At the Water’s Hedge: International Insider-Trading Enforcement After Morrison Hugh B. Hamilton III

by Hugh B. Hamilton III

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Abstract

From copy rooms to boardrooms, many Americans have succumbed to the siren song of insider trading. As U.S. companies have gone international, so too have corporate secrets ripe for exploitation. With the growth of overseas derivatives based on U.S. stock, foreigners are able to engage in insider trading to a similar extent as Americans.

But in Morrison v. National Australia Bank, the Supreme Court limited the reach of the statutory insider-trading prohibition to transactions taking place in U.S. territory or transactions in securities listed on U.S. exchanges. Neither condition applies to overseas insider trading using derivatives. However, courts have reasoned that when the trader’s broker hedges by buying stock on a U.S. exchange, that transaction can be attributed to the trader, thus bringing the scheme within Morrison.

This hedging theory depends on the acts of third parties—the brokers—to create insider-trading liability, thus giving arbitrary windfalls to blameworthy traders and creating both evidentiary and legal hurdles for U.S. enforcement. Because Morrison has backed courts into this unworkable corner, it should not govern in insider-trading cases.

There is a fix: the Dodd-Frank Wall Street Reform and Consumer Protection Act abrogated Morrison for enforcement actions, albeit imperfectly. By abandoning the theory in favor of Dodd-Frank’s pragmatic standard, courts can more nimbly and forcefully protect U.S. markets from foreign fraud.

Author’s Note: On January 24, 2019, after this Note was sent to print, the Tenth Circuit decided SEC v. Scoville, No. 17-4059 (10th Cir. 2019), the appeal of Traffic Monsoon discussed in Part IV.A. The court held that Dodd-Frank abrogated Morrison and restored the conduct-and-effects test for enforcement actions, as advocated here. Scoville, slip op. at 15–23. Other circuits should adopt the court’s reasoning in order to ensure a nationally uniform standard for enforcement of the securities laws.

At the Water’s Hedge: International Insider-Trading Enforcement After Morrison Hugh B. Hamilton III

by Hugh B. Hamilton III

Click here for a PDF file of this article

Abstract

From copy rooms to boardrooms, many Americans have succumbed to the siren song of insider trading. As U.S. companies have gone international, so too have corporate secrets ripe for exploitation. With the growth of overseas derivatives based on U.S. stock, foreigners are able to engage in insider trading to a similar extent as Americans.

But in Morrison v. National Australia Bank, the Supreme Court limited the reach of the statutory insider-trading prohibition to transactions taking place in U.S. territory or transactions in securities listed on U.S. exchanges. Neither condition applies to overseas insider trading using derivatives. However, courts have reasoned that when the trader’s broker hedges by buying stock on a U.S. exchange, that transaction can be attributed to the trader, thus bringing the scheme within Morrison.

This hedging theory depends on the acts of third parties—the brokers—to create insider-trading liability, thus giving arbitrary windfalls to blameworthy traders and creating both evidentiary and legal hurdles for U.S. enforcement. Because Morrison has backed courts into this unworkable corner, it should not govern in insider-trading cases.

There is a fix: the Dodd-Frank Wall Street Reform and Consumer Protection Act abrogated Morrison for enforcement actions, albeit imperfectly. By abandoning the theory in favor of Dodd-Frank’s pragmatic standard, courts can more nimbly and forcefully protect U.S. markets from foreign fraud.

Author’s Note: On January 24, 2019, after this Note was sent to print, the Tenth Circuit decided SEC v. Scoville, No. 17-4059 (10th Cir. 2019), the appeal of Traffic Monsoon discussed in Part IV.A. The court held that Dodd-Frank abrogated Morrison and restored the conduct-and-effects test for enforcement actions, as advocated here. Scoville, slip op. at 15–23. Other circuits should adopt the court’s reasoning in order to ensure a nationally uniform standard for enforcement of the securities laws.