Want Some Inside Information?
On August 10, 2000 the SEC established Regulation Fair
Disclosure (FD) and New Insider Trading Rules. These rules took effect 60 days
after publication in the Federal Register.
The new rules relate to three issues:
- Selective disclosure by issuers of material nonpublic
- When insider trading liability arises in connection with a
trader's "use" or "knowing possession" of material
nonpublic information; and
- When the breach of a duty of trust or confidence in a
family or other non-business relationship gives rise to liability under the
misappropriation theory of insider trading.
SEC Chairman Arthur Levitt said, "High quality and
timely information is the lifeblood of strong, vibrant markets. It is at the
very core of investor confidence. Regulation FD will bring all investors,
regardless of the size of their holdings, into the information loop -- where
On December 20, 1999, the SEC proposed new Regulation FD -
for "fair disclosure" - to combat selective disclosure.
Regulation FD would require that when an issuer intentionally discloses material
information, it do so publicly and not selectively. The company may make the
required disclosure by filing the information with the SEC, or by another method
intended to reach the public on a broad, nonexclusionary basis, such as a press
release. When selective disclosure of material information is made
unintentionally, the company must publicly disclose the information promptly
There was a vast response to the proposal with nearly 6,000
comments received. The responses ranged from those of investors wanting tighter
regulations to those of securities industry professionals concerned with the
impact of the regulation on the timely dissemination of information.
In response, revisions to the original Regulation FD were
made. The principal changes are:
- Narrowed Scope of the
The regulation will apply only to an issuer's communications
with market professionals, and holders of the issuer's securities under
circumstances in which it is reasonably foreseeable that the security holders
will trade on the basis of the information. The regulation will not apply to
issuer communications with the press, rating agencies, and ordinary-course
business communications with customers and suppliers.
The regulation will apply only to communications by the
issuer's senior management, its investor relations professionals, and others
who regularly communicate with market professionals and security holders.
- Rule of Disclosure that
Does Not Create Private Liability
The regulation text makes clear that it is a disclosure
rule. It does not create liability for fraud. Where the regulation is
violated, the SEC could bring an administrative proceeding seeking a cease and
desist order, or a civil action seeking an injunction and/or civil penalties.
The regulation has been revised to eliminate the prospect of
private liability for companies solely as a result of a selective disclosure
- Requirement of
Intentional or Reckless Conduct
The regulation requires public disclosure only where the
person making the selective disclosure knows or is reckless in not knowing
that the information disclosed was both material and nonpublic.
- No Application to Most
Registered Offerings or Foreign Issuers
The regulation now expressly excludes communications made in
connection with most registered securities offerings.
The regulation does not apply to foreign issuers.
- No Effect on Eligibility
for Short-Form Registration or Resales under Rule 144
A violation of Regulation FD will not disqualify a company
from use of short-form registration, or affect investors' ability to resell
under Rule 144.
With these changes, Regulation FD establishes a clear rule
against selective disclosure and encourages broad public disclosure. At the same
time, it does not impede legitimate business communications or expose issuers to
liability for selective disclosure arising from arguable but mistaken judgments
about the materiality of information.
In a nutshell, the passage of Regulation FD means U.S.
companies are required to disseminate material information to the public before
or at the same time that they provide that information to selected analysts,
investors or other securities industry professionals.
The prohibitions against insider trading play an essential
rule in maintaining the fairness, health, and integrity of our markets. Insider
trading law has developed on a case-by-case basis under existing provisions of
the federal securities laws. From time to time there have been issues on which
various courts have disagreed. The SEC has developed new Rules 10b5-1 and 10b5-2
to resolve two such issues.
These two amendments will clarify and enhance existing
prohibitions against insider trading. The first addresses the important but
unsettled question of whether insider trading liability arises when a person
trades while "aware" of material nonpublic information. The second
amendment addresses what types of family or other non-business relationships can
give rise to liability under the misappropriation theory of insider trading. In
all other respects, the law of insider trading remains unchanged.
Courts have split on whether insider trading liability
requires trading while in "knowing possession" of material nonpublic
information, or proof that the trader "used" the information in
trading. New Rule 10b5-1 provides that a trader is in violation if the trader is
"aware" of material nonpublic information when making the purchase or
sale. The rule also establishes several affirmative defenses or exceptions to
liability. These exceptions permit persons to trade in certain specified
circumstances where it is clear that the information they are aware of is not a
factor in the decision to trade, such as when following a pre-existing plan,
contract, or instruction that was made in good faith.
Clarifying Duties of Trust
or Confidence in Misappropriation Cases
The misappropriation theory of insider trading provides that a
person commits insider trading by misappropriating and trading on inside
information in breach of a duty of trust or confidence. The theory's application
is most clear in cases involving misappropriation of confidential information in
breach of an established business relationship, such as lawyer-client or
The SEC's new Rule 10b5-2 will clarify how the theory applies
to certain non-business relationships. Under the new rule, a person receiving
confidential information under the following circumstances would owe a duty of
trust or confidence, and thus could be liable under the misappropriation theory
- The person agreed to keep
- The persons involved in the
communication had a history, pattern, or practice of sharing confidences
that resulted in a reasonable expectation of confidentiality
- The person who provided the
information was a spouse, parent, child, or sibling of the person who
received the information, unless it were shown affirmatively, based on the
facts and circumstances of that family relationship, that there was no
reasonable expectation of confidentiality.
The ultimate goal of the SEC's actions is to level the playing
field for all involved. If you think you have received inside information, do
not act on it. Until the information is available to the general public it is
useless and any trading actions are in violation of the SEC's Insider Trading