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Congress may finally have a definition for insider trading

Congress hopes to address a long-standing issue in prosecuting white-collar crime: actually defining “insider trading.”

On Thursday, the U.S. House of Representatives passed a bill proposing a federal standard for insider trading in a 410 to 13 vote, securing overwhelming support on both sides of the party line. The bill, introduced by Connecticut Democrat Jim Himes, would define insider trading as a trade made on any information that was “obtained wrongfully” (such as theft, a violation of federal data protection laws, or breach of a confidentiality agreement). 

“If we’re going to send people to jail, we have to actually write specific laws about why that happens,” Himes told Yahoo Finance in an interview on Friday.

There is currently no statutory definition for insider trading. The Securities and Exchange Commission has its own standards on when insider trading is illegal and will file lawsuits against individuals that have allegedly used material, nonpublic information to make trades. 

But the courts ultimately have to use their own discretion to decide if the SEC’s standards are fair and if alleged insider traders indeed violated those standards. In many cases the lawsuits are prosecuted under fraud provisions, instead of dedicated “insider trading” provisions.

Himes says the lack of a statutory definition has led to “churn in the courts” as decisions and convictions have been overturned. But he acknowledged that it was complicated for lawmakers to land on a specific definition for insider trading. Using the example of a Walmart employee who counts cars in a parking lot, Himes said not all nonpublic information would constitute illegal activity.

“The key there: was the information wrongfully obtained? Did you know that you were doing something wrong when you then trade it on that information? So it is a little bit fiddly, but at the end of the day it's not that hard,” Himes said. 

Lack of standards

Connecticut Democrat Jim Himes (Photo by Samuel Corum-Pool/Getty Images)

Himes said the legislation was designed to be closely aligned with the “best thinking” that came out of the courts.

lawsuit against hedge fund managers Todd Newman and Anthony Chiasson brought the issue of insider trading to the Supreme Court’s doorstep in 2015, but the highest court in the nation decided not to review the case and establish a law-of-the-land precedent.

But in 2016, the Supreme Court took up Salman v. United States, in which Bassam Salman traded on information passed down from a brother-in-law who worked in Citigroup’s healthcare investment banking group. In that case the Supreme Court upheld an appellate court decision for prosecutors, rejecting Salman’s argument that he wasn’t guilty of insider trading because his brother-in-law hadn’t received tangible compensation like cash in exchange for the inside tips.

The Himes bill also clarifies that the person trading the security can still be prosecuted on “insider trading” even if they were not the person who actually wrongfully obtained the information.

Per the legislative text, if the person trading the securities in question “consciously avoided being aware” of the fact that the information was wrongfully obtained, then that person could still have committed illegal insider trading. The bill also prohibits those with inside information from passing it on to others if it’s “reasonably forseeable” that the person will trade on that information or forward it to those who will.

Twelve Republicans and one independent voted against the bill. One of those Republicans, Kentucky Representative Thomas Massie, said in statement that he opposed the bill because it did not include an “exclusivity provision that would have made this bill the exclusive law of the land.”

North Carolina Republican Patrick McHenry, who is also the ranking member of the House Financial Services Committee, said Thursday that he also would have liked more stringent language making the Himes bill the only law spelling out insider trading. But he ultimately supported the bill because it reflected “Republican priorities.”

The bill now heads to the Republican-led Senate, where Himes said passage could be challenging.

“Mitch McConnell has turned the Senate into a machine for the approval of federal judges and not much else is getting done,” Himes said, adding he is trying to work with Senate Republicans and the Senate Banking Committee on next steps.

The Senate Banking Committee declined to answer questions from Yahoo Finance on whether or not it would take up the Himes bill.

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