Controls over insider trading are not limited to those contained in Sec. 16 of the 1934 Act. In addition, the application of a general antifraud rule and more recent congressional action augment the arsenal of weapons aimed at curbing insider trading abuses which includes trading in insurer issued securities such as the stock of an insurance company.

Despite the statutorily imposed requirements pertaining to insider trading by Sec. 16 and the reaffirmation of its value in combating insider abuses, at least in the courts, over time Sec. 16 has been overshadowed by the general antifraud Rule 10b-5 which the SEC promulgated in 1942 to implement Sec. 10(b) of the Securities Exchange Act of 1934. In essence, this Rule renders it illegal for any person, by use of the mails, any instrumentality of interstate commerce or any facility of a national securities exchange, to (1) defraud, (2) make untrue statement of a material fact or omit to state a material fact in order to make the statement made not misleading, or (3) engage in any act which operates as a fraud or deceit upon any person in connection with the sale of any security. Given the general nature of this proscriptive language, the manner in which this Rule has been applied to insider (and outsider) trading situations has developed through judicial evolution.

The duties of securities markets participants in the acquisition and use of information have been founded on several theories. One theory of responsibility suggests that insider trading sanctions should be based upon the existence of a fiduciary relationship between the trader and the corporation. A second theory is predicated on a sense of an unfairness when one trades on price-sensitive information which is not generally known to other participants in the marketplace. This equity or unfairness theory turns on the concept that it is unfair for some investors to trade based upon informational advantage which other investors cannot overcome through their own efforts. Use of inside information not known to the public is inconsistent with other investors’ legitimate expectations of honest and fair securities markets in which all play by the same rules. A third theory centers upon the process by which the information is obtained. This theory suggests that an individual’s duties are determined not by the mere possession of information but by the nature of the process by which the information is acquired. Over the past several decades, in efforts to maintain investor confidence in the securities markets, each of these theories has been employed in applying Rule 10b-5 to concrete insider trading cases.

Initially and traditionally, the courts impose on corporate insiders (officers, directors and controlling shareholders) a duty either to disclose nonpublic material information to those with whom they may be trading or refrain from trading in securities based upon such information. Subsequently the applicability of the rule was enlarged from traditional insiders to situations involving "tippers" and "tippees," that is, insiders giving and those persons receiving material nonpublic information. The director’s (insider’s) duty is not avoided simply because he or she is not involved in the actual trade.

Furthermore, in determining what constitutes insider trading, there has also emerged concern over fairness. That is, one ought not take advantage of information unavailable to others. This broader applicability of Rule 10b-5 received explicit judicial recognition in SEC v. Texas Gulf Sulphur Co. wherein the Court of Appeals of the Second Circuit said

In finding that employees, as well as directors and officers, are subject to insider trading duties, the Court set forth a broad rule of disclosure:

Here the duty to disclose or abstain from trading arose from the possession of unpublished information regardless of whether the person had a fiduciary duty.

By extending the duty to either disclose or abstain from trading to anyone holding inside information, the duty is now to the market rather than the more limited fiduciary duty to the corporation and its shareholders. This "anyone" language led to a series of cases defining a new expanded group of persons having the duty not to trade on unpublished information including outside attorneys and accountants coming into possession of information obtained while working for a corporation, underwriters of corporate securities, etc.

The trend toward the expansion of the concept of what constitutes unlawful insider trading appeared to end with the Supreme Court’s decision in Chiarella v. United States in which the Court did not find that a duty to disclose arises from mere possession of nonpublic information. However, as a result of Chief Justice Burger’s dissent in this case, an additional theory has come into play as to the applicability of Rule 10b-5 in the context of insider information. This is referred to as the misappropriation theory. Justice Burger argued that anyone who obtains material nonpublic information by unlawful means should be subject to the same duty as an insider to disclose the "misappropriated" information or refrain from trading.

This misappropriation theory has more recently come to be applied by various courts. Under this theory, parity of information is not required. Instead, a person may ferret out information which can result in a business advantage. In an arms length transaction, one party is not obligated to the other unless they stand in some type of confidential or fiduciary relationship with one another. However, the duty to disclose changes when an informational advantage is obtained not by superior experience, foresight or industry, but rather by some inappropriate means. That is, a person’s disclosure obligation is not premised solely on the possession of superior information but rather on the process by which such information is acquired. In short, a person who has misappropriated nonpublic information has a duty to disclose the information or refrain from trading.

After Chiarella, the SEC promulgated Rule 14e-3 which prohibits both insiders and outsiders possessing material nonpublic information from trading in corporate tender offers. Furthermore, in this release, the SEC indicated its intention to prosecute outsiders under Rule 10b-5 using Chief Justice Burger’s dissenting opinion. In the ensuing years, the SEC has successfully brought several actions charging outsiders with violation of Sec. 10(b) in which the misappropriation theory was applied in finding against the defendant.

In summary,

In efforts to maintain the efficacy of the securities markets as an allocator of resources, both the actual and the perceived integrity of the securities markets is essential. In the absence of a precise statutory definition of "insider trading," the standards governing the use of information not generally available have evolved and continue to evolve through judicial decision making in concrete circumstances in the application of the general standards contained in the Securities Exchange Act of 1934 and Rule 10b-5.

In the process, generally the law has come to prohibit (1) trading by an insider in possession of material nonpublic information, (2) trading by one who is not an insider if he or she comes into possession of material nonpublic information (a) from an insider having a duty to keep such information confidential or (b) which was misappropriated, and (3) communicating material nonpublic information to others. It has become clear that the concept of an insider is intended to be broad including the issuer’s officers, directors and employees having access to the material nonpublic information as well as the person in whom the issuer has trust and with whom it has a professional confidential relationship. Information is material if a reasonable investor would consider such information important in making an investment decision or if such information is reasonably certain to substantially impact the price of the issuer’s securities. Information is nonpublic until it has been effectively communicated to the market.

As will become even more apparent in the discussion below, insurance companies and persons associated with them are not immune to the obligations imposed by the standards aimed at curbing insider trading abuses.

In 1970, Congress amended the Investment Company Act of 1940 by adding Sec. 17(j) to prohibit insider trading in securities held by or to be purchased by a registered investment company. This Section was not self-executing, but rather required adoption of rules or regulations by the SEC for implementation. However, apparently lacking an immediate sense of urgency, the SEC did not do so until 1980 when it promulgated Rule 17j-1. However, by the early 1990s, trading by investment company insiders had become one of the larger issues. Concern has mounted over the fact that advisers to investment companies, which possess a huge amount of assets, have access to nonpublic information about securities in which the investment companies trade. There are unique opportunities for those involved in fund management to come into possession of such information and to engage in abusive personal insider trading based upon such information. As a consequence, there is increased regulatory focus on the securities practices of investment companies including registered separate accounts of life insurers as well as mutual funds serving as the funding vehicles for registered separate accounts organized as unit investment trusts.

Rule 17j-1(a) provides that it shall be unlawful for any affiliated person or any principal underwriter of a registered investment company or any affiliated person of an investment adviser of or principal underwriter for a registered investment company, in connection with the purchase or sale of a security held or to be acquired by such registered investment company to (1) employ any device, scheme or artifice to defraud such registered investment company, (2) make any untrue statement of a material fact or omit to state a material fact to such registered investment company necessary to render the statement not misleading, (3) engage in any act or course of business which operates as a fraud upon any such registered investment company, or (4) engage in any manipulative practice as to such registered investment company. Every investment company and each investment adviser of or principal underwriter for such investment company must adopt a written code of ethics containing provisions reasonably necessary to prevent its access persons from engaging in these prohibited activities and shall use reasonable care and institute reasonable procedures to prevent violations of the code.

As to a registered investment company or investment adviser thereof, the Rule 17j-1 defines an access person as any director, officer, general partner or advisory person. An advisory person includes any employee of the investment company or investment adviser who, in connection with his or her regular functions or duties, makes, participates in or obtains information regarding the purchase or sale of a security by the registered investment company, or whose functions pertain to the making of recommendations as to such purchases or sales. In addition, an advisory person includes any natural person in a control relationship to the investment company or investment adviser who obtains information concerning recommendations made to such company as to the purchase or sale of a security.

Following the adoption of Rule 17j-1, the Investment Company Institute (ICI) developed a drafting guideline for use by its members in preparing a code of ethics. In doing so, the ICI sought guidance from the SEC on various interpretative issues. Commonly investment companies, investment advisers and principal underwriters have adopted codes based on the ICI mode. The model covers definitions, exempted transactions, prohibitions, reporting requirements and sanctions.

In early 1994, the ICI established a special Advisory Group to evaluate the current law, regulation, and industry practices and standards. In June 1994, the Board of Governors of the ICI recommended that all investment companies, their investment advisers and principal underwriters amend their code of ethics to incorporate the recommendations of the Advisory Group. Although the SEC responded favorably to the ICI’s action, as of late 1994, it has not indicated whether it will undertake any action of its own. Although the Advisory Group’s recommendations are not mandated by law or regulation, they may very well establish the industry standard. A code of ethics failing to conform to such standard, in the context of an access person engaging in prohibited activity, may be found to not have contained provisions reasonably necessary to prevent such activity thereby triggering penalties and sanctions for violation of Rule 17j-1. Thus, the ICI Advisory Group recommendations loom very important.

The ICI Advisory Group concluded that there is continued justification to rely on the industry to develop standards on issues of personal investing subject to the ongoing oversight of the SEC. While an absolute prohibition on personal investing is not deemed to be necessary, the Advisory Group recommended several substantive standards which should be applied to the entire industry.

Every investment company should incorporate in its code of ethics a statement of the general fiduciary principles governing personal investment including certain standards as a minimum, that is, the duty to place the interest of shareholders first, the requirement that all personal securities transactions should be conducted in accordance with the code and in a manner to avoid actual or potential conflict of interests, and the fundamental standard that investment company personnel should not take inappropriate advantage of their positions.

Among other things, the code of ethics should prohibit investment personnel from acquiring any securities in an initial public offering so as to prevent any possibility of their improperly profiting from their positions. The code should prohibit access persons from executing a securities transaction on a day during which any investment company in his or her complex has a pending "buy" or "sell" order in that same security. Furthermore, a portfolio manager should be banned from buying or selling a security within at least seven days before and after an investment company that he or she manages trades in that security. Profits on trades during such "blackout" periods should be disgorged. The code of ethics should ban all investment personnel from profiting in the purchase and sale, or sale and purchase, of the same securities within 60 calendar days (that is, a ban on short-term sales). In most situations, investment personnel should not serve on the boards of directors of publicly traded companies.

In addition to imposing substantive standards, the ICI Advisory Group set forth recommendations as to compliance procedures. Codes of ethics should require all access persons to "preclear" personal investments and to do so in a manner to identify any prohibition or limitation applicable to the proposed investment. All access persons should direct their brokers to provide to a designated compliance official, on a timely basis, copies of confirmations of all personal securities transactions and periodic statements for all securities accounts. Each investment company should monitor personal investment activity by access persons after preclearance has been granted. All investment personnel should disclose all personal securities holdings at the beginning of employment and annually thereafter. Access persons should be required to certify annually that they have read, understood and complied with the code of ethics and have reported all personal securities transactions required to be disclosed.

As indicated earlier, insurer personnel involved with investment companies, investment advisers and/or principal underwriters are not immune to the obligations which arise in connection with the insider trading requirements applicable in the investment company situation.

In 1984, in an effort to deter insider trading, Congress enacted the Insiders Trading Sanctions Act which increased sanctions against those insiders trading in securities while possessing material nonpublic information. The Act provides for a possible civil penalty up to "three times the profit gained or loss avoided" as the result of insider trading. Previously the SEC could only seek disgorgement of the profits gained by the insider trading which merely put the violator in the same position as if he or she had not violated the law. In addition, the Act increased the potential penalty for a criminal violation of the Securities Exchange Act of 1934 from $10,000 to $100,000 as well as potential imprisonment.

The impact of the Sanctions Act proved to be disappointing. Despite the stiffer penalties, increased acquisition and merger activity seemingly stimulated even more insider trading activity. The SEC found it necessary to bring case after case in an effort to stem insider trading. In further response to the problem, in 1988, Congress enacted the Insider Trading and Securities Fraud Enforcement Act establishing new as well as defining old responsibilities, liabilities and penalties.

Through this Act, Congress sought to enlist employers in the financial industry, including insurance companies, in the battle against insider trading. It does so by imposing on them a significantly greater responsibility to detect and deter insider trading and other securities fraud. The Act makes controlling persons (that is, persons who stand in a control relationship to the primary actor such as employers and persons with power to influence the direction of management, policies or activities of another person) liable under certain circumstances for civil penalties on the basis of insider trading by their employees. In doing so, the Act establishes supervision of employees as a foundation of the federal regulatory scheme for investor protection. Liability may arise if such controlling person knew or recklessly disregarded the fact that a controlled person was likely to engage in insider trading and failed to take appropriate steps to prevent such act or acts.

Investment adviser and broker-dealer firms are especially vulnerable to risk since they are often in a position of knowing insider trading information and they have clients having interest in such information. Furthermore, the Act imposes special responsibilities on investment adviser and broker-dealer firms by requiring them to establish, maintain and enforce written policies and procedures reasonably designed to prevent misuse of material nonpublic information, that is, insider trading. If failure to do so allows a violation to occur or contributes to a violation, the investment adviser or broker-dealer firm may be subject to civil insider trading penalties. Since the law does not precisely define what constitutes insider trading, the scope of its embrace has evolved through SEC and judicial interpretation of the general antifraud provisions of the federal securities laws.

These penalties can be considerable. Although the Act authorizes the SEC to seek penalties in the amount of three times the profit gained or loss avoided because of insider trading, penalties for those persons who control violators can be increased to the greater of $1.0 million or treble the amount of profit or loss. As a consequence, violations resulting in even a small amount of profit or loss can result in a $1.0 million penalty for a controlling employer.

The Act also increases the maximum criminal penalties for securities law (including insider trading) violations from $100,000 to $1,000,000 and from 5 to 10 years imprisonment per violation. Nonnatural persons are subject to a maximum criminal penalty of $2.5 million. The Act establishes a new Section 20A in the Securities Exchange Act of 1934 providing an express private right of action against insider traders and tippers in certain instances and grants the SEC authority to award bounty payments to informants.

Insurers and various persons associated with insurers are subject to insider trading requirements and liabilities in one or both of two contexts. First, stock insurers have outstanding their own securities such as shares of common stock. Insiders (officers, directors and significant shareholders) of a domestic insurer are subject to Sec. 16 type statutory requirements (either federal, state patterned after federal, or both) as to disclosing their position as insiders, recapture of short term profits and selling short. Furthermore, the use of inside information in the purchase or sale of such securities, whether by insiders (such as officers, directors or tipees) or by employees who come into possession of insider information, may violate the antifraud Rule 10b-5 standards against insider trading in the insurer’s own securities.

Second, with increased involvement in the securities business through the issuance of products falling within the definition of a security (for example, variable insurance contracts), serving as investment advisers and/or securities brokers-dealers (whether directly or through affiliates) and/or an expanded role of investment activity, insurers have enlarged their exposure to the potential applicability of the federal prohibitions against insider trading with respect to the securities of other companies.