Telling the Truth Slant—Defending Insider Trading Claims against Legal and Financial Professionals

William Mitchell Law Review Volume 28 | Issue 4 2002 Telling the Truth Slant—Defending Insider Trading Claims against Legal and Financial Professionals Terry Fleming Follow this and additional works at: http://open.mitchellhamline.edu/wmlr Recommended Citation Fleming, Terry (2002) "Telling the Truth Slant—Defending Insider Trading Claims against Legal and Financial Professionals," William Mitchell Law Review: Vol. 28: Iss. 4, Article 1. Available at: http://open.mitchellhamline.edu/wmlr/vol28/iss4/1 This Article is brought to you for free and open access by the Law Reviews and Journals at Mitchell Hamline Open Access. It has been accepted for inclusion in William Mitchell Law Review by an authorized administrator of Mitchell Hamline Open Access. For more information, please contact . © Mitchell Hamline School of Law Article 1 Fleming: Telling the Truth Slant—Defending Insider Trading Claims against 03_FLEMMING 4/18/2002 4:59 PM TELLING THE TRUTH SLANT – DEFENDING INSIDER TRADING CLAIMS AGAINST LEGAL AND FINANCIAL PROFESSIONALS Terry Fleming† I. II. III. IV. V. INTRODUCTION. ..................................................................1422 BACKGROUND......................................................................1422 A. The Development of Insider Trading Liability. ............... 1422 1. The Traditional or Classical Theory. ........................ 1422 2. The Misappropriation Theory.................................. 1426 B. Materiality. .............................................................. 1429 C. Non-public Information.............................................. 1432 D. The Intent to Defraud. ............................................... 1432 E. Causation - the Use and Possession Controversy. ............ 1433 THE MORALITY OF INSIDER TRADING..................................1436 DEFENDING INSIDER TRADING CLAIMS................................1438 A. Reliance on Counsel. ................................................. 1438 CONCLUSION.......................................................................1442 Tell all the Truth but tell it slant — Success in Circuit lies Too bright for our infirm Delight The Truth’s superb surprise As Lightning to the Children eased With explanation kind The Truth must dazzle gradually Or every man be blind – Emily Dickinson † Attorney, Lindquist & Vennum, PLLP, Minneapolis, Minnesota. 1978, College of St. Thomas; J.D. 1981, Harvard Law School. B.A. 1421 Published by Mitchell Hamline Open Access, 2002 1 William Mitchell Law Review, Vol. 28, Iss. 4 [2002], Art. 1 03_FLEMMING 1422 4/18/2002 4:59 PM WILLIAM MITCHELL LAW REVIEW [Vol. 28:4 I. INTRODUCTION. Insider trading cases against legal and financial professionals tend to be hotly litigated disputes over factual rather than legal issues. Defending these cases requires a persuasive, slanted presentation that explains in a consistent and credible manner the defendant’s conduct and transactions and supports the defendant’s good faith in the face of what is ordinarily a multi-layered but exclusively circumstantial case that the defendant engaged in fraudulent and deceptive securities transactions. II. BACKGROUND. A. The Development of Insider Trading Liability. Insider trading liability may arise in the context of criminal, civil or administrative proceedings. The U.S. Department of Justice has jurisdiction to pursue criminal actions. The Securities and Exchange Commission (SEC), self-regulatory agencies, and state securities enforcement agencies may initiate civil and administrative proceedings based on insider trading allegations. Private parties may also bring civil claims based on insider trading allegations. Insider trading claims are frequently pursued against classic insiders - officers and directors of corporations, who in the regular course of their duties have access to material, nonpublic information. Professionals assisting those corporations, officers and directors—lawyers, investment bankers and other financial advisors—frequently have access to this same information in the normal course of providing professional services. Indeed, it is not surprising that many insider trading claims are brought against these professionals, who are sometimes characterized as “temporary 1 insiders” by virtue of their temporary access to inside information. 1. The Traditional or Classical Theory. Insider trading liability is ordinarily based on a violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b- 1. See Robert S. Karmel, Insider Trading: Law, Policy and Theory after O’Hagan, 20 CARDOZO L. REV. 83, 84 n.6 (1998) (“Attorneys, more than any other group, have been prosecuted for insider trading.”). Id. http://open.mitchellhamline.edu/wmlr/vol28/iss4/1 2 Fleming: Telling the Truth Slant—Defending Insider Trading Claims against 03_FLEMMING 4/18/2002 4:59 PM 2002] INSIDER TRADING 1423 2 5 thereunder. Liability for trading on inside information is usually premised on Rule 10b-5’s ban on fraudulent acts or practices. “Under the ‘traditional’ or ‘classical’ theory of insider trading . . . Rule 10b-5 [is] violated when a corporate insider trades in [that corporation’s securities] on the basis of material, nonpublic 3 information.” Initially, the prohibition against insider trading was articulated as a “disclose or abstain” rule. This rule required a corporate insider with a fiduciary duty to the corporation and its shareholders to either disclose material, inside information or abstain from trading in the corporation’s stock. That rule was first stated in 4 Cady, Roberts & Co., where the SEC found a director of a company passing on an inside tip had violated the obligation to “disclose or abstain.” In that case, the director, who was also a broker, recommended that his customers sell the company’s stock based on a tip from a corporate insider of a dividend cut. The SEC noted the existence of a relationship allowing access to inside information intended only for a legitimate corporate purpose, and the unfairness of permitting an insider to take advantage of that 5 information by trading without disclosure. The Second Circuit Court of Appeals and ultimately, the U.S. Supreme Court, 6 subsequently endorsed this “disclose or abstain” rule. The U.S. Supreme Court subsequently found that, in a face-toface transaction, a buyer with inside information about a company has a duty to disclose such information to the seller before 7 consummating a transaction. At least initially, the scope of insider trading liability was fairly limited, and only applicable in situations where the insider had a fiduciary duty to the party with whom the insider traded, or to the 2. See 15 U.S.C. § 78j(b) (2001); 17 C.F.R. § 240.10b-5 (2001). Insider trading liability under federal securities law may also be predicated on section 14(e) of the Securities Exchange Act of 1934 and Rule 14e-3 thereunder (concerning tender offers), and Section 16 of th (...truncated)