The law of insider trading is a dismal mess, a result of the Supreme Court's decision in cases like Dirks and Chiarella. In those two cases, the Court essentially limited insider trading to the violation of a fiduciary duty. The misappropriation doctrine, approved in O'Hagan, added trading in violation of a duty of trust and confidence.
Still, there are a number of cases where uncertainty exists about the application of the prohibitions on insider trading for those who have inside information but do not necessarily violate a duty when they trade. Thus, the law is sufficiently unclear (or clear in a ridiculous way) that a federal district court held that the theft of material non-public information over the Internet did not constitute insider trading because the alleged thief (a resident of Ukraine) did not violate any duty. See SEC v. Dorozhko, 2008 U.S. Dist. LEXIS 1730 (SD NY Jan. 8, 2008).
The latest rub in this area concerns gifts. A study of large gifts by David Yermack at NYU examines the contribution of stock by CEOs of public companies to charities, including their own family foundations. As he concludes: "I find that CEOs' stock gifts occur just prior to significant drops in their firms' stock prices, a pattern that enables the donors to obtain increased personal income tax benefits. This timing is more pronounced when executives donate their own shares to their own family foundations." Moreover, the study indicated the possibility of backdating. "Evidence related to reporting delays and seasonal patterns suggests that some CEOs backdate stock gifts to their own family foundations in order to increase personal tax benefits."
Despite the potential use of material non-public information, the behavior arguably does not violate the proscriptions on insider trading. Why? Because insider trading amounts to fraud in connection with the purchase or sale of a security. A gift is typically not treated as a purchase or sale. But is that right? The definition of "sale" in the Exchange Act includes "any contract to sell or otherwise dispose of." Section 3(a)(14). Moreover, the definition does not include language in the 1933 Act definition that extends sales to any transaction "for value." See 15 USC 77b(3). Finally, the courts have noted that the definition is broader than the common law notion of a sale. See Rathborne v. Rathborne, 683 F.3d 914, 920 (5th Cir. 1982).
Could a gift be a sale for purposes of the insider trading prohibitions? In The Regulation of Corporate Disclosure, 3.05, here is one possible analysis:
- Putting aside textual differences in the definition of sale under the two Acts, the critical hurdle concerns the absence of value. The concept of gift seems to embrace generosity rather than the quid pro quo associated with sales. Value, however, may arise from two broad sources. First, read most broadly, value in the form of publicity or reputation often accrues to donors. . . . Even a narrow reading of "value" can be met by gifts to charities. Under the Internal Revenue Code, donors receive a deduction from income for such gifts. Thus, they obtain a direct, quantifiable pecuniary gain the form of a reduction in federal (and possibly state) income tax liability.
Gifts to charities by insiders who benefit from inside information could, therefore, be in violation Rule 10b-5. At least the argument is there. This suggests that corporate insider trading policies should include prohibitions on gifts while in possession of material non-public information.