New Risks Faced by Plaintiffs Prosecuting Private Causes of Action for Insider Trading

April 10, 2014 Published Work
TerraLex Connectiions

Originally Published in the April 2014 Issue of TerraLex Connections.


Justice Department prosecutions and Securities and Exchange Commission enforcement actions have once again brought sensationalist attention to insider trading. Headlines blare about the existence and reliance upon "expert" networks by traders and managers, the use of wiretaps and informants in the heretofore exempt world of hedge funds and investment banks, and the imposition of millions of dollars in fines, restitution orders and jail time for those found to have engaged in or benefitted from insider trading.[i] Generating fewer headlines but frequently posing equally interesting legal and policy questions are the private suits that follow governmental action.[ii] These putative class actions often mimic the SEC's or DOJ's announcements and filings, seeking to slipstream in the government's wake to a large disgorgement award, and an equally handsome attorney's fee. Slipstreaming, however, has its risks and this article will discuss several fact-specific pleading and substantive hurdles that may be encountered in these actions: finding a plaintiff who may have traded "contemporaneously" with the alleged insider so as to have standing to pursue the claim, and recovering damages if the SEC first secures disgorgement from the insider.

Private Right of Action for Insider Trading

Despite the uncertain foundation underlying civil theories of insider trading as constituting fraud under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5,[iii] the implied, private cause of action for insider trading was first sanctioned by the Second Circuit in Shapiro v. Merrill Lynch in 1974 on the theory that Section 10(b) and Rule 10b-5 impose a duty on those in possession of material inside information to either disclose it to the investing public or abstain from trading in or recommending the securities concerned while such inside information remains undisclosed.[iv] Reasoning that the strong policy considerations behind the "disclose or abstain" rule serve Section 10(b) and Rule 10b-5's purpose "to protect the investing public and to secure fair dealing in the securities markets by promoting full disclosure of inside information,"[v] the Second Circuit authorized a private right of action for insider trading "to prevent corporate insiders and their tippees from taking unfair advantage of the uninformed outsiders."[vi] In doing so, it also canvassed the full range of possible damage for the uninformed outsiders and concluded that disgorgement of the insider's profits gained or losses avoided was the punishment that best fit the offense.

Several years after Shapiro, the United States Supreme Court in Chiarella v. United States addressed insider trading articulating two theories of liability.[vii] Under the "classical theory" discussed by the majority, insiders violate Section 10(b) when they trade on material nonpublic information because their failure to disclose such information breaches the "relationship of trust and confidence" that exists between a corporate insider and shareholders of that corporation. This duty to disclose applies equally to corporate insider's "tippee" who "inherits [the insider's disclosure] obligation to the shareholder."[viii] Under the competing "misappropriation" theory, discussed in the concurring and dissenting opinions, persons who are not corporate insiders with direct fiduciary obligations to shareholders nonetheless violate the Securities laws when they trade while aware of material nonpublic information.[ix] In Justice Powell's concurrence, he suggested that Rule 10b-5 may be violated by breaching a duty of silence that an employee owes to his employer and to his employer's customers.[x] Chief Justice Burger's dissent supported a broader version suggesting that the duty to disclose or abstain from trading derived from the "unfairness inherent in trading on such information when it is inaccessible to those with whom one is dealing."[xi] Although Chiarella's concurrence and dissent laid the conceptual groundwork for the misappropriation theory, the Supreme Court deadlocked on the viability of the theory in its subsequent decision in Carpenter v. United States.[xii]

Shortly thereafter, amidst the insider trading scandals of the mid-1980s, the evolving theories of insider trading liability, and the Supreme Court's deadlock on the misappropriation theory, Congress passed the Insider Trading and Securities Fraud Enforcement Act of 1988 (the "Act"), establishing a statutory right of action based on that theory under Section 20A of the Exchange Act.[xiii] Among other things, the Act codified certain elements of the implied course of action previously established by case law, including the requirement that the allegedly aggrieved party have traded contemporaneously with the insider, and the limitation of available damages to a single disgorgement of the profit made or loss avoided.[xiv]

Contemporaneous – Congress Defers to Courts

When first considering whether an implied private right of action for insider trading existed and, if so, who could bring such an action, the Shapiro Court limited the potential large universe of potential plaintiffs to those who had traded contemporaneously with the insider.[xv] Shapiro did not define contemporaneous, which it and subsequent courts viewed as a proxy or substitute for privity or harm, [xvi] but did state that a plaintiff who traded 3 or 4 days after the insider's trade was considered to have standing.[xvii] Later in Wilson, the Second Circuit held that a month between trades was not contemporaneous.[xviii] Several subsequent cases discussed the range of 3 to 4 days without specifically defining contemporaneous.[xix]

In passing the Act, Congress did not define contemporaneous. Instead the legislative history refers to three decisions within the Second Circuit, Wilson v. Comtech Telecommunications Corp., Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc. and O'Connor & Associates v. Dean Witter Reynolds, Inc. as having developed the definition,[xx] with one representative speaking in terms of a plaintiff being on the opposite side of the insider trade.[xxi] Continuing on the path set by Shapiro, Congress adopted disgorgement as the sole damage remedy for any recovery, expressly limiting the available relief to one disgorgement whether made to the SEC or to private plaintiffs. [xxii]

"Contemporaneous" Case law Since the Act

In the twenty-five or so years since passage of the Act, the "contemporaneous" jurisprudence has developed almost exclusively at the district court level, with no reported circuit court or Supreme Court opinions on the subject. Some of the district court jurisprudence is imprecise as it is often not clear what span of time between trades exists.[xxiii] Other cases contain relatively little discussion of what standards are being brought to bear in assessing and applying the contemporaneous requirement. [xxiv]

In those cases that evidence some analysis of what "contemporaneous" means, two or three themes emerge: the most limiting are those cases that hold or suggest that the trade must be on the same day to be contemporaneous.[xxv] Another line of cases refers to a three day period, relying on the concept that stock trades normally take three days ("T+2") to clear or settle on an exchange.[xxvi] Finally, there are some opinions that elide the issue by citing other cases and remarking, without analysis, that periods up to six or even ten days may be considered contemporaneous.[xxvii]

To the extent that courts impose increasingly stricter interpretations of contemporaneity, it will be more difficult to find appropriate plaintiffs, a challenge made all the more difficult by the Private Securities Litigation Reform Act's heightened pleading standard, which requires that contemporaneity be pled with particularly.

SEC's Fair Fund Procedures Limit Recovery to Those Who Traded on Same Day as Insider

In distributing amounts disgorged to the SEC by insider trading defendants under the Fair Fund provision of the Sarbanes-Oxley Act of 2002,[xxviii] the SEC appears to be structuring distribution plans in deference to principles of actual privity, limiting recovery to those who either traded on the same day as the insider or were on the opposite side of the trade from the insider. In several cases where it was possible to determine which investors were on the other side of the insider trades, the SEC has limited recovery of Fair Fund proceeds to those investors who were in actual privity with the insider.[xxix] In other cases, the SEC's proposed plans of distribution limit the range of potential claimants to those who traded on the same day as the insiders.[xxx] In these cases, the SEC has described such traders as those "harmed by the improper conduct alleged in the Commission's lawsuit" [xxxi] and in one case defined "injured investors" as those "contemporaneous traders" who had traded on the same days as the insider.[xxxii] Since the purpose of the Fair Fund provision is to compensate injured investors, the determination of who is an eligible Fair Fund claimant in an insider trading case sheds substantial insight on the SEC's understanding and interpretation of the contemporaneous requirement. [xxxiii] The SEC's interpretation of the contemporaneous requirement provides defendants facing private civil insider trading actions additional authority for a more exacting proxy for privity than suggested by most case law, which, if adopted in the civil insider context, will make it more difficult to find appropriate plaintiffs.

The "T+2" Rule

Case law, legislation history and the SEC's Fair Fund Process demonstrates that "contemporaneous," in the context of stock trades and almost instantaneous executions on modern exchanges, should not be construed in terms of weeks or months. To the extent "contemporaneous" is a rough proxy for privity or "harm," there is simply no justification for lengthy periods. On the other hand, requiring a plaintiff to be "on the other side" of the insider trade, as suggested by one legislator, presents substantial practical issues about how plaintiffs satisfy their pleading requirements.[xxxiv] While, the "other side" of the trade approach may very well be appropriate for the purpose of the SEC's Fair Funds process or even for purposes of private insider trader actions in the case of matchable block trades or if and when it becomes relatively easy to match up a series of trades, at present a more sensible approach may be to adopt, as an outer limit, the "T+2" standard (day of trade plus 2 more) of clearing or settlement of trades on the exchanges. At the very least, establishing T+2 as an outer limit will provide some clarity amidst the diffuse case law, without hindering further development of more precise definitions in appropriate circumstances or as technology progresses.

Limiting Damages to a Single Disgorgement

Another significant hurdle facing putative class actions that follow in the wake of a governmental action is the Act's requirement that the total amount of damages imposed against any person under Section 20A "be diminished by the amounts, if any, that such person may be required to disgorge, pursuant to a court order obtained at the instance of the Commission." [xxxv] As one court within the Second Circuit commented "[i]t is clear that the underlying purpose of allowing disgorgement as an exception to the traditional out-of-pocket measure of damages is to prevent unjust enrichment….[Thus] once ill-gotten gains have been disgorged to the SEC, there remains no unjust enrichment and, therefore, no basis for further disgorgement in a private action. Any other result would conflict with the well settled principle in the Second Circuit that a private party may not recover punitive damages for a violation of Section 10(b) and Rule 10b–5."[xxxvi] Moreover, because the SEC typically turns over disgorged proceeds to the victims of insider trading, this limitation on damages also reflects the law's general prohibition against double recovery for the same injury.[xxxvii] Consequently, where an inside trader has disgorged all profits gained or losses avoided to the SEC, any subsequent private action for insider trading would be moot because the relief sought could not be given.[xxxviii] Further, where the SEC fair fund proceeds are distributed to injured investors, the named plaintiff and putative class members would also lack Article III standing to mount a civil action because any injuries resulting from the alleged insider trading would have been fully compensated by the fair funds disbursement.[xxxix]


Slipstreaming in the wake of governmental action for insider trading cases presents unique challenges for private actions. Pleading contemporaneity with particularity may present a hurdle, and may not survive a motion to dismiss. More significantly, the inability to recover damages subsequent to a SEC disgorgement order undoubtedly tempers a private plaintiff's appetite to bring such actions in the first place.

[i] See, e.g., Anita Raghavan, Rajat Gupta's Lust for Zeros, N.Y. Times, Jan. 27, 2009,; Peter J. Henning, More Use of Wiretaps Is Likely to Come in Trading Cases, N.Y. Times, June 24, 2013,; Peter Lattman and Ben Protess, SAC Capital Is Indicted, and Called a Magnet for Cheating, N.Y. Times, July 25, 2013,

[ii] See, e.g., Brodzinsky v. Frontpoint Partners LLC, et al., 11-cv-00010, (WWE) (D. Conn. Jan., 2011); Gordon v. Sonar Capital Mngnt. LLC et al, 11-cv-9665, (JSR) (S.D.N.Y. Dec., 2011); Kaplan v. SAC Capital Advisors LP et al, 12-cv-9350, (VM) (S.D.N.Y. Dec., 2012); Birmingham Retirement and Relief Sys v. SAC Capital Advisors LLC, et al, 13-cv-02459, (VM) (S.D.N.Y April, 2013).

[iii] See James J. Park, Rule 10b-5 and the Rise of Unjust Enrichment Principle, 60 Duke L.J., 345, 360 (2010) (Rule 106-5's "prohibition of insider trading fits uneasily with the view that [the rule] is directed primarily at fraud.").

[iv] Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 495 F.2d 228 (2d Cir. 1974).

[v] Id. at 235.

[vi] Id. (internal quotation marks and citation omitted).

[vii] Chiarella v. United States , 445 U.S. 222 (1980); Dirks v. SEC, 463 U.S. 646 (1983); Donna M. Nagy, Insider Trading and the Gradual Demise of Fiduciary Principles, 94 Iowa L. Rev. 1315, 1317 (2009).

[viii] Dirks, 463 U.S. at 655-56.

[ix] Nagy, supra note 7, at 1317.

[x] Chiarella, 445 U.S. at 238 (Stevens, J., dissenting).

[xi] Id. at 241 (citation omitted) (Burger, C.J., dissenting).

[xii] In Carpenter, the Supreme Court addressed the validity of the misappropriation theory in its review of a Second Circuit opinion which applied the theory to a case involving a Wall Street Journal reporter who tipped information about companies that he planned to disclose in his upcoming column. Carpenter v. United States, 791 F.2d 1024, 1026 (2d Cir. 1986), aff'd by a divided court, 484 U.S. 19 (1987) (4-4 decision). However, the Supreme Court was equally divided on whether to sanction the misappropriation theory and therefore affirmed the Section 10(b) and Rule 10b-5 convictions under the theory without opinion. 484 U.S. at 24.

[xiii] Pub. L. No.100-704, 102 Stat. 4677 (1988). Years after the Act was passed, the United States Supreme Court in United States v. O'Hagan, 521 U.S. 642 (1997) endorsed the more limited version of the misappropriation theory as developed in Chiarella's concurrence and in Carpenter. In O'Hagan, the Supreme Court found that Section 10(b) and Rule 10b are violated when a person misappropriates material nonpublic information from a corporate insider, such as his employer, in breach of a duty of confidentiality or loyalty owed to that insider as opposed to the shareholder. Id.

[xiv] Pub. L. No.100-704, 102 Stat. 4677 (1988).

[xv] 495 F.2d at 241. Insider trades which occur after a plaintiff's trade are not actionable, no matter how close in time they may be. In re Take-Two Interactive Sec. Litig., 551 F. Supp. 2d 247, 311 n. 51 (S.D.N.Y 2008); O'Conner & Associates v. Dean Witten Reynolds, Inc. 559 F. Supp. 800, 803 (S.D.N.Y. 1983).

[xvi] See Neil V. Shah, Section 20A and the Struggle for Coherence, Meaning, and Fundamental fairness in the Express Right of Action for Contemporaneous Insider Trading Liability, 60 Rutgers L. Rev. 791, 812-813 (2009); In re MicroStrategy, Inc. Sec. Litig., 115 F.Supp. 2d 620, 663 (E.D. Va. 2000) (acknowledging that contemporaneity serves as a privity substitute); Buban v. O"Brien, No.94-0331, 1994 U.S. Dist. LEXIS 8643, at *7 (N.D. Cal. June 16, 1994) ("[P]roxy is a surrogate for the traditional requirement of contractual privity between plaintiffs and defendants.").

[xvii] Shapiro, 495 F.2d at 241.

[xviii] Wilson v. Comtech Telecomm Corp., 648 F. 2d 88, 94-95 (2d Cir. 1981).

[xix] See Elkind v. Liggett & Myers, Inc, 635 F.2d 156, 173 (2d Cir. 1980) (the only outside purchasers who "might conceivably have been damaged by the insider-trading were those who bought Liggett shares between the afternoon of July 17 and the opening of the market on July 18" when the nonpublic information was disclosed); O'Connor & Assoc. v. Dean Witter Reynolds, Inc, 559 F.Supp. 800, 803-04 (S.D.N.Y. 1983) (holding that only those plaintiffs who had pled that they had traded less than a week after the defendant traded were "sufficiently contemporaneous" to state a cause of action for insider trading).

[xx] See H.R. Rep. 910,100th Cong., 2d Sess. at 27 n.22 (1988), reprinted in 1988 U.S. Code Cong. and Admin. News at 6064 (citing Wilson, 548 F.2d 88; Shapiro, 495 F.2d 228; O'Connor, 559 F. Supp. 800).

[xxi] See Report of the House Comm. on Energy and Commerce on the Insider Trading and Securities Fraud Enforcement Act of 1988, H.R. Rep. No. 100-910, at 40, 100th Cong., 2d Sess. 27 (Sept. 9, 1998).

[xxii] 15 U.S.C. §78t-1(b).

[xxiii] Redtail Leasing, Inc. v. Thrasher (In re Motel 6 Sec. Litig.), No. 93 Civ. 2183, 1997 U.S. Dist. LEXIS 3909 (S.D.N.Y. Apr. 1, 1997) (failing to identify or discuss the number of days, if any, that separated the plaintiff's trades from the defendant's trades); Fridrich v. Bradford, 542 F.2d 307, 324 (6th Cir. 1976) (Celebrezze, J., concurring) ("Since the mechanics of the market place make it virtually impossible to identify the actual investors with whom an insider is trading, the duty of disclosure is owed to investors as a class who trade on the market during the period of insider trading") (footnote omitted); Kumpis v. Wetterau, 586 F. Supp. 152, 154 (E.D. Mo. 1983) (refusing to grant motion to dismiss where a complaint only vaguely identified the dates of plaintiff's trades because one trade might "fall within the parameters of the contemporaneous rule.").

[xxiv] Gordon v. Sonar Capital Mngnt, No. 11 Civ. 9665, NYLJ 1202608756667, at *1 (S.D.N.Y., Decided June 12, 2013) (the complaint failed to allege contemporaneous transactions because the plaintiff's alleged sales were not conducted "within a few days" of defendant's purchases); In re Oxford Health Plans, Inc. Sec. Litig., 187 F.R.D. 133, 144 (S.D.N.Y. 1999) ("[f]ive trading days is a reasonable period between the insider's sale and the plaintiff's purchase to be considered contemporaneous…").

[xxv] See e.g., In re Aldus Sec. Litig., No.92-885, 1993 U.S. Dist. LEXIS 5008, at *21-22 (W.D. Wash. Mar. 1, 1993) ("[G]iven the unquestionably high volume of Aldus stock traded daily during the period in question, it is clear that plaintiffs did not trade with defendants…as no plaintiffs traded on the days of the allegedly wrongful trades."); In re AST Research Sec. Litig., 887 F.Supp.231, 234 (C.D. Cal. 1995) ("The same day standard is the only reasonable standard given the way the stock market functions."); Feldman v. Motorola, Inc., No.90-5887, 1993 U.S. Dist. LEXIS 14631, at *38 (N.D. Ill. Oct. 14, 1993) ("Generally, the contemporaneity requirement is not met if a plaintiff's trades occurred more than a few days apart from a defendant's transaction. In the context of stock heavily traded on a daily basis, it has been held that trades are not contemporaneous unless they take place on the same day.") (citations omitted); In re MicroStrategy,115 F. Supp. 2d at 663 (E.D. Va. 2000) ("[T]he modern realities of the securities markets support an increasingly strict application of contemporaneity in order at once to satisfy the requirement's privity-substitute function and to guard against ‘making the insider liable to all the world.'"); Buban, 1994 U.S. Dist. LEXIS 8643, at *11 (citing Neubronner v. Milken, 6 F.3d 666, 670 (9th Cir.1993)); Evergreen Equity Trust v. Fed. Nat'l Mortgage Ass'n, 503 F. Supp. 2d, 68-71 (D.D.C. 2007) ("to expand the reach of Section 20A beyond same day trades would, in effect, permit plaintiffs to assert claims where it is implausible that they traded with defendants."); In re Take-Two Interactive Sec. Litig., 551 F.Supp. 2d at 311 n.51 (collecting cases).

[xxvi] In re Silicon Graphics, Inc. Sec. Litig., 970 F.Supp.746, 761 (N.D. Cal. 1997) ("Given that stock trades settle within three days, and allowing for the possibility of an intervening three-day weekend, only purchases within six days of insider sales are truly contemporaneous. Once an insider's sale settles, other trades are no longer in the market with that insider and risk no relative disadvantage from that insider's failure to disclose."); In re Engineering Animation Sec. Litig., 110 F.Supp.2d 1183, 1196 (S.D. Iowa 2000) (finding that three days satisfies the contemporaneous requirement).

[xxvii] In re GPC Biotech A.G. Sec. Litig., 597 F.Supp.2d 412, 427 (S.D.N.Y. 2009) (leaving open the possibility that "[s]ales within six days or even ten days may be ‘contemporaneous'"), vacated on other grounds, No .07 Civ. 06728, 2009 U.S. Dist. LEXIS 122189 (S.D.N.Y. Dec. 29, 2009); In re Enron Corp. Securities, Derivative & "ERISA Litig.," 258 F.Supp.2d 576, 599 (S.D. Tex. 2003) (noting that "[d]ifferent courts have found that ‘contemporaneity' requires the insider and the investor/plaintiff to have traded anywhere from on the same day, to less than a week, to within a month, to ‘the entire period while relevant and nonpublic information remained undisclosed'") (citation omitted).

[xxviii] Section 308(a) of the Sarbanes-Oxley Act permits the SEC to collect civil penalties in enforcement actions and add them to disgorgement funds for the benefit of the victims of security law violations. 15 U.S.C. § 7246(a).

[xxix] See SEC v. Saleh, et al, Civ. No. 3:09-cv-01778-M, Doc. No. 24-1 (N.D. Tex. Jan. 5, 2011) (approving distribution plan in insider trading case which defined eligible Fair Fund claimants as persons who sold option contracts from September 4, 2009 through September 18, 2009, which options were purchased by the insider defendant and subsequently sold by the defendant after the material nonpublic information was disclosed on September 21, 2009); SEC v. Abatemarco, 10 Civ. 9527, (WHP), Doc. No. 17-1 (S.D.N.Y. Mar. 23, 2012) (approving distribution plan which defined eligible Fair Fund claimants as the person or firm who sold call option contracts in the securities from December 10, 2010 through December 15, 2010, which options were purchased by the defendant).

[xxx] SEC v. Fitts, et al., No.03-CV-10658, (DPW) (D. Mass Aug. 26, 2003) (approving SEC's proposed plan "for distributing funds to defrauded investor" which defined eligible claimants as "all persons and/or entities who sold MetroWest common stock on May 23, 2001" the date the insider defendant bought stock while in possession of material nonpublic information); SEC v. Skowron, et al, Civ, No. 10-cv-8266, (DAB), Doc. No. 47 (S.D.N.Y. May 13, 2013) (approving Fair Fund Plan of Distribution to Investors which defined eligible claimants as whose persons who purchased securities on the same dates that the insider defendants traded while aware of material nonpublic information); SEC v. Luzardo, No. 01Civ.9206, (DC) (S.D.N.Y. May 6, 2004) (approving SEC plan of distribution which defined eligible claimants as those persons who were "Contemporaneous Traders" meaning that they sold securities on one or more of the dates that the disgorging defendants bought securities).

[xxxi]Skowron, Doc. No. 43, SEC's memorandum of law in support of motion for an order approving a fair fund plan of distribution to investors, at 4.

[xxxii] Luzardo, No. 01Civ.9206 (DC).

[xxxiii] Verity Winship, Fair Funds and the SEC's Compensation of Injured Investors, 60 Fla. L. Rev. 1103, 1121 (2008) ("The function of the Fair Fund provision –to permit the SEC to make another category of monetary relief available for distribution to injured investors –and the text's reference to ‘the relief of victims' indicate that its purpose was to compensate injured investors.") (citation omitted).

[xxxiv] The Second Circuit in Shapiro acknowledged substantial issues with requiring actual privity commenting that where transactions occur on an anonymous national securities exchange, it would be as a practical matter "impossible to identify a particular defendant's sale with a particular plaintiff's purchase. And it would make a mockery of the ‘disclose or abstain' rule if we were to permit the fortuitous matching of buy and sell orders to determine whether a duty to disclose has been violated." 495 F.3d at 237.

[xxxv] Pub. L. No.100-704, 102 Stat. 4677 (1988).

[xxxvi] Litton Indus., Inc. v. Lehman Bros. Kuhn Loeb Inc., 734 F. Supp. 1071, 1076 (S.D.N.Y. 1990).

[xxxvii] See S.E.C. v. Lorin, 869 F. Supp. 1117, 1129 (S.D.N.Y. 1994) (acknowledging that the SEC as a matter of practice generally turns over disgorged proceeds to the victim and that courts often require that victims receive such proceeds) (collecting cases).

[xxxviii] Martin-Trigona v. Shiff, 702 F.2d 380, 386 (2d Cir. 1983) ("The hallmark of a moot case or controversy is that the relief sought can no longer be given or is no longer needed.").

[xxxix] The Second Circuit recently held the injured investors had no Article III standing to challenge an SEC order authorizing disbursement to the United States Treasury for money remaining in a fair fund because the injured investors had been fully compensated by disbursement from the fair fund for the losses suffered in connection with improper "trading ahead" and "interpositioning" tactics. See Martin v. SEC, Doc. No. 11-2011 (2d Cir. Oct. 30, 2013).