Securities and Exchange Commission Historical Society

Wrestling with Reform: Financial Scandals and the Legislation They Inspired

Manipulating Markets, Making Law: ITSFEA of 1988

Hostile Takeovers and Insider Trading

The Senate Banking Committee also grappled with hostile takeovers.  Sixty-four takeover bills had been defeated in the previous session, but within a week of the Boesky revelations, Senator Proxmire began work on new takeover legislation. (29)

The 1980s boom in hostile takeovers, conducted by corporate raiders who gained control of companies and stripped them of assets, gave arbitrageurs like Boesky opportunities for profit.  Corporate executives opposed takeovers because they allowed outsiders to acquire companies for their own gain and displace established leadership.  Wall Street, however, believed that they made corporations and thus markets more efficient.  Corporate leaders sought legislative protection against takeovers, while the securities industry conceded more oversight and self-regulation in exchange for the elimination of the poison pills and greenmail devices used to fight them.

Senator Proxmire’s legislation paired insider trading penalties with measures preventing companies from being “put in play.”  The proposed penalties, a maximum ten-year prison term and fines of up to $1 million, were widely supported.  Senator Proxmire also demanded rapid disclosure of purchases of more than three percent of shares and expanded the tender offer window, both measures meant to help companies detect and fight takeover attempts.  His bill, and a similar proposal by Representative Dingell, sharply restricted the use of golden parachutes, greenmail and poison pills. Proxmire's bill, stripped of takeover provisions, became the Senate’s primary legislative vehicle despite opposition from the White House and the SEC. (30)

On June 17, the Pitt committee produced a fresh bill that codified and clarified judicial definitions of insider trading.  One was misappropriation theory, which stated that using information inconsistently with one’s fiduciary duty constituted insider trading.  A new approach was to create a presumption of possession of material, nonpublic information. The committee also established anti-tipping rules tailored to fight the practices of corporate raiders, giving the SEC rulemaking authority and imposing the same insider trading penalties as the Proxmire bill.  D’Amato considered this bill “a needed complement” to the Insider Trading Sanctions Act and Pitt urged quick action before the Supreme Court narrowed the definition of insider trading.  The SEC remained reluctant to define the practice and wanted to continue enforcing it under existing law.  Tired of waiting, Senator Riegle demanded “a specific proposal” from the SEC by mid-July. (31)

The SEC provided the basis of the Insider Trading Act of 1987, which defined the practice as “buying or selling securities while in possession of material nonpublic information that was ‘wrongfully’ obtained or used” through “theft, bribery, misrepresentation, or espionage” or “a breach of a duty to maintain information in confidence.”  The proposal bolstered Chinese walls, upheld the possession standard, and strengthened rights of private action.  It did not, however, incorporate misappropriation theory.  Pitt and his colleagues considered the SEC’s proposal an improvement and agreed to work toward a compromise. (32)

Three things prevented legislation from passing that fall.  First, Representative Dingell still opposed defining insider trading.  Second, the October market break left Congress unwilling to risk further weakening Wall Street.  Third, the Supreme Court ruled in Carpenter.  The SEC’s victory in the lower courts bolstered the legitimacy of the misappropriation theory.  Justice Lewis Powell, the theory’s leading opponent, retired before the case was heard and a divided Court failed to either strike down or endorse the misappropriation or insider trading theory more broadly.

While many believed that, by sustaining the SEC’s enforcement program, Carpenter obviated the need for new legislation, Representative Markey insisted that the decision “invites Congress to enact legislation.”  Two days later, the SEC and the Pitt committee submitted a compromise explicitly including misappropriation; prohibiting trading while in possession of material nonpublic information, rather than simply trading using the information; and including a “general tipping prohibition” that gave the SEC flexibility.  This resolved most of the contention between the SEC and the Senate.

But in March, Representative Dingell again refused to approve any definition of insider trading, closing off that avenue and giving the House the impetus to produce insider trading legislation just in time for the last act of the Boesky drama: the reeling in of Michael Milken. (33)

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(29) New York Times, “Takeover Inquiries by Congress Seen,” November 18, 1986.   New York Times, “D’Amato Blamed in Takeover Bill Delay,” November 25, 1986.  New York Times, “Congress Weighs Takeover Curbs in Effort to Stem Insider Trading,” November 23, 1986.

(30) Washington Post, “Proxmire Introduces Insider Bill,” June 5, 1987.  New York Times, “Bill Seeks New Rules on Mergers,” June 5, 1987.

(31) Hearing, Definition of Insider Trading, Part I, 2, 4, 17-21, 108-111, 120.  Pitt recommended the removal of the presumption of use clause later, to avoid drawing constitutional challenges. Wall Street Journal, “White House Could Back Bill Defining Insider Trading, Senate Panel Is Told,” June 22, 1987.

(32) Hearing, Definition of Insider Trading, Part II, Statement of Charles Cox, 14, 20, 29, 62. 

(33) New York Times, “‘Insider’ Definition in New Law Urged,” November 17, 1987.  Hearing, Insider Trading Proscriptions Act, December 15, 1987, 13-15.  Wall Street Journal, “SEC Proposes Insider-Trading Measure that Includes Misappropriation Theory,” November 20, 1987.  Wall Street Journal, “Dingell Opposes Bill Defining Insider Trading,” March 9, 1988.

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