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Defining what is criminal in America is quintessentially a legislative function. While a matter of some debate early in our history, the central role of Congress in this task has been settled since the Supreme Court’s 1812 opinion in United States v. Hudson & Goodwin. How is it then that the Securities and Exchange Commission has just redefined the crime of insider trading? For that is precisely the purport of SEC Rules 10b5-1 and 10b5-2, which went into effect last week. The SEC’s response would be that Congress delegated to it the authority to define fraud under Section 10(b) of the Securities Exchange Act of 1934: “It shall be unlawful for any person … to use or employ … any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” Since Congress made criminal every willful violation not only of the Securities Exchange Act but also of every rule promulgated under the act, the SEC would argue that it has the authority to redefine the crime of insider trading. Not so fast. For the past several years, the Supreme Court has been engaged in a realignment of Congress’ powers, beginning with United States v. Lopez (1995). So far, it has not invoked the nondelegation doctrine. But on Nov. 7 the Court hears argument in Browner v. American Trucking Associations, where the U.S. Court of Appeals for the D.C. Circuit resurrected the nondelegation doctrine to strike down two clean air standards promulgated by the Environmental Protection Agency. The D.C. Circuit opinion a year earlier and the granting of certiorari last spring caused a considerable stir within the Washington legal community. The SEC’s new insider trading rules should do the same for those interested in safeguarding Congress’ sole authority to define federal crimes. NO DELEGATION ALLOWED The nondelegation doctrine is a corollary of the separation of powers. Article 1, Section 1 of the Constitution vests “[a]ll legislative Powers … in a Congress of the United States.” This essential function may not be delegated, but Congress may call upon coordinate branches of government to deal with details. Some would call the latter delegation. How much is too much is the constitutional conundrum. The nondelegation doctrine was at its apogee in the early 1930s, when the Supreme Court used it to strike down such New Deal legislation as the National Industrial Recovery Act in Panama Refining Co. v. Ryan (1935) and Schechter Poultry Corp. v. United States (1935). Congress had, in both cases, empowered another entity to define criminal conduct. The issue in Panama Refining was the delegation of authority to the president to criminalize the transportation of petroleum produced in excess of amounts prescribed by state regulations. In Schechter Poultry, the company was indicted for violating the state wage and hour provisions for those dealing with “live poultry” and other offenses, including the sale of an “unfit chicken,” all of which violated fair competition codes promulgated by a federal administrative agency. The Schechter Court was unanimous in finding the National Industrial Recovery Act unconstitutional. But in the decades since, the nondelegation doctrine became sclerotic. Its resurrection to invalidate two of the EPA’s National Ambient Air Quality Standards (NAAQS) is therefore noteworthy. The EPA interpreted the Clean Air Act to grant it power to establish primary NAAQS guided only by the command to set them at a level “requisite to protect the public health” and with “an adequate margin of safety.” In the event that the EPA set the standards above zero exposure, it was required to make a policy judgment balancing environmental welfare against the economic costs of promoting that welfare, among other factors. The D.C. Circuit found that the Clean Air Act did not provide the EPA with policy standards to guide its rule-making. The absence of a congressionally defined “intelligible principle” to guide it meant that the EPA’s judgments were akin to lawmaking. A precursor of this nondelegation revival can be found in then-Associate Justice William Rehnquist’s 1980 concurrence in Industrial Union Department, AFL-CIO v. American Petroleum Institute. Rehnquist argued that the provisions of the Occupational Safety and Health Act of 1970 were deficient under the nondelegation doctrine. Congress had empowered the secretary of labor to promulgate toxic material standards that, “to the extent feasible,” assure that no employee “will suffer material impairment of health or functional capacity.” Rehnquist found the standard lacking because Congress had effectively left to the secretary the core issue of how to strike a balance between safety and efficiency. Nonetheless, nine years later, Chief Justice Rehnquist joined the majority opinion in Mistretta v. United States rejecting a nondelegation challenge to the U.S. Sentencing Commission. The Mistretta Court found the commission constitutional because it had not been given the power to “make crimes of acts never before criminalized” and was given the power to establish sentencing guidelines only in accordance with relatively specific standards and within a previously legislated “hierarchy of punishment.” That’s not an argument that the SEC can make as to its new insider trading rules. GROWING THE CRIME Defining insider trading to embrace all that the SEC deems anti-social has proven quite formidable. From its simplest beginnings, the doctrine has been expanded — by the SEC and the courts — in an ever-widening circle: from corporate directors in In re Cady, Roberts & Co. (SEC, 1961) and their tippees in SEC v. Texas Gulf Sulphur Co. (2nd Circuit, 1968), to underwriters in In re Investors Management Co. (SEC, 1971), corporate printers in Chiarella v. United States (Supreme Court, 1980), journalists in Carpenter v. United States (Supreme Court, 1987), and family members of insiders and their tippees in United States v. Chestman (2nd Circuit, 1991). Congress’ role in this expanding offense has been limited to increasing civil penalties in the Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988. Despite 40 years of SEC effort, the law on insider trading remains unsettled. Rules 10b5-1 and 10b5-2 seek to resolve some of the open issues in the SEC’s favor. But the agency’s reliance on Section 10(b) to promulgate the new rules raises nondelegation issues similar to those in Browner. This congressional grant of authority to prescribe rules that the SEC deems “necessary or appropriate in the public interest or for the protection of investors” is almost without limits. An expansive interpretation of Section 10(b) effectively bestows upon the commission the power to define new crimes. In the past, this has not been a major problem because Rule 10b-5 has been nothing more than a mirror image of Section 10(b). Expansive interpretations to deal with factual permutations have been produced, for the most part, by the courts in litigated matters — a tolerable, if not ideal, method of defining anti-social conduct. But now the SEC has gone an important step further. The agency is not merely stretching the definition of insider trading, but rewriting it. Previously, a charge of insider trading generally required that someone actually “use” nonpublic information. But the new Rule 10b5-1 rejects a use standard. It imposes liability on a person who purchases or sells a security while simply being aware of material nonpublic information — unless he can satisfy one of four affirmative defenses that generally establish that the trade resulted from “a pre-existing plan, contract, or instruction that was made in good faith.” Since mere awareness of inside information is not sufficient to prove fraudulent intent, the new rule imposes liability for conduct falling short of fraud. At the same time, the new Rule 10b5-2 sets forth nonexclusive bases for determining whether a fiduciary duty exists between a provider and a recipient of inside information in misappropriation cases. The rule deems the requisite duty to exist when, among other things, material nonpublic information is shared between (a) persons with a history of sharing confidences, such that the information provider has a reasonable expectation of privacy, or (b) spouses, parents, siblings, or children, unless the recipient can prove that she did not agree to keep the information confidential and the provider did not have a reasonable expectation of privacy. But a reasonable expectation of privacy or the existence of a close family relationship is not necessarily akin to a fiduciary duty, a breach of which is necessary to prove fraud. Thus, Rule 10b5-2 also proscribes conduct falling short of fraud. THE LINE IS CROSSED There can be little doubt then that the SEC’s rules define new crimes. There also can be little doubt that Congress may not delegate the definition of new crimes. Nor can the SEC look to Mistretta for rescue since there the Supreme Court specifically noted that the Sentencing Commission was not given the power to define new crimes. Unfortunately, Section 10(b) provides no guidance whatsoever as to the type of conduct Congress intended to proscribe. It speaks in the most general of generalities: “necessary or appropriate in the public interest or for the protection of investors.” And that standard does not provide a sufficiently intelligible principle to ensure that SEC rule-making is consistent with congressional intent. Fundamental policy choices are left unresolved by the delegation, including the question of how the SEC balances protecting investors with other important values. Could the SEC declare, for example, that it is in the public interest to ban all trading by corporate insiders regardless of whether they possess any material nonpublic information? Simply put, there is no meaningful difference between the EPA’s interpretation of the Clean Air Act found unconstitutional in Browner and the SEC’s interpretation of Section 10(b) relied on to promulgate the new rules. When Congress fails to clearly articulate the means for reaching its policy goals, the responsibility for making often profound policy decisions is unconstitutionally shifted away from the body most responsive to the people. Nowhere is that less desirable than with the criminal law. To plagiarize Justice Antonin Scalia’s phrasing in Mistretta, the Securities and Exchange Commission cannot act as “a sort of junior-varsity Congress.” Otto G. Obermaier, a former U.S. attorney for the U.S. District Court for the Southern District of New York, is a partner in the New York office of Weil, Gotshal & Manges. Robert S. Berezin is an associate at the firm.

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