Taking Misappropriation Seriously: State Common Law Disgorgement Actions For Insider Trading
80 Pages Posted: 12 Feb 2021
Date Written: February 11, 2021
In two recent cases, Kokesh v. SEC, and Liu v. SEC, the U.S. Supreme Court cut back substantially on one of the Securities and Exchange Commission’s most important enforcement powers. This is the ability to seek disgorgement from persons who violate the federal securities laws, depriving them of their ill-gotten gains.
Previously, the Supreme Court had developed a largely property-based theory of insider trading. Why is insider trading evil? Because material nonpublic information is property that the trader has fraudulently obtained and must not use for his own purposes
In this article I bring these thoughts together. I examine the restitutionary remedy of disgorgement in the specific context of insider trading. I argue that disgorgement can and should be sought in private rights of actions brought under state common law rather than by the SEC under the federal securities laws. Delaware and New York already permit issuers to do so in the context of what is known as classic insider trading. If one takes the Supreme Court’s insider trading jurisprudence seriously, other owners of information should also be able to do so under the alternate misappropriation theory of insider trading. Such cases would not be subject to the limitations imposed by Kokesh and Liu. More importantly, they would avoid many of the doctrinal quandaries that have arisen under the notoriously problematic federal caselaw.
Private disgorgement actions under state law would be a supplement to, not a replacement of, SEC civil actions for injunctions and fines and Department of Justice criminal actions. Indeed, private actions will probably largely be parasitic on federal actions because insider trading is often only revealed through government investigation. And there are reasons to expect that relatively few state disgorgement actions will be brought, if for no other reason that the amount of profits most insider traders make are typically quite modest.
Nevertheless, I argue that by the logic of the Supreme Court’s jurisprudence, the owners of the material nonpublic information are the appropriate parties to bring disgorgement litigation. Indeed, part of my impetus for writing this article is to illustrate how the Supreme Court’s approach which combines property, fiduciary duty and fraud elements, is inadequate for addressing the public policy issues involving insider trading as a federal offense.
The Supreme Court correctly believes that the federal insider trading law is constrained by the fact that Sec. 10(b) of the Securities Exchange Act of 1934 only bans fraud, not bad acts generally. Consequently, coherence in federal insider trading law would require Congressional action which, in turn, would require identifying what is wrongful about insider trading from a market perspective so that we can define it. Unfortunately, although there is a wide spread, albeit far from universal, intuition that some trading on the basis of material nonpublic information violates the policies underlying the federal securities laws, so far there is not a consensus as to why.
Keywords: insider trading, disgorgement, restitution, private rights of action, state common law
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