely defined with set

consequences and guidelines, insider trading will continue to strive, citizens will continue to be

confused, and the court will continue to hopefully define the case in its own terms.

Case Law

Insider trading has slowly evolved over the last century. Throughout its history, slowly

the definition and its guidelines are filled out. These key cases are what defines insider trading as

of today. The following several cases highlight the ambiguity of current laws and how these

recent cases has changed the current guidelines.

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Early Precedents

SEC v. Texas Gulf Sulphur Company (1968) . Insider trading definition began with the

passing of law called The Securities Exchange Act of 1934. Its definition in simplicity, broadly

bans certain types of stock fraud. However, it wasn’t until “SEC v. Texas Gulf Sulphur Company

(1968)” in 1968 that set the precedent of anyone possessing inside information must either

disclose the details to all investors or refrain from trading until that information is public (“SEC

v. Texas Gulf Sulphur Company”, 2014). Though, from that point on, insider trading is hard to

define as Section 10 and Rule 10b-5 (Chen, 2017) became the key provisions to prosecute illegal

insider trading the main basis of the SEC investigations but doesn’t actually define the what the

crime is. Essentially, Rule 10b-5 of Section 10 defines that it is illegal to defraud, make false

statements, omit relevant information, or otherwise conduct operations of business that would

deceive another person in relation to conducting transactions involving stock and other securities

(Chen, 2017)

Dirks v. SEC (1983). For example, in Dirks v. SEC (1983), Raymond Dirks, a financial

analyst, was accused of insider trading because he exploited a fraud in Equity Funding, a life

insurance company in 1973 (Dirks v. SEC, 463 U.S. 646, 1982). Since Dirks was an advisor to

multiple clients, he allegedly committed a crime because of his “tips.” As the SEC continues to

investigate upon Dirks, he appealed to the U.S. Court of Appeals for the District of Columbia

Circuit, which affirmed the SEC’s decision. Finally, the U.S. Supreme Court took the case under

its wing. With such ambiguity of the broad law, they ruled in a 6-3 majority decision for the

petitioner. Dirks may have committed the crime indirectly, but because he was in a position

where he did not breach a fiduciary duty, he did not break the law with intentions. Additionally,

the Court also held that an insider is only liable for insider trading when he makes a profit on the
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information before disclosing (Dirks v. SEC, 463 U.S. 646, 1982). Therefore, since Dirks did not

obtain a beneficial relationship with Equity Funding, the fraudulent company, the court held him

unaccountable. This case briefly shows the importance of how clear law definition should be. In

this case, the SEC, District Court of Columbia, and the U.S. Court of Appeals all ruled against

Dirks. Fortunately, the U.S. Supreme Court decided to overturned the decision creating a

precedent for all future similar insider trading cases. However, that didn’t stop insider trading

from being vague as legislators have yet to propose clear guidelines and definition for the crime.

Modern Case

Salman v. U.S (2016).The most recent significant insider trading case was Salman v. U.S.

(2016) because it was an insider trading case in the Supreme Court for the first time in nearly

two decades. Maher Kara, an investment banker for Citigroup and his brother, Michael, who has

a chemistry degree had been communicating about mergers and acquisitions for 3-4 years

(“Salman v. United States”, n.d.) . However, Maher suspected his brother was using confidential

information for insider trading. During those 4 years, Michael became engaged with Bassam

Yacoub Salman ́s sister. With such close family relationships, Salman received confidential

information from Michael and proceeds to make $2.1 millions dollars in profit (“Salman v.

United States”, n.d.). He later on argued the case and said that there was insufficient evidence

and that the insider did not gain any benefits because insider trading is identified as a mutual and

beneficial relationship between the tipper and the client. However, the outcome of the case was

unanimous in that tipping can be a form of gift to close relations with the family and counts as a

form of insider trading. What this shows is that even after Dirks v. SEC (2016), nearly twenty

years, the Supreme Court has to still make changes to insider trading guidelines. Since the act of
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1934, over the past nine decades, the law itself continues to evolve and change to make it less

ambiguous.

The Future of Insider Trading

Former U.S. Attorney for Manhattan Preet Bharara believes that the current laws

regarding insider trading, as currently written, causes confusion and provides no clarification in

the business realm (Bharara & Jackson Jr., 2018). As of today, it is difficult to prosecute anyone

under the law due to its ambiguity because it is hard to prove anyone committing the crime since

there needs to be evidence of the insider involving a “breach of duty.” As a result, he plans to

lead a team to decipher the law and reconstruct it in a way that can applicable to any insider

trading incident. The newly created team, consist of panel of experts that will propose new

insider trading reforms to protect American investors (Bharara & Jackson Jr., 2018). Insider

trading is not easily fixable because ambiguity will alway exist in some form of way and insiders

will continue to find loopholes in the market system. However, this team can be the beginning of

a solution to stop future crimes but also allow investors to follow a clear guideline to stray away

from the harmful act.

Trading has been the basis of an successful country even back in ancient times. It has

provided technological, medical, and scientific advancement as well as a booming economy. As

a result, consumers benefit from them whether it be a better lifestyle, cure for multiple types of

disease, and jobs. However, with recent rises in insider trading cases and a lack of a promising

regulator, the U.S. market system has been in a decline of trust and confidence which sharply

affects a nation’s economy. The SEC deals with a law that is unclear to the public and struggles

to be consistent in investigations and prosecuting insiders. On the other hand, Congress needs to

closely examine these issues such as the ambiguity in the definition itself and provide
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clarification to insider trading. With a emergence of the Bharara Task Force and a likeliness

cooperation of the SEC, insider trading will hopefully establish clarity and reduce the amounts of

insider trading that are unidentified. It will eventually lead to an increase in trust, confidence, and

a highly functional market system that will continue to strengthen the nation’s economy and the

lives of normal citizens.

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