Illegal insider trading is a serious securities law violation which carries potential civil and criminal penalties. Civilly, the penalties can be as large as three times the gross profit on the trading. An insider trading investigation by the SEC requires experienced securities counsel, as the initial investigation often dictates the final outcome. If you have questions regarding an SEC subpoena or an investigation, call Mark Astarita, Esq. at 212-509-6544. Mark and his partners have decades of securities litigation experience as SEC Staff attorneys, and broker-dealer attorneys.
Insider trading laws have significant impact on the stock market, and the conduct of investors. I have been representing investors and financial professionals in insider trading investigations for over 30 years, starting in the mid-1980’s when my then partner and I represented a financial printer in an SEC federal court proceeding using a new, and now generally accepted, legal theory. Since that time, I have represented registered representatives and investors from all walks of life, in dozens of investigations. The insider trading laws and court decisions have changed dramatically over those decades, with the SEC and the courts expanding the scope of the theory of insider trading beyond all reasonable bounds. However, it is this concept that we need to deal with, and we have had a great deal of success in defending potential defendants – because the investigation gets closed before an case is filed.
Insider Trading Definition
“Insider trading” is a term that most investors have heard and usually associate with illegal conduct. Recent government actions, including the criminal case against Martha Stewart have enforced that view. However, Martha Stewart was not convicted of insider trading, she was convicted for obstruction.
There is no statutory definition of “insider trading”. As defined by the courts, it refers to purchasing or selling a security while in possession of material, non-public information concerning that security, where the information is obtained from a breach of fiduciary duty, or a duty arising from a relationship of trust or confidence.
Obtaining the material information by way of a breach of duty or confidence is the key to the violation, but after decades of court rulings, it is almost impossible for a court to find that a duty was NOT breached in an insider trading case. Some duties are obvious – the CEO of the company, the CEO’s assistant, and every other employee owe a fiduciary duty to teh company and if they use, or disclose, material non-public information, they are liable for insider trading, often even if they didn’t trade themselves.
Other examples are more of a stretch – the employee of the financial printer of the public company, or the truck driver for a financial publication have all been accused of insider trading, and with the SEC demanding penalties of three times the profit (while ignoring losses from the same trading) the downside is significant.
Legal Insider Trading
However, the term “insider trading” also includes both legal conduct. The legal version is when corporate insiders, officers, directors, employees and large shareholders, buy and sell stock in their own companies. When corporate insiders trade in their own securities, they must report their trades to the SEC. Many investors and traders use this information to identify companies with investment potential, the theory being, if the insiders are buying the stock, they must know more about their company than everyone else, so it is a good idea to buy the stock.
Reports of transactions by insiders are filed with the SEC on Forms 3, 4 and 5, and the SEC has an excellent overview of these forms and the requirements for filing of same. Most of the internet based financial quote sites have information for each particular security. Visit Yahoo Finance and select a security, then select the menu choice for Insider Transactions. Here is the insider trading page for Citigroup for an example.
Illegal Insider Trading
The insider trading definition that we are concerned about is the buying or selling of a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Over the last 10 years, the SEC and the courts have greatly expanded this definition, to include trading by individuals whose “relationship of trust” is so remote as to be non-existent, but that discussion is left for another day. While myself and most other securities attorneys believe that the concepts of insider trading have been expanded beyond all permissible bounds, the law today is that if material information about a company, or about the company’s stock, is obtained in violation of any duty to any person and used to trade, the trader is guilty of insider trading.
Insider trading violations may also include “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate such information. Examples of insider trading cases that have been brought by the SEC are cases against:
- Corporate officers, directors, and employees who traded the corporation’s securities after learning of significant, confidential corporate developments;
- Friends, business associates, family members, and other “tippees” of such officers, directors, and employees, who traded the securities after receiving such information;
- Employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded;
- Government employees who learned of such information because of their employment by the government;
- Employees of financial printers who learned of the information during the course of their employment; and
- Other persons who misappropriated, and took advantage of, confidential information from their employers.
In recent years, the SEC and the Courts have expanded this further, and insider trading can now include trading by the random man in the street if the SEC believes that he obtained the information from someone who should not have the information. See SECLaw Blog posts on insider trading for more information. In my opinion, this has all gone too far, and the SEC needs to be reigned in on the expansion of insider trading liability.
The theory behind the prohibition is that it undermines investor confidence in the fairness and integrity of the securities markets. The SEC claims that the detection and prosecution of insider trading violations as one of its enforcement priorities, and all investors must be aware of the potential danger in trading on a “tip” from someone who knows non-public information regarding a security.
The SEC adopted new Rules 10b5-1 and 10b5-2 to resolve two insider trading issues where the courts have disagreed. Rule 10b5-1 provides that a person trades on the basis of material nonpublic information if a trader is “aware” of the material nonpublic information when making the purchase or sale. The rule also sets forth several affirmative defenses or exceptions to liability. The rule permits persons to trade in certain specified circumstances where it is clear that the information they are aware of is not a factor in the decision to trade, such as pursuant to a pre-existing plan, contract, or instruction that was made in good faith.
Rule 10b5-2 clarifies how the misappropriation theory applies to certain non-business relationships. This rule provides that a person receiving confidential information under circumstances specified in the rule would owe a duty of trust or confidence and thus could be liable under the misappropriation theory.
Insider trading carries severe civil and criminal penalties. If you are contacted by a regulatory agency regarding trades that you made, you should contact a securities attorney before speaking to the regulators. For more information about the defense of insider trading allegations, contact Mark Astarita of Sallah Astarita & Cox, at email@example.com. For more general information regarding insider trading and the SEC’s views of it, read Insider Trading -A U.S. Perspective.
You may also be interested in:
- SEC Subpoenas – Tips for Responding How you respond to an SEC subpoena makes a difference. Tips from an experienced securities attorney.
- UBS YES Losses? Investors who lost money in UBS’ Yield Enhancement Strategy (YES) may be able to recover their losses
- Recover GPB Capital Losses After inquiries by the SEC, FINRA and the FBI, GPB Capital has announced significant losses in the value of its investment funds. Two of its funds, GPB Holdings II and GPB Automotive Portfolio, have reported losses of 25.4% and 39%, respectively according to InvestmentNews.com GPB Capital Holdings is a New York based alternative asset management firm with approximately ...
- SDNY Defines Customer under FINRA Rule 12200 Judge Laura Taylor Swain of the Southern District of New York has issued a decision defining a customer, for purposes of FINRA Rule 12200 as being a person or entity who have an account with the member, or who has purchased goods and services from the member. In doing so, it orders some claims in the ...
- GPB Capital Investigations Heat Up With losses approaching 70% for some investors, sitting on the sidelines, waiting for the funds to turn around is apparently not working for investors in the GPB Capital funds, and the situation is not getting better. While investors are filing arbitrations to recover their losses in GPB Capital, and investigations pending by the SEC and FINRA, ...
- UBS Ordered to Pay Broker $1.6 Million A former star broker for UBS Financial Services Inc. who was repeatedly called a “bitch” by her boss won a $1.6 million discrimination arbitration award last month. According to InvestmentNews.com, the broker, Chrisine Carona, worked for UBS in Boston from March 2009 through July 2017 and currently is employed by Morgan Stanley. She was the top performing female adviser ...
- Broker Recruiting Protocol Question When changing firms, and moving between two firms that are part of the Broker Recruiting Protocol, can the broker take client account numbers with her. We get that question a lot. Under the Protocol a broker may take only the client name, address, phone number, email address, and account title of the clients that she serviced ...