together this confidential information and trading on it. It also came at a cost: He was caught by the SEC, which noticed the suspicious trading activity in the targeted stocks. It wasnât long before he was sanctioned by the SEC, forced to give back his trading profits, and charged by New York prosecutors, among the first criminal prosecutions ever for insider trading.
Chiarella was eventually convicted of securities fraud for trading on inside information, and his conviction was upheld on appeal. But the Supreme Court agreed to hear the case, and in a stunning move, reversed course. The court ruled in favor of Chiarella and nullified the SECâs main arguments for bringing the action in the first place: that by handling confidential information Chiarella was actually a corporate insider. That meant, according to the SEC, he owed a âdutyâ to the investors of the corporate entities involved not to trade on the shares of the target companies before the news was made public.
The Courtâs decision, announced in 1980, put the SEC on notice that its use of 10-b wasnât a blank check to bring just any case. In fact, the ruling made Swiss cheese out of one of the key arguments that the SEC had used in its war against insider trading: that anyone with access to nonpublic information that can move a stock is a classic insider, owing a duty to shareholders and âvictimizingâ them by trading on it.
Chiarella was not a company insider in the same way that board members in Texas Gulf Sulphur had been, the court ruled. The government couldnât even call the people on the other side of his trades real victims. Chiarella bought his stock on the market, where people trade all day for different reasons.
In other words, fairness in the markets had its limits.
It would be limited even more three years after the Chiarella decision, and nearly eleven years after the SEC first charged Ray Dirks with insider trading. Once again the commission was before the nationâs high court, looking for a bit of redemption, and of course, a further expansion of what the law considers insider trading, even if the agency did pick a pretty lousy example to make its case.
The echo chamber inside the commission failed to come to grips with what Dirks had really done. He had performed a function that was good for the markets and for investors. He had uncovered a fraud, and while his clients benefited first, so eventually did other investors as his information became reflected in the price of Equity Fundingâs stock.
Hereâs what Pitt meant by the SEC âdropping the ballâ on Dirks: After charging the analyst in a civil proceeding, it expected Dirks to take his punishment and walk away. But Dirks wasnât the âsweatingâ kind of stock analyst. He built a career taking on managements who ran fraud like Equity Funding, and short sellers he believed were wrong about companies they targeted as frauds.
He was also willing to take on the SEC, and he won. The Supreme Courtâs ruling established a precedent that would define insider trading for years to come, but not in the way the purists in federal law enforcement had wanted. By stretching for the ultimate enforcement tool, the SEC wound up having the law diminished. Keep in mind that nothing in what the commission found Dirks had done resembled the wild quid pro quos of payments and other compensation that would become the modus operandi of the markets decades later, or even the gross abuses found before. He followed up on a tip from a company insider, a former executive from Equity Funding who told him that the outfit was a fraud. He investigated the claim, interviewing executives at the company, and came to his own conclusion about the stock. It was the ultimate in what traders would later call the âmosaic theoryââpiecing together various pieces of data and then making a market call.
Common sense may have been missing from the
Chiarella was eventually convicted of securities fraud for trading on inside information, and his conviction was upheld on appeal. But the Supreme Court agreed to hear the case, and in a stunning move, reversed course. The court ruled in favor of Chiarella and nullified the SECâs main arguments for bringing the action in the first place: that by handling confidential information Chiarella was actually a corporate insider. That meant, according to the SEC, he owed a âdutyâ to the investors of the corporate entities involved not to trade on the shares of the target companies before the news was made public.
The Courtâs decision, announced in 1980, put the SEC on notice that its use of 10-b wasnât a blank check to bring just any case. In fact, the ruling made Swiss cheese out of one of the key arguments that the SEC had used in its war against insider trading: that anyone with access to nonpublic information that can move a stock is a classic insider, owing a duty to shareholders and âvictimizingâ them by trading on it.
Chiarella was not a company insider in the same way that board members in Texas Gulf Sulphur had been, the court ruled. The government couldnât even call the people on the other side of his trades real victims. Chiarella bought his stock on the market, where people trade all day for different reasons.
In other words, fairness in the markets had its limits.
It would be limited even more three years after the Chiarella decision, and nearly eleven years after the SEC first charged Ray Dirks with insider trading. Once again the commission was before the nationâs high court, looking for a bit of redemption, and of course, a further expansion of what the law considers insider trading, even if the agency did pick a pretty lousy example to make its case.
The echo chamber inside the commission failed to come to grips with what Dirks had really done. He had performed a function that was good for the markets and for investors. He had uncovered a fraud, and while his clients benefited first, so eventually did other investors as his information became reflected in the price of Equity Fundingâs stock.
Hereâs what Pitt meant by the SEC âdropping the ballâ on Dirks: After charging the analyst in a civil proceeding, it expected Dirks to take his punishment and walk away. But Dirks wasnât the âsweatingâ kind of stock analyst. He built a career taking on managements who ran fraud like Equity Funding, and short sellers he believed were wrong about companies they targeted as frauds.
He was also willing to take on the SEC, and he won. The Supreme Courtâs ruling established a precedent that would define insider trading for years to come, but not in the way the purists in federal law enforcement had wanted. By stretching for the ultimate enforcement tool, the SEC wound up having the law diminished. Keep in mind that nothing in what the commission found Dirks had done resembled the wild quid pro quos of payments and other compensation that would become the modus operandi of the markets decades later, or even the gross abuses found before. He followed up on a tip from a company insider, a former executive from Equity Funding who told him that the outfit was a fraud. He investigated the claim, interviewing executives at the company, and came to his own conclusion about the stock. It was the ultimate in what traders would later call the âmosaic theoryââpiecing together various pieces of data and then making a market call.
Common sense may have been missing from the
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