Insider Trading

The Securities and Exchange Commission [hereinafter SEC] has announced that it has launched an investigation into the practice of doctors selling secrets about new drug research to Wall Street. See David Heath et al., Regulators Probe Sale of Secrets by Doctors, Seattle Times, Aug. 10, 2005, available here; see also Jenny Anderson, Today’s Insider Trading Suspect May Wear a Lab Coat, N.Y. Times, Aug. 9, 2005, available here. On Sunday, August 7, the Seattle Times ran a special report on the sale of drug research, see here, which has led to Senator Charles E. Grassley calling on the Justice Department to join the SEC in investigation. According to the New York Times article, Senator Grassley wrote a letter to the new chairman of the SEC, Christopher Cox, and to Attorney General Alberto Gonzales, that “[s]elling drug secrets violates a trust that is fundamental to the integrity of both scientific research and our financial markets.”

According to the Seattle Times’ special report, the newspaper found at least 26 cases in which doctors sold critical details of their drug research to Wall Street firms, and in 24 of these cases, “the firms issued reports to select clients with detailed information obtained from doctors involved in confidential studies. The reports advised clients whether to buy or sell a drug stock.” Luke Timmerman et al., Drug Researchers Leak Secrets to Wall St., Seattle Times, Aug. 7, 2005, available here.

This sort of behavior suggests insider trading, which is criminalized by 15 U.S.C. § 78j(b). It is a violation of this section for a person to use any manipulative device or contrivance in contravention of the SEC’s rules and regulations. According to United States v. O’Hagan. 521 U.S. 642, 652 (1997), the “misappropriation theory” of insider trading applies to this sort of behavior, and is characterized by the misappropriation of confidential information for securities trading purposes; in short, the misappropriation theory “premises liability on a fiduciary-turned-trader’s deception of those who entrusted him with access to confidential information.” Id. To establish a criminal violation of section 78j(b), the government must prove that the person willfully violated the statute. Id. at 666.

The punishment for a violation of section 78j(b) is found at 15 U.S.C. § 78ff(a), which holds that a person who willfully violates the statute can be fined not more than $5,000,000, imprisoned for not more than 20 years, or both. However, the defendant may avoid imprisonment if he can prove that he had no knowledge of the rule. Id.