Insider Trading and the Primacy of the Legislature: Beyond Two Martomas

NOTES

Insider Trading and the Primacy of the Legislature:

Beyond Two Martomas

JORDAN A. PINO*

ABSTRACT

When the U.S. Supreme Court adopted the “personal benef‌it” requirement

for insider trading liability, the Court explained that the objective test would

help courts to identify improper disclosures of material nonpublic informa-

tion. In Dirks v. SEC, the Court focused the inquiry on whether the tipper dis-

closed the conf‌idential information for a personal gain, and it listed several

examples that would create an inference of a personal benef‌it to the insider. A

chief basis for the requirement was to draw a clear line between permissible

and impermissible disclosures. After all, the Court did not want to render

impermissible the pursuit itself of informational advantage, especially

because securities analysts routinely “ferret out” nonpublic information to

make trading judgments, and this is healthy for the market in the aggregate.

But the personal benef‌it requirement has been stretched and contorted since

its inception in 1983. And many contend that it has been (or should be) ren-

dered obsolete. Just in the past six years, the Second Circuit has changed its

interpretation of the personal benef‌it requirement three times—in only two

cases. In a rare and curious move in United States v. Martoma, the Second

Circuit aff‌irmed the court below in one opinion, only to amend it with another

opinion—using a different rationale—several months later. After Martoma II,

the original personal benef‌it requirement seems to have been rendered func-

tionally obsolete in the Second Circuit.

Recent scholarship has criticized the state of insider trading law, and some

have proposed a number of new tests. In this Note, however, I argue that the

Second Circuit’s doctrinal shifts illustrate that the insider trading doctrine

needs reform. Specif‌ically, I argue that statutory language def‌ining the insider

trading prohibition is warranted. On the one hand, a regime that authorizes

both civil and criminal liability for insider trading, despite uncertainty as to

what circumstances may elicit prosecution, runs up against the rule of legality

and other rule of law principles, such as notice, predictability, and legitimacy.

But, on the other hand, fairly obvious instances of improper trading escape

* J.D., Georgetown University Law Center, 2020; B.A., Boston College, 2017. © 2020, Jordan A.

Pino. I would like to thank Urska Velikonja and the students of her Fall 2019 seminar, Securities

Enforcement, for their helpful comments and suggestions on earlier drafts of this Note. I also thank

Donald Langevoort for his guidance and Jessica Wherry for her feedback and scholarly writing support.

Finally, my thanks to the editors of the Georgetown Journal of Law & Public Policy.

553

prosecution under the doctrine altogether. For instance, hedge funds rely on

obtaining “edge” from nonpublic information, sometimes provided from illegal

tipping chains. But prosecutors tend to avoid cases against remote tippees. The

Second Circuit’s subjective inquiry after Martoma II may make it easier to pros-

ecute those involved in tipping chains. Whether or not this is a positive out-

come, legislation should def‌ine a manageable and comprehensive standard for

prosecutors in all jurisdictions to follow.

While some have argued that data on “real” insider trading—or, the cases

that enforcers actually bring—detract from the proposition that new legislation

is required, in this Note I emphasize that uncertainty about the outer bounds of

the doctrine leaves enforcers both with a lack of clarity about what facts will

lead to a prevailing prosecution as well as an unacceptable degree of discretion

to employ in isolated cases. For prosecutors, market participants, and analysts

especially, this uncertainty takes its toll. But it need not. The passage of long-

awaited legislation could easily clarify this common-law crime.

TABLE OF CONTENTS

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 555

I. INSIDER TRADING ORTHODOXY AND RECENT SHIFTS . . . . . . . . . . . 558

A. Doctrinal Foundation and the Classical Theory of Liability . . 558

B. Tippers, Tippees, and the Rise of the “Personal Benef‌it”

Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 561

C. The Misappropriation Theory of Liability. . . . . . . . . . . . . . . . 563

D. Rules and Regulations: The SEC Prunes the Landscape . . . . . 564

E. Recent Judicial Shifts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 565

II. THE INSIDER TRADING REGIME NEEDS REFORM . . . . . . . . . . . . . . . 569

A. The Second Circuit’s Disposition of United States v. Martoma

Reveals Results-Oriented Reasoning Unfaithful to the Policy

Consensus of Dirks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569

B. The Second Circuit’s Inconsistency between Martoma I and

Martoma II Introduces Substantial Uncertainty About Insider

Trading Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 573

III. LEGISLATIVE ACTION IS WARRANTED . . . . . . . . . . . . . . . . . . . . . . 577

CONCLUSION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 582

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