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

The SEC Takes Command

In the Matter of Cady, Roberts & Company

Shortly after Cary's arrival in March 1961, the SEC began to use Section 10(b) of the 1934 Securities Exchange Act to enforce insider trading sanctions. Cary reasoned that it would be shocking for business executives to personally profit from their inside information about the corporations they managed because he felt that those actions were likely to reduce public confidence and aggregate investment in the markets.

In addition, the January 1962 Supreme Court decision in Lehman Brothers, which prevented the SEC-advocated broadening of the Section 16 prohibition against "persons" having 10 percent or more ownership interest in short sale stock from applying to investment banking concerns, required the SEC to adopt a new approach.(16) Within months of becoming Chairman, facing with the obstacle of using Section 16 as an effective enforcement tool, and with the problems of relying on the common law of fraud to regulate insider trading, Cary wrote an administrative opinion In the Matter of Cady, Roberts & Company that rejected the majority state approach and expanded Rule 10b-5 as a basis for insider trading causes of action.(17)

The board of directors of Curtiss-Wright Corporation had decided to reduce the company's quarterly dividend, and J. Cheever Cowdin, one of the company's directors who also served as a partner in the stock brokerage firm Cady, Roberts & Company, advised Robert M. Gintel, another of his partners, of the impending dividend cut. Relying on that information, Gintel sold several thousand shares of Curtiss-Wright stock that had been held in customer accounts before the announcement, and before the company's stock declined in value.

Cary believed this was a classic "tippee" case, where the possessor of the inside knowledge himself earned no profits from the information but the person whom had been "tipped" to the information did. Many critics of enforcement of insider trading prohibitions argued that, unlike cases of direct fraud, there was no harm to anyone in such a case. Neither the company nor the sellers of stock could claim any damage by virtue of the use of the information. But Cary believed the information belonged to the corporation, and therefore any use of it by any individual for personal profit fell within prohibitions of Rule 10b-5.

Cary's administrative opinion announced what became known as the "disclose or abstain rule," whereby an insider in possession of material nonpublic information must disclose such information before trading, or if disclosure be impossible or improper, must abstain from trading in that company's stock. The announcement of the administrative rule established no common law precedent, but it did establish principles which, when advocated by the SEC over the next few years, would become the law of the land.

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Footnotes:

(16) Anthony Lewis, "High Court Rejects S.E.C. Bid to Widen Ban on Insider Profit," The New York Times, January 23, 1962, 60; Blau v Lehman, 368 US 403 (1962).

(17) Seligman, Transformation of Wall Street, 345; 40 SEC 907 (1961)


Related Museum Resources

Papers

November 8, 1961
image pdf (Courtesy of the Library of Congress)
January 15, 1962
image pdf (Courtesy of the National Archives and Records Administration)
February 13, 1962
image pdf (Courtesy of the National Archives and Records Administration)
May 29, 1962
transcript pdf (Courtesy of the National Archives and Records Administration)
June 14, 1962
transcript pdf (Courtesy of the National Archives and Records Administration)
November 15, 1963
image pdf (Courtesy of the National Archives and Records Administration)
November 21, 1963
transcript pdf (Courtesy of the National Archives and Records Administration)

Photos

1962

(standing) Manuel F. Cohen and Jack M. Whitney III; (seated) Byron D. Woodside, William L. Cary and J. Allen Frear, Jr.

Oral Histories

18 September 2007

Paul Windels, Jr.

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