Senate Banking Committee Releases Testimony of University of Chicago Law School Professor – InsuranceNewsNet

WASHINGTON, April 19The Senate Bank, Housing and Urban Affairs Commission given the following testimony by Mr. Todd Hendersonprofessor at the University of Chicago Law Schoolinvolving a hybrid audience on April 5, 2022titled “Maintaining Market Fairness: Considering Insider Trading Legislation”:

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Thank you for having me testify on the subject of the regulation of capital raising and insider trading. These issues are at the heart of our economy. Every business needs to fundraise, and laws and regulations have a huge impact on how this is done and, importantly, how much it costs. It’s easy and perhaps politically attractive to add more and more obligations to corporations, but the costs of compliance don’t just fall on wealthy investors or abstract corporations — they’re paid by every American. While we need laws to prevent fraud and ensure accurate disclosure of information, every dollar spent to comply with regulations is a dollar not spent on employing workers, investing in research and development, and providing products and services. services to ordinary Americans. The purpose of the law should be to compel companies not to spend more than absolutely necessary to protect investors and ensure sound capital markets. After all, as a society, we pay the costs of regulation, and we should be willing to do so only if the return exceeds that cost.

There is no doubt that the costs of fundraising are too high today. The burden of complying with securities disclosures is many times greater than it was just a few decades ago. To give just one example, consider the disclosure obligations under Regulation SK. These regulations have 102 specific disclosure items set out in more than 140,000 words in 385 pages of the Code of Federal Regulations – the rules have increased twenty-fold since 1980. This means many lawyers can find work, but fewer engineers , chemists and others who are actually discovering things that improve our world.

In addition, the risk of baseless lawsuits for securities fraud remains high, despite efforts by Congress to eliminate them. The result was a sharp decline in the number of public companies and the number of companies going public. There are about half as many public companies today as there were in 2000. Companies are also using new means of accessing public capital – such as SPACs – to circumvent the costs of ‘Initial Public Offering. While the verdict has yet to be passed on SPACs, the fact that such an innovation is seen as necessary by investors and businesses should give regulators pause before racking up new introduction-related costs. on the stock market by traditional means.

Instead of trying to ease the burden on public enterprises, the SECOND double, issuing proposed rules that will overlap shareholders, workers and customers with even greater costs. At the same time, it hampers the ability of all Americans to invest in private markets. Private companies are an important alternative to public companies, and market returns from private equity and other alternative asset classes have exceeded public returns over the past few decades. Private equity not only provides an important investment option for investors of all kinds, but it helps turn around struggling businesses, provides all businesses with an alternative governance approach that can meet their needs at particular times. and, most importantly, provides discipline against public companies. managers who can act self-interested. Congress and the SECOND should expand the ability of every investor to access private equity and other asset classes, consistent with fiduciary obligations under ERISA and other laws.

Let me touch briefly on insider trading. When talking about insider trading, it is important to put aside conventional wisdom on the subject. There is nothing illegal about trading based on “material nonpublic information” about a company. Investment advisors and stock analysts make their living by researching information benefits for their clients. Without these incentives, there will be less information about stock prices, which means they will be less

precise. The consequence will be that capital will not be allocated where it is most valuable. This hurts everyone, not just investors.

Insider trading based on an informational advantage is illegal only if it results in a violation of the anti-fraud provisions of the federal securities laws. Under existing case law, this typically occurs when an insider of a company trades material nonpublic information for their own benefit, when someone deceptively takes material nonpublic information that does not belong to them and uses for commercial purposes, or when such persons provide — as a “tipper” — the Material Non-Public Information to someone else to trade for personal benefit. Judge Ginsburg clarified this land approach according to her in United States vs. O’Hagan.

The Insider Trading Protection Act merely purports to codify our existing insider trading prohibitions. But the real effect of the ITPA would be to increase uncertainty for analysts and traders who do the essential work of incorporating information into stock prices. When law professors can turn everyday scenarios—such as overheard conversations about cases and papers left in the back of airplane seat pockets—into challenging guesses for law school exams, the result is a huge deterrent to the labor needed to ensure accurate stock pricing.

This means not only a risk of misallocation of capital, but also significant compliance costs for investment funds. It is important to note that these costs of ensuring that investment professionals do not break the law will fall disproportionately on small and medium-sized investment funds. To make matters worse, these funds are more likely to be owned and managed by minorities and women, and to be those that take alternative positions on issues related to ESG and other issues.

There are several problems with the ITPA in its current form.

First, the ITPA codifies the existing personal benefit requirement for a payer, but includes an “indirect personal benefit”. It is possible to describe virtually any human interaction as bringing an “indirect benefit” to the participants. Instead, the law should reflect the common sense notion that the news source received something tangible and of value in return or provided what amounts to a monetary gift to a relative or friend.

Second, the ITPA states without controversy that trading in information wrongly obtained or disclosed as a result of theft, deception, or breach of fiduciary duty will result in liability. However, it also contains a catch-all provision, extending the concept to “a breach of a confidentiality agreement, breach of contract or breach of any other personal or other relationship of trust”. It is a system prone to abuse, with companies potentially able to prevent individual investors from trading simply by providing them with information, whether they want to or not.

Third, the ITPA expands the types of traders who can be held liable for insider trading. Currently, a trader must act with some form of intent to violate the law. Under the bill, however, anyone who “was aware, consciously avoided being aware, or recklessly disregarded” that the information was wrongly obtained or disclosed may be subject to legal action. The ITPA is silent on the meaning of “recklessly ignored”, which would seem to implicate innocent traders with real wrongdoers.

Finally, the ITPA does not contain an exclusivity clause stating that it will be the sole basis for bringing federal insider trading prosecutions. Allowing prosecutors to choose the law they prefer is no way to provide clear rules to the marketplace. Indeed, there is a federal law that allows the justice department to bring an action for insider trading without having to demonstrate the existence of a personal advantage. So much for the personal benefit of the ITPA.

It is little disputed that the knowing use of blatantly unlawfully obtained nonpublic material information to reap gains in the securities market – commonly referred to as “theft” – is what the government should be trying to prevent. At the same time, we don’t want to chill the valuable communications between company insiders and market participants, which provide investors with important real-time information about their investments. ITPA is an opportunity for Congress establish insider trading prohibitions with a clear set of limited rules that the government and investors can easily follow.

To this end, Congress needs – at a minimum – to narrowly define “personal benefit”, to abandon the catch-all provision on how information may be wrongfully obtained or disclosed, to limit liability to those with actual knowledge of their wrongdoing and to make the ITPA the exclusive basis for federal insider trading claims.

Thank you.

Jon J. Epps