• Introduction
• Pre-Securities Act Common Law Enforcement
• The Securities Exchange Act of 1934 - Principles of Full Disclosure
• Foundations of Fairness: The SEC Develops Theories and Rules on Corporate Disclosure
• The SEC Takes Command
• Counterattack From the Supreme Court
• Raising the Stakes
  • Corporate Take-Overs and Insider Trading Scandals in the 1980s
  • Congressional Deference to SEC Enforcement
• Power of SEC Resilience
• Old Debate and New Rules: SEC Regulation of Insider Trading in the Global Marketplace

Fair To All People: The SEC and the Regulation of Insider Trading

Raising the Stakes

Corporate Take-Overs and Insider Trading Scandals in the 1980s

The 1980s are often remembered as a decade of unbridled financial greed and lawlessness, resulting from the rise of corporate takeovers financed by "junk bonds". The notoriety of the scandals largely succeeded in obscuring the steadfast role of the SEC, particularly its Enforcement Division, in ferreting out and successfully prosecuting many of those financial wrongdoers. The public and political reaction to the sensational scandals involving Ivan Boesky, Dennis Levine and Michael Milken, and financial institutions such as Drexel Burnham Lambert, also forced the SEC to re-examine its own philosophy on insider trading. As Congress, responding to public pressure to stem insider trading abuses passed more specific legislation criminalizing the most egregious conduct, the SEC pressed hard to avoid a legislative definition of insider trading they felt would hamper their enforcement efforts.

1981 SEC Commission

The massive amounts of money that insider traders made in the takeover craze of the 1980s raised the public profile and Congressional concerns about insider trading. The political climate surrounding hostile takeovers and high profile insider trading scandals, which demanded greater enforcement efforts, clashed with the conservative common law counterrevolution led by Justice Powell. The SEC believed that Justice Powell's theories in Chiarella and Dirks were inadequate to address those growing concerns and to restore its fundamental principles of fairness and investor confidence in the markets. These events caused the SEC to pursue new avenues and theories to curb insider trading, that allowed it interpretative flexibility.

In 1984, in response the Reagan administration's hands-off approach toward business and to the notoriety of the high profile insider trading scandals, the SEC proposed legislation that would allow it to seek civil penalties of up to three times the actual profits in insider trading cases. Congress reacted to the scandals and to the proposed SEC solution by passing the Insider Trading Sanctions Act (ITSA).(44) ITSA imposed treble-damages and increased the maximum criminal fine for any violation of the Exchange Act to $100,000.

More significantly, the debate exposed the administrative and intellectual dilemma the SEC faced in establishing a clear definition of insider trading. Senator Alfonse D'Amato (R-NY) proposed a definition that would not require the SEC to show intentional fraud, merely that some contractual or fiduciary duty had been breached. But during testimony, Chairman Shad cautioned against adopting a specific definition before the SEC had itself drafted one. ITSA imposed stricter penalties but failed to establish a clear definition of insider trading.(45) The new, stricter limits, however, proved politically insufficient to re-establish public confidence in the markets as investigations uncovered major new scandals involving massive insider trading among insiders and institutional investors. As a result, Congress held new hearings on insider trading in June and July 1986.(46)

July 10, 1985 Boesky inscription to Dennis Levine

Those hearings called for renewed action by the SEC to respond to what critics called a lax effort to stem the burgeoning insider trading crisis. In reality, while the scandals created a sensation, it was not the amount but the profitability of insider trading that had changed, due primarily to the use of junk bond financing of massive corporate takeovers. The SEC, wary of reacting imprudently to political pressure to specifically define insider trading, or to create a "bounty" for insider trading informants, denied that the scandals created an insider trading crisis.

The testimony of Chairman Shad and that of John Fedders, Director of the SEC's Division of Enforcement, often took a low-key approach to the insider trading crisis. Fedders pointed out that while insider trading abuses got enormous publicity, "the goal right now for the enforcement program is not to target it in one area."(47) Congress nonetheless pressed on making claims about the rising incidence of insider trading and the danger it posed to the markets. For Congress, the perception became reality because even the perception of widespread insider trading could undermine investor confidence.

Senator D'Amato claimed during the 1987 Senate SEC oversight hearings that "the public cannot help but think that the dice are loaded…[because] of recent scandals," and demanded Congressional action to restore public confidence.(48) House Subcommittee Chair Edward Markey opened the House hearings with a similar warning, stating that the "war against insider trading must be fought on many fronts" and that "during a time when Wall Street has been set aflame with fraudulent activity, those of us in public office will not be seen as fiddling."(49)

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