Scienter Potentia Est: The Case for the Presumption of Use Standard in Insider Trading

Fordham Journal of Corporate & Financial Law Volume 30 Issue 1 Article 4 2025 Scienter Potentia Est: The Case for the Presumption of Use Standard in Insider Trading Audrey Nelson Fordham University School of Law Follow this and additional works at: https://ir.lawnet.fordham.edu/jcfl Part of the Business Law, Public Responsibility, and Ethics Commons, Corporate Finance Commons, Judges Commons, Securities Law Commons, and the Supreme Court of the United States Commons Recommended Citation 30 Fordham J. Corp. & Fin. L. 137 (2025). This Note is brought to you for free and open access by FLASH: The Fordham Law Archive of Scholarship and History. It has been accepted for inclusion in Fordham Journal of Corporate & Financial Law by an authorized editor of FLASH: The Fordham Law Archive of Scholarship and History. For more information, please contact . SCIENTER POTENTIA EST: THE CASE FOR THE PRESUMPTION OF USE SCIENTER STANDARD IN INSIDER TRADING Audrey Nelson * ABSTRACT Is it possible to accidentally insider trade? The Supreme Court has held that scienter is a necessary element of all § 10(b) and Rule 10b5 actions, 1 but the federal appeals courts are split on how the scienter requirement applies to insider trading cases. 2 In a non-insidertrading § 10(b) case, the Supreme Court stated that § 10(b) scienter requires intentional misconduct. 3 Although the Supreme Court has not heard a case specifically about the scienter element in the context of insider trading, those who support a use requirement claim that the § 10(b) scienter element requires the plaintiff to show that the insider used the MNPI in the decision to trade. 4 Those who support a possession standard reason that possession of MNPI creates an unfair informational advantage, which is sufficient reason to prohibit an insider from trading. 5 They also argue that it is J.D. Candidate, Fordham University School of Law, 2025; B.S., Colorado College, 2020. I would like to thank Professor Caroline Gentile for her expertise and indispensable guidance through the research and writing process. I would like to thank the staff of the Fordham Journal of Corporate & Financial Law for their support and feedback. I am also grateful to my family and friends for their encouragement and care. 1. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 201-02 (1976) (holding that § 10(b) requires an element of scienter); Aaron v. SEC, 446 U.S. 680, 691 (1980) (clarifying that scienter is an element in both public and private 10b-5 cases). 2. Donald C. Langevoort, What Were They Thinking? State of Mind Puzzles in Insider Trading 3 (Geo. L. Fac. Pub. and Other Works, Paper No. 2496, 2023). 3. Id. 4. United States v. Smith, 155 F.3d 1051, 1067-68 (9th Cir. 1998); Hochfelder, 425 U.S. at 197. 5. United States v. Teicher, 987 F.2d 112, 120-21 (2d Cir. 1993). * 137 138 FORDHAM JOURNAL OF CORPORATE & FINANCIAL LAW [Vol. XXX impractical to require a plaintiff to prove a defendant actually used the MNPI in the decision to trade. 6 This Note argues that possession of MNPI should create a rebuttable presumption of use for the purposes of insider trading liability under the § 10(b) and Rule 10b-5 scienter requirement. This standard best balances the Supreme Court’s clarification that fraud under 10(b) includes intentional conduct 7 with the practicality of the knowing possession standard. INTRODUCTION...................................................................................... 139 PART I ................................................................................................... 140 A. Scienter is an element of insider trading ................................ 140 B. The Possession/Use Debate ................................................... 144 C. General Background on the Securities Exchange Act of 1934........................................................................................ 146 PART II.................................................................................................. 146 A. Review of Caselaw on Scienter ............................................. 146 1. Caselaw Supporting the Possession Standard.................. 147 i. 2nd Circuit ................................................................. 147 ii. 1st Circuit .................................................................. 148 2. Caselaw Supporting the Use Standard ............................. 149 i. 9th Circuit .................................................................. 149 3. Caselaw Supporting Standards Between Possession and Use ............................................................................ 151 i. 11th Circuit ................................................................ 151 ii. 7th Circuit .................................................................. 153 B. The 1984 Insider Trading Sanctions Act’s Support of the Possession Standard ............................................................... 154 C. The SEC’s Rulemaking in Support of the Possession Standard ................................................................................. 155 D. Diverging Interpretations of the 2021 Insider Trading Prohibition Act ....................................................................... 156 PART III ................................................................................................ 158 A. The Best Standard is a Rebuttable Presumption of Use When in Possession of MNPI ................................................ 158 B. The Supreme Court Should Take the Next Opportunity to Clarify the Scienter Standard ................................................. 162 6. See Andrew Verstein, Mixed Motives Insider Trading, 106 IOWA L. REV. 1253, 1257 (2021). 7. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 201-02 (1976) (holding that § 10(b) requires an element of scienter); Aaron v. SEC, 446 U.S. 680, 691 (1980) (clarifying that scienter is an element in both public and private 10b-5 cases). 2025] SCIENTER POTENTIA EST 139 CONCLUSION ......................................................................................... 163 INTRODUCTION If material nonpublic information (“MNPI”) does not factor into someone’s decision to trade, is that person engaging in insider trading? For example, a company’s employee owns stock in the company. She plans to sell her stock at the end of the week to make a down payment on a new home, but she does not have a written trading plan. During that week, she learns nonpublic information that the company is about to be bought by a competitor. Although she appreciates the higher selling price, the merger in no way factored into her decision to sell her shares on Friday. She sells her stock as planned. Should the employee be liable for insider trading? Whether this employee is liable for insider trading depends on the circuit she is in. The Supreme Court has made it clear that scienter is a required element of insider trading, 8 but the circuit courts disagree on the l (...truncated)