TREATISE ARTICLE--Insider Trading Sanctions Act of 1984--Prior to the Insider Trading Act of 1988

The principal purpose of the Insider Trading Sanctions Act is to create an additional remedy that the Commission may seek with respect to insider trading violations: a civil penalty "not to exceed three times the profit gained or loss avoided as a result of such unlawful purchase or sale." [FN1] The civil penalty can be imposed only at the instance of the Securities and Exchange Commission and is payable to the United States Treasury; private parties cannot seek relief based on provisions of the Act. The Commission retains all its other remedies, including ancillary relief in an action for an injunction. The Commission has typically in this context sought disgorgement of profits, a remedy approved in Materia, [FN2] as noted by the House report, such funds can be utilized to compensate those adversely affected by the nondisclosure. [FN3] Courts have discretion as to the amount of the penalty (up to the maximum) based on the "facts and circumstances." Presumably, the mere fact that disgorgement has been sought and granted is no reason in itself to deny the request for a civil penalty since the whole theory of the Insider Trading Sanctions Act is that disgorgement is not a sufficient punishment. The temptation to engage in insider trading may be too strong if all that will be lost is the amount of the gain. Since it is a civil penalty it follows that (1) proof of the violation has to be only by a preponderance of the evidence [FN4] and (2) nonpayment of the penalty will not result in imprisonment. If one fails to pay the penalty, the Attorney General is authorized to bring an action in the appropriate United States district court to recover the amount of the penalty. [FN5] The Act defines "profit gained," or "loss avoided," as the difference between the sales price (or purchase price, as appropriate) and the value (presumably market price) of the security as determined a reasonable period of time after the withheld information is publicly disseminated. [FN6] The First Circuit had previously applied a similar test in a disgorgement context rejecting the Commission's contention that the actual profit, if greater, should be disgorged. [FN7] The Commission must initiate an action to recover such penalty within five years of the date of the appropriate purchase or sale; this does not, however, limit the period of time in which the penalty if imposed can be collected. [FN8]

The Commission is authorized to seek such penalty when any person violates any provision of the Exchange Act or rules or regulations adopted thereunder "by purchasing or selling a security while in possession of material nonpublic information" in a transaction effectuated through an exchange or a broker or dealer and which (except as to standardized options) does not involve a public offering by an issuer. [FN9] The language excludes, without any explanation in the legislative history, face to face transactions, the area in which the law relating to insider trading was initially developed. [FN10] It also excludes a public offering by an issuer (except as to standardized options), presumably because adequate disclosure would be made in the prospectus. In the case of standardized options, however, there will be disclosure about the options but not the underlying securities in the prospectus which probably explains why the penalty provisions are applicable to trading on the basis of inside information with respect to such options.

The Act does not make purchasing or selling a security while in possession of material nonpublic information unlawful, it is only when such purchases or sales violate any of the provisions of the Exchange Act or rules or regulations adopted thereunder that there is a right to seek a civil penalty. [FN11] What constitutes such a violation depends upon the existing law (and further judicial and/or administrative developments). It is, however, broad enough to embrace insider trading that is a violation of Rule 10b-5 and/or Rule 14e-3. The House report assumes in this regard that it would be applicable to persons who misappropriate information. [FN12] International Capital Markets and Securities Regulation Database updated December 2006

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