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Insider Trading Enforcement Trends in 2022

Insider trading enforcement has been robust in 2022, with the Department of Justice, Securities and Exchange Commission, and Commodity Futures Trading Commission bringing numerous high-profile cases. Our firm closely monitors insider trading developments to keep clients informed. This article provides an in-depth summary of key insider trading enforcement trends and emerging legal issues arising from cases filed over the past year.

Increased Scrutiny of Rule 10b5-1 Trading Plans

Rule 10b5-1 plans provide an affirmative defense for corporate insiders to sell company stock in a manner designed to avoid potential insider trading allegations. However, in recent years, regulators have grown increasingly skeptical that executives are manipulating these plans for personal gain rather than implementing them in good faith.

In September 2022, the SEC brought a settled administrative case against the CEO of a China-based mobile internet company who allegedly entered into a sham 10b5-1 plan after becoming aware of a material decline in advertising revenue from the company's largest partner. Despite adopting the 10b5-1 plan, the SEC found that the CEO still proceeded to trade on inside information in advance of the company announcing its financial results.

This SEC enforcement action follows reports that the Department of Justice and SEC had initiated a coordinated sweep of potentially suspicious trades executed through 10b5-1 plans. It also comes on the heels of the SEC's adoption in December 2022 of amendments to Rule 10b5-1 that impose significant new restrictions and disclosure requirements related to these plans for directors and officers.

The increased regulatory scrutiny of 10b5-1 plan trading, along with the new compliance burdens imposed by amendments to the rule, serve as a reminder of the need for diligent adherence to best practices by companies establishing or administering these plans and executives relying on them for trades. Documentation should demonstrate good faith adoption of plans when executives lack material nonpublic information. Companies should also confirm no overlapping plans are in place and impose meaningful cooling-off periods between plan adoption and first trades. Ongoing monitoring can help detect any anomalies suggesting potential abuse.

Novel "Shadow Trading" Theory of Insider Trading Liability

In its enforcement efforts, the SEC is also pursuing a novel "shadow trading" theory to potentially expand the scope of insider trading liability. The concept arose in SEC v. Panuwat, where a former biotech company executive was accused of misappropriating confidential nonpublic information that his employer was about to be acquired. Notably, however, the executive did not trade in securities of his employer or the acquiring company. Instead, the SEC alleges that, armed with the knowledge of the impending acquisition, the executive purchased out-of-the-money call options in a separate public company that operated in the same industry and whose stock price could also foreseeably be impacted by news of the acquisition.

In allowing the SEC's "shadow trading" claim to proceed past a motion to dismiss, the federal district court endorsed the agency's creative application of insider trading law and underscored its efforts to push the boundaries of liability. The SEC's novel theory takes aim at an executive who allegedly violated his fiduciary duties by, without disclosure, trading securities of other companies whose price might be affected by the nonpublic news learned through his employment. This expands the traditional focus on prohibiting trades in one's employer's securities while aware of material nonpublic information.

To mitigate risks in light of the SEC's expanding enforcement efforts, public companies should consider reviewing and updating their insider trading policies. A best practice is to explicitly prohibit trading not only in securities of the company itself, but also those of other publicly traded companies that could be impacted by the company's material nonpublic information. Compliance personnel should be vigilant for indications of opportunistic "shadow trading" around major announcements or events.

Digital Asset Markets Present Insider Trading Enforcement Challenges

One of the most noteworthy emerging insider trading enforcement trends is a new focus on potential misconduct within the cryptocurrency and digital asset markets. In 2022, both the Department of Justice and the Securities and Exchange Commission brought their first handful of cases alleging illegal insider trading related to cryptocurrencies or non-fungible tokens (NFTs).

For example, in SEC v. Wahi, the SEC accused an employee of leading cryptocurrency exchange Coinbase of tipping his friends and family to trade in certain crypto assets pre-listing on the exchange's platform. The DOJ similarly indicted the tippees for wire fraud in connection with the trades. However, because the SEC charged violations of Section 10(b) of the Securities Exchange Act, it had to take a position on which specific digital assets qualified as "securities" subject to the insider trading prohibition. The SEC complaint alleges that 9 of the 25 cryptocurrencies traded were investment contracts and therefore securities under the Howey test.

The SEC's approach to determining on an asset-by-asset basis whether insider trading liability attaches has faced criticism from those arguing it amounts to improper regulation through enforcement rather than formal rule-making. It also highlights the challenges regulators face in adapting existing insider trading legal frameworks to emerging digital asset markets. While the DOJ can sidestep the issue by charging wire fraud and other crimes, the SEC's enforcement ability remains contingent on taking a stance on whether any given cryptocurrency is a security. Insider trading in digital asset markets will likely remain an enforcement focus, meaning companies in the space face risks and should implement robust controls.

Legal Setback for DOJ in Blaszczak Appeal

In an appellate loss for insider trading prosecutors, the Second Circuit Court of Appeals in United States v. Blaszczak held in December 2022 that confidential pre-decisional Medicare reimbursement rate data from the Centers for Medicare and Medicaid Services (CMS) was not "property" that could be converted or misappropriated for purposes of Title 18 wire fraud charges. The court distinguished between commercially sensitive business data that constitutes a company's "stock in trade" capable of being stolen (as in Carpenter) versus pure regulatory information of a government agency.

The Blaszczak case involved a hedge fund consultant who obtained the confidential CMS rate information from an agency employee and shared it with hedge fund portfolio managers to execute profitable trades. While the defendants were convicted after trial under Title 18 for securities fraud and conversion of government property, the Second Circuit overturned the convictions in light of the Supreme Court's intervening Bridgegate ruling on the narrow scope of property interests covered by federal fraud statutes. However, the appeals court noted that Title 15 securities fraud charges could still be brought in such instances of misappropriating government information, albeit subject to the Dirks personal benefit test.

While a setback for Title 18 fraud theories in future government insider trading cases, Blaszczak does not foreclose other avenues for enforcement. Nonetheless, it demonstrates the impact that evolving judicial interpretations of fraud statutes can have on prosecutors' insider trading enforcement strategies and successes. The case also exemplifies the complex insider trading issues that can arise at the intersection of criminal fraud, securities, and employment laws.

Ramped Up Insider Trading Enforcement in Commodities Markets

Another noteworthy trend is the Commodity Futures Trading Commission stridently expanding its insider trading enforcement efforts within the commodities markets it oversees. The CFTC historically lacked an extensive track record of pursuing insider trading cases. However, creation of the agency's Insider Trading and Information Protection Task Force in 2018 signaled a new priority for the CFTC.

Consistent with this ramped up focus, 2022 saw the CFTC bring a number of enforcement actions targeting alleged futures trades based on misappropriated material nonpublic information. For example, it filed a case against a natural gas company president for allegedly disclosing confidential information about upcoming block trades to an outside trader in exchange for kickbacks. The CFTC also won a jury verdict against an introducing broker accused of trading opposite customers without consent based on their order information.

With its professed commitment to policing wrongdoing in commodities markets and the powerful tool of the relatively new anti-fraud Rule 180.1 modeled after SEC Rule 10b-5, the CFTC shows no indication of easing up on commodities-related insider trading enforcement efforts. Companies and individuals participating in commodities and futures markets should be aware of heightened regulatory scrutiny in this space.

Key Takeaways

In summary, regulators remained aggressive across the board in insider trading prosecutions this past year. Key areas to keep watching include digital asset markets, Rule 10b5-1 plan compliance practices, related-company "shadow trading," setbacks to Title 18 fraud charges, and intensified CFTC enforcement. The sheer breadth of cases pursued in 2022 against tippers, tippees, and securities industry professionals suggest insider trading enforcement will continue full steam ahead.

Public companies and investment firms should evaluate their policies, procedures, and training programs to confirm they are keeping pace with emerging insider trading risks and enforcement trends. Please reach out if Lucosky Brookman can provide guidance or assistance with crafting or assessing your insider trading compliance program. We monitor developments in this area closely and are always available as a resource.