Professors Stephen Bainbridge (UCLA Law School), M. Todd Henderson (Chicago Law School), and Jonathan Macey (Yale Law School) jointly filed an amicus brief in opposition to the DOJ’s petition for rehearing en banc of the panel decision in United States v. Newman. The sole point of the professors’ submission was to contest the contention of the DOJ and the SEC that the Newman decision threatened the integrity of the United States securities markets. The professors argued that, to the contrary, the panel’s application of the “personal benefit” standard stated by the Supreme Court in Dirks v. SEC enhanced the integrity of the securities markets by reducing the “chilling effect” on lawful disclosures of a vague rule favoring government flexibility in determining when disclosures are unlawful. The amicus brief is available here: Amicus Brief of Professors Bainbridge, Henderson and Macey in U.S. v. Newman.
As they summarized at the outset of the brief: “Far from endangering the integrity of the markets, the Newman opinion correctly applies the Supreme Court’s personal benefit test—a test founded in the Supreme Court’s explicit determination that the market must be protected from the chilling effects of standardless liability for insider trading. The threat to market integrity comes not from Newman’s correct application of the personal benefit test, but from the government’s and the SEC’s campaign to make Dirks’s ‘personal benefit requirement . . . a nullity.’ Newman op. at 22.” Professors’ Brief at 3.
The professors argued that the Supreme Court’s adoption of the “personal benefit” requirement in Dirks was specifically aimed at finding a way to differentiate between lawful and unlawful disclosures of nonpublic information in order to assure that lawful disclosures, which enhance marketplace efficiency and integrity, are not “chilled” by creating an uncertain prospect of liability for such disclosures under a less than clear standard. The Dirks Court drew the line with the “personal benefit” standard: “The distinction between fraudulent disclosure, in breach of that duty, and permissible disclosure, turns on the purpose for which disclosure is made. [Citing Dirks v. SEC, 463 U.S. 646, 662 (1983).] The ‘personal benefit’ test is the litmus test used to gauge the underlying purpose that motivates the insider to disclose information. Unless the insider ‘personally benefits’ from the disclosure, there is no breach of duty, and so no derivative liability if the recipient of the information trades.” Professors’ Brief at 4.
The Dirks standard was founded on precedent and the language of the statute, but also “on an explicit policy determination to protect the market from the threat of prosecutorial over-reaching.” Id. The “SEC advocated for a far broader liability rule than the Supreme Court was willing to countenance.” The Dirks Court rejected the SEC’s broader standard of illegality “on the explicit policy ground that the SEC’s rule would impair ‘the preservation of a healthy market.’” Id., quoting Dirks, 463 U.S. at 658. The Dirks court was explicitly protecting the ability of market analysts to “ferret out” information from insiders, which “enables more accurate pricing in capital markets and helps to assure that capital will ultimately be allocated to the highest value users.” Professors’ Br. at 5-6, citing Dirks, 463 U.S. at 658-59. Accordingly, “Broad prohibitions against trading based on material, non-public information—such as the SEC’s proposed interpretation of Section 10(b) in Dirks—ultimately damage the overall health of the market, because they limit the incentives of market participants to seek out information on which to trade.” Id. at 6.
The Professors note that the “personal benefit” test was the Supreme Court’s means of proving a “limiting principle” for investors and analysts using “objective criteria.” Id. at 8. In the professors’ view: “To effectively protect the socially beneficial activities of market participants operating under the eye of the SEC, requires definite and objective limits on the scope of insider trading liability.” As the Dirks Court said, relying “on the reasonableness of the SEC’s litigation strategy” as the only assurance that activities will not be prosecuted “can be hazardous.” Id. at 8, quoting Dirks, 463 U.S. at 664 n.24.
The professors argue that the Newman panel drew the right line. “The Newman panel correctly recognize[ed] that the government would make ‘a nullity’ of the personal benefit rule.” Professors’ Brief at 12. “Newman protects the integrity of the market by placing a meaningful and objective limit on the scope of insider trading liability, allowing investors[,] analysts and insiders to function with reasonable certainty and security about whether their conduct violates the law. In contrast, the government’s version of the personal benefit test fails to supply a standard to which market participants can reasonably conform their conduct.” Id.
Feb. 26, 2015
Contact Straight Arrow privately here, or leave a public comment below: