The Dangers of Insider Trading: New York Congressman Chris Collins Pleads Guilty and Resigns His Seat

The term “fiduciary duties” encompasses a set of responsibilities that serve as the cornerstone of regulating the securities markets. At the heart of these responsibilities are the duties of loyalty and care. When a person is placed in a position of trust and confidence, and abuses that position, that abuse can fairly be seen as a breach of those fiduciary duties.

Insider trading fits squarely into this legal framework. The central theory of insider trading is called “tippee-tipper” liability. In this scenario, the insider does not trade the stock him- or herself. Instead, the insider conveys the material nonpublic information to a third party, who then trades the stock for a profit or to avoid a loss. Legal liability attaches to both the tipper and the tippee because of the fiduciary duties owed by those individuals to the public shareholders and to the marketplace. (The tipper often is also breaching a fiduciary duty owed to the company from which he or she obtained the material nonpublic information.)

For Christopher Collins, the now-former U.S. Congressman representing the 27th Congressional District of New York, the severe consequences of violating these fiduciary duties have come to fruition. According to the Securities and Exchange Commission’s (SEC) complaint against Collins, which you can find here, Collins was serving as an independent director of an Australian biotech company called Innate Immunotherapies when he received confidential information concerning a failed clinical trial for Innate’s newest multiple sclerosis drug. When Collins learned of the failed trial, he contacted his son, Cameron Collins, to inform him. Armed with this inside information, Cameron sold nearly 1.4 million Innate shares before the news of the failed trial was made public. A few hours after Cameron had sold his shares, Innate announced the negative news and the stock price plummeted.

Some observers are skeptical of government intervention in the markets and are leery of what they see as over-regulation. They may ask: what did Collins do wrong? In short, he violated the fiduciary duties that he owed to the company, to its shareholders and to the public markets. The SEC scrutinizes those who would manipulate the markets for their personal benefit using material nonpublic information. And by doing so, it aims to protect the integrity of the marketplace and the rights of everyday shareholders who are not privy to inside information.

When material nonpublic information concerning a publicly traded company is disseminated to only a handful of individuals, that information is as good as gold. The easiest way to unethically capitalize on this information is to permit a small group of people, perhaps family members, to profit (or avoid loss) by either selling or buying the stock. Philosophers of criminology might argue that insider traders should not be severely punished because they are less culpable than violent offenders. After all, Collins did not physically harm anyone, and may never have even intended to inflict economic harm on the markets or on investors.

Nonetheless, the SEC, in conjunction with other agencies and self-regulatory organizations like the United States Department of Justice, the New York State Department of Financial Services, and the Financial Industry Regulatory Authority (FINRA), have concurrent jurisdiction to detect, investigate and regulate suspected insider traders, and the law enforcement authorities can strip insider traders of their freedom and send them to prison if convicted of criminal charges.

The law is in in flux, though. While the burden of proof has always fallen on the government to prove its case beyond a reasonable doubt, recent developments suggests that the government’s burden has recently become heavier.

In the case of Jesse Litvak, the Second Circuit Court of Appeals overturned his insider-trading conviction. The government tried to argue that liability attached because Litvak’s misrepresentations in trading mortgage-backed securities were material to a reasonable investor. However, the Court disagreed and emphasized that the materiality standard is objective. The Court noted that reasonable investors trading in the complex mortgage-backed securities market would rely upon sophisticated valuation methods, rather than relying on Litvak’s statements concerning market price. The Court also concluded that the counterparty’s personal belief that Litvak was acting as a fiduciary was irrelevant because no fiduciary relationship existed. Therefore, Litvak was not held liable because Litvak’s misrepresentations were not material to the reasonable investor.

Unfortunately for Collins, his manipulative conduct was as clear as day, and the Litvak precedent could not save him. There were no mortgage-backed securities or complex valuation models involved in his case. Instead, the facts of his case were far more routine. He clearly shared confidential information concerning a failed clinical trial with some of his closest family members. Collins’s guilty plea and resignation from Congress should send a clear and simple message to securities industry professionals and others in privileged positions: when you possess material nonpublic information, do not trade.

If you are a securities trader, or serve as a board member of a publicly traded company, be wary. Insider-trading prosecutions are not going anywhere. Be prudent, be ethical and honor your fiduciary duties as if your freedom depended on it.

If you are a corporate board member, senior corporate executive, broker or any type of financial services employee with questions about insider-trading liability or fiduciary duties, please contact a securities attorney at The Galbraith Law Firm. Call 212.203.1249 or email kevin@galbraithlawfirm.com for a free confidential consultation regarding your legal rights.