(Note: this post was originally published at the Harvard Law School Forum on Corporate Governance and Financial Regulation.. It is based upon a paper available for download here)
The Second Circuit's decision in United States v. Newman has led many commentators to predict fewer insider trading enforcement actions, a prediction quickly validated by Preet Bharara, United States Attorney for Manhattan, who has both unwound guilty pleas and dropped active prosecutions. For Newman's critics and defenders alike, it is obvious that insider trading prosecution in the stock market is now in a period of stumbling retreat.
Yet the stock market is not the only financial market, and the trajectory of insider trading law looks very different if other asset classes are considered. Commodities markets are the world's largest and oldest markets, and Wednesday marked the very first time an individual was sanctioned for insider trading in commodities.
Commodities are primarily regulated by the Commodity Futures Trading Commission (CFTC), a once timid regulator now inclined to muscular enforcement actions. On December 2, the CFTC issued an order filing and simultaneously settling charges against Arya Motazedi, a trader of gasoline and oil futures. The Order asserts that Motazedi had prior knowledge of the timing, size, and prices of his employer's trades. He used this proprietary information to trade in anticipation of market price movements. Because of this insider trading (and a few more charges discussed below), Motazedi will pay almost $350,000 in fines and restitution, and he will be forever banned from his chosen profession.
This Order is significant for three reasons.
First, it is simply the first insider trading case brought for commodities trading. Despite numerous Congressional hearings, insider trading in commodities avoided the legal restrictions visited upon securities traders during the twentieth century. As recently as 2009, the CFTC could assert, "the CFTC has no jurisdiction over insider trading in any way...." Much changed when Dodd-Frank gave the CFTC a new anti-fraud authority akin to the Securities Exchange Act's § 10(b). In the preamble to its subsequent anti-fraud rules, the CFTC quietly noted that "trading on the basis of material nonpublic information in breach of a pre-existing duty ... may be in violation of [this rule]." This statement was a hint of the Commission's possible intentions and authority, but nothing became of it until now.
Second, the CFTC Order unmistakably adopts the language of securities insider trading law, rather than charting some new path. For example, the Order reports
"Motazedi accomplished his fraud by misappropriating non-public, confidential and material information. Motazedi and his employer shared a relationship of trust and confidence that gave rise to a duty of confidentiality.... Motazedi routinely had access to material non-public information.... Motazedi breached his duties to his employer by using this information to trade in personal trading accounts and by failing to disclose such trading to his employer."
By incorporating the key elements from a securities insider trading claim, the Commission has endorsed the view that securities and commodities markets are enough alike that the logic of one can rationally apply to the other. This is a view that many -- including prior Commissions -- have resisted. Can anyone really have a secret about the price of corn, given that farmland is visible from the road? Can such secrets be material, given the vast size of commodities markets? To whom is the secrecy owed, given that there is no "shareholder" of corn? If the CFTC wanted to address these questions and embrace the rationales and doctrine of securities insider trading, Motazedi offered an excellent opportunity. Motazedi really did trade using pilfered and important information, just like any executive trading in her own company's stock before a public disclosure.
Third, the Commission chose to brandish its new authority here, even though it could have achieved the same result more conservatively. Motazedi's insider trading behavior could easily have been punished as mere front-running, a form of market abuse long prohibited (and associated with insider trading). Nor was that Motazedi's only sin. He also caused his employer to make dozens of unnecessary trades on unfair terms against dummy accounts he himself secretly owned. That conduct gave the Commission ample ammunition to exact a tough settlement even without mention of insider trading. By tacking on insider trading charges where the results are already overdetermined, the CFTC puts traders on notice of its expanded authority without putting that authority to a strenuous legal test.
Those interested in insider trading should pay close attention to trading in non-securities. Especially in recent years, some of the most important enforcement events have far from public equity exchanges. Commodities such as oil, currencies, and interest rate benchmarks (e.g. LIBOR) have been the epicenter for brazen market abuse and assertive experiments in enforcement.
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