Securities and Exchange Commission Historical Society

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

Counterattack From the Supreme Court

Chiarella v. United States

Powell's first opportunity to challenge the policy approach of the SEC came in the high-profile case of Chiarella v. United States.(35) Vincent Chiarella worked for Pandick Press, a financial printer that printed disclosure materials for tender offers. Despite attempts by the companies to conceal the names of the takeover targets, Chiarella was able to break the code, and he traded shares of the companies he knew were involved. At the request of the SEC, the U.S. Department of Justice brought charges against Chiarella and he was convicted of violating Rule 10b-5, by trading on the basis of material nonpublic information. The Second Circuit affirmed his conviction, relying on the "equality of access to information" theory which was slightly less broad than the "parity of information" theory that the Second Circuit had adopted in Texas Gulf Sulphur.

Chiarella represented an expansion of state common law because Chiarella had no fiduciary relationship with any party to his stock transactions. Justice Powell, writing the majority decision for the Supreme Court, struck down what he considered the SEC's aggressive interpretation. He believed that extending the applicability of Rule 10b-5 to these kinds of situations would injure the efficiency of the markets. Powell also challenged the institutional capacity of the SEC as an administrative agency to expand the rules beyond that which Congress had intended. "The SEC," Powell wrote to a friend, "should have gone to Congress long ago" rather than depend on its own interpretation in writing "expansive rules" extending the "vague language" (e.g., Rule 10b-5) "to the edge of rationality."(36)

Justice John Paul Stevens countered that, while there may have been a fraud by Chiarella in his misappropriation of information, it was against the clients of Pandick Press, not the investors. In his review of the trial record, Powell discovered that this "misappropriation" argument had not been presented to the jury, and he persuaded the Supreme Court to refuse to consider the theory in the case. Although Chief Justice Warren Burger dissented and would have found liability using the misappropriation theory, Powell succeeded in establishing the common law of fraud, rather than the SEC's expansive extension of Congressional intent, as the basis for Rule 10b-5 liability.

Even as Chiarella was winding through the courts, the SEC announced a crackdown on insiders who used non-public information to trade for their own accounts. Instead of relying on reports by stock exchanges of suspicious trading, the SEC sought $12 million from Congress to create a computer system to monitor stock trading, corporate filings and news items. Stanley Sporkin, Director of the SEC's Division of Enforcement, acknowledged that his division had "definitely been placing greater priority on insider trading" than in the past. Assistant Director Edward D. Herlihy likened insider trading to "going to the track and knowing which horse will win the race before placing a bet," a practice he considered the kind of overreaching that "jeopardizes investor confidence in the integrity and fairness of the market."(37) By finding its definition of an "insider" too broad in Chiarella, the Supreme Court complicated what SEC officials admitted were "tough cases to prove," making the Commission's task of punishing insiders more difficult.

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Footnotes:

(35) 445 U.S. 222 (1980)

(36) Pritchard, Powell and the Counterrevolution, 930, quoting a letter from Powell to Michael P. Dooley, Professor of Law, University of Virginia, (October 25, 1980).

(37) Judith Miller, "S.E.C. Cracking Down On Trading by Insiders," The New York Times, March 7, 1980, D1.


Related Museum Resources

Papers

June 19-23, 1972
Manual for SEC Enforcement Training Program

(Courtesy of Gregory G. Faragasso)

April 23, 1974
document pdf (Courtesy of Theodore Levine)
April 23, 1974
document pdf (Courtesy of Theodore Levine)
June 28, 1979
Brief for the Petitioner Vincent F. Chiarella on Writ of Certiorari to the U.S. Court of Appeals, Vincent F. Chiarella against United States of America

(Courtesy of the Library of Congress)

August 10, 1979
Brief for the United States on Writ of Certiorari to the U.S. Court of Appeals, Vincent F. Chiarella v. United States of America

(Courtesy of the Library of Congress)

October 31, 1979
image pdf (Courtesy of the Library of Congress)
March 18, 1980
Supreme Court of the United States: Vincent F. Chiarella v. United States on Writ of Certiorari to the U.S. Court of Appeals

(Courtesy of the Library of Congress)

June 2, 1983
image pdf (Courtesy of the estate of John R. Evans; made possible through a gift from Quinton F. Seamons)
October 14, 1983
transcript pdf (Courtesy of the estate of John R. Evans; made possible through a gift from Quinton F. Seamons)
May 1984
document pdf (Courtesy of Theodore Levine)

Photos

1974

Presentation of Distinguished Service Award

Oral Histories

23 September 2003

Stanley Sporkin

Programs

25 September 2002

Roundtable on Enforcement

Moderator: Irving Pollack, Stanley Sporkin

Presenter(s): Theodore Altman, David Doherty, Benjamin Greenspoon, Theodore Levine, Alan Rosenblat, Thomas Rae, Richard Rowe, David Silver, Theodore Sonde, Wallace Timmeny

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