Insider trading is the practice of buying or selling stocks based on material, non-public information that is available to a corporate insider, but not the general public. Although once considered a “perk” of corporate employment, currently insider trading is investigated and pursued aggressively by both the U.S. Securities and Exchange Commission and the U.S. Department of Justice.
Insider trading happens when an individual trades in the shares of a publicly traded company based on superior information that is only available to a small number of individuals, or business insiders. By having limited access to this additional information, the investor is able to make better and smarter decisions about the true value of the stock than the public at large. This creates an unfair market advantage to the individuals who have this material, non-public information.
How Does Insider Trading Work?
Generally speaking, insider trading involves a corporate insider gaining access to material, non-public information. This is done either through legitimate course of employment in furtherance of performing one’s job duties, or through unlawfully gaining access to this information outside of one’s job responsibilities. After gaining this information, the corporate insider will trade in order to make a profit or trade in order to avoid a loss before this material information becomes available to the general public.
Frequently, the corporate insider is not the individual who does the trade. Oftentimes, the trades are done in the names of their spouses, family members, friends, and acquaintances. Any trade, regardless of who does it, that is based on material non-public information is considered insider trading.
Does Insider Trading Only Apply to Stocks?
Although generally insider trading applies to stocks, it can also apply to stock options and derivatives, which allow an investor to buy or sell a stock in the future at a pre-set price. Buying and selling stocks, options, or derivatives based on material, non-public information can result in a civil enforcement action being brought by the SEC, as well as a criminal action being brought by the U.S. Attorney’s Office.
What is Considered Material Non-Public Information for Insider Trading?
The U.S. Securities and Exchange Commission defines “Insider information” as information that is:
- Not available to the general public;
- Provides an unfair advantage to the individual who is trading on that information.
Not all insider information is considered material; it must be of such magnitude as to impact the stock price or cause a substantial impact on the investor’s decision to buy or sell the security. Similarly, if an investor makes trades based on his or her own legitimate expertise or extensive research regarding the company’s financial position, rather than insider information, that is perfectly legal and is not considered to be insider trading.
Importantly, civil and criminal liability for insider trading only attaches if the individual acts and trades on that information, or otherwise does something with that information i.e. gives it to another person. For example, let’s say the company’s accountant knows that the company will report a loss for the next quarter, but does not trade on that information until it is made public. In that situation, no liability for insider trading can attach either on the civil or criminal front.
Who is Considered an Insider for the Purposes of Insider Trading?
The U.S. Securities and Exchange Commission determine that an insider is anyone who can access material, non-public information about a company and anyone who owns 10% of the company. The Courts have extended the definition of “insider” to those individuals who have access to non-public information by virtue of their employment, even if they are not employed by the company. This expanded definition would apply to attorneys, bankers, and consultants who have access to insider information because they provide a professional service to the company.
Who Can Be Charged For Insider Trading?
In order for liability to attach for insider trading, the corporate insider does not need to be the one trading based on material, non-public information. Liability can attach to the corporate insider for sharing the material non-public information with another individual. This is called “tipper liability.”Tipper liability applies to directors, executives, employees, or contractors of the company on the theory that they have a fiduciary duty to acting in the best interests of the company.
The outside individual who trades on this information will be subject to “tippee liability.” Although the outside individuals do not owe a fiduciary duty to the company, the U.S. Supreme Court in a 1983 case, Dirks v. SEC, held that the “tippee” can be prosecuted for insider trading because they have the same duty as the corporate insider. However, an important difference in insider trading cases between “tipper” and “tippee” liability is that the Government must establish that the “tippee” knew or had reason to know that the information that they were trading on was non-public.
Does the Corporate Insider Need to Make a Profit on the Trade for Insider Trading Liability to Arise?
It is not a requirement that the corporate insider personally profit from trading on material, non-public information. It doesn’t matter if the trade is done by your broker at your direction, or if another individual makes the trade in their own account based on insider information. Liability will still attach
What Are Some Examples of Insider Trading?
- Corporate insiders trading in company’s stock after learning of material information that has not been disseminated to the public;
- Friends, family members, acquaintances who traded on material, non-public information after learning about it from corporate insiders;
- Attorneys, bankers, consultants who gained access to material, non-public information through their employment in connection to providing services to the company and traded on it.
Who Has Been Convicted of Insider Trading?
Many individuals have been convicted of insider trading. Most of the insider trading cases do not involve public figures, celebrities, or executives of publicly traded companies and therefore, frequently do not make the paper. Some prominent individuals who have been convicted of insider trading are:
- Jeffrey Skilling – former CEO of Enron who was criminally charged and convicted of insider trading (and other criminal charges) for selling shares of his company with full knowledge that the company’s financial situation was very different from what the investors and the public were led to believe;
- Martha Stewart- sold shares of ImClone based on receiving advance knowledge that FDA denied approval for the company’s new cancer drug. Ms. Stewart avoided substantial losses by selling her stock before the information became available to the general public, but she was indicted for securities fraud and other charges. At trial, she was convicted of conspiracy, obstruction of justice and two counts of lying to the investigators.
- Joseph Nacchio – former CEO of Qwest Communications International was found guilty of insider trading at trial in the U.S. District Court for the District of Colorado for selling $52 million in stock sales, while knowing that the public was not aware of the company’s difficulties of meeting investor goals.
Who Investigates Insider Trading?
Both the U.S. Securities Exchange Commission and the U.S. Department of Justice have oversight over insider trading. Since its formation in 1934, the U.S. Securities and Exchange Commission pursues civil violations of federal securities laws, including insider trading the the U.S. Department of Justice, in conjunction with the Federal Bureau of Investigation pursues criminal violations. Frequently, the two agencies conduct parallel investigations regarding the same allegations. Therefore, if you receive a Subpoena from the SEC or a target letter from the U.S. Department of Justice to find out if there is a parallel proceeding being investigated by the other agency.
What Are the Penalties for Insider Trading?
Insider trading penalties depend on whether it is a criminal case or a civil enforcement action.
Criminal Penalties for Insider Trading
Criminal insider trading cases are frequently brought under 18 U.S.C. § 1348 – Securities and Commodities Fraud. Violations of 18 U.S.C. § 1348 are punishable by up to 25 years in prison and a fine up to $250,000. Although the maximum sentence for insider trading and other criminal securities and commodities fraud violations is 25 years, the exact sentence will be imposed by the judge, and will take into account U.S. Federal Sentencing Guidelines.
Civil Penalties for Insider Trading
Although cases brought by the U.S. Securities and Exchange Commission won’t result in criminal penalties or any jail time, the financial penalties associated with those violations are very substantial. Under The Insider Trading Sanction Act of 1984 and The Insider Trading and Securities Exchange Act of 1988, insider trading penalties are three times the profits gained from the trade based on insider information. That is to say, is someone made $50,000 on a trade based on insider information, the trading penalty would be $150,000. SEC can also charge you pre-judgement interest, or interest that is owed from the time of the illegal trade to the time the settlement agreement is entered into.
Additionally, SEC cases will often lead to loss of professional licenses, bans from holding executive positions – i.e. director or officer – in publicly traded companies, and injunctions from committing further violations of the securities laws.
Contact Us for Your Initial Consultation
If you or your loved one have questions on insider trading, or have recently received a subpoena from the U.S. Securities and Exchange Commission, or a target letter from the U.S. Department of Justice, you need experienced counsel to assist you. Call us at 212-729-9494 or contact us today for your free initial consultation to find out if we are the right firm for you.