Insider trading is illegal. It occurs when someone knows important but secret information about a company and then trades that company's securities (e.g. stocks, bonds, call options) to gain an advantage when the stock price moves after the information is released. Insider tipping is also illegal. It means telling others about secret stock-price-moving information. Another FAQ explains why financial regulators oppose both trading on and tipping inside information.
The laws of insider trading and tipping apply to everybody. They do not apply only to company insiders or executives, though their positions tend to put them at more risk than ordinary employees.
Pursuing insider-trading violations has long been a high priority of the Securities and Exchange Commission (SEC), the federal agency that regulates and enforces securities laws in the United States. Also, the SEC has agreements with many countries throughout the world, giving it access to people who violate US securities law outside the US.
Over the years, the SEC and the US Dept. of Justice have looked for insider trading as it has adapted in novel circ*mstances, such as the Covid-19 pandemic. See an article elsewhere on this website for examples of insider-trading charges brought for violations stemming from the unique circ*mstances brought by Covid-19. For some background on insider-prevention during the pandemic, see articles from the law firms Ropes & Gray, Bass Berry, WilmerHale, and Blank Rome.
Extensive Scope
The insider-trading laws apply to market-moving information not only about a company you work for but also about any company you may know through a special or personal relationship: e.g. through a family member who works for that company, or through a vendor, supplier, or client of your company.
The SEC now wields a formidable array of digital technology to spot, track, and examine links between people involved or connected with suspicious stock-trading activities. As explained in a 2019 speech by former SEC Chair Jay Clayton, the SEC uses sophisticated data analytics, including pattern recognition, to detect suspicious stock trading. For example, he noted, the SEC's ATLAS tool lets the agency's staff harness multiple streams of data, including blue sheets, pricing, and public announcements. The tool is routinely used to look for insider trading before a major equity event, detect serial insider trading, and research historical securities prices for litigation. In 2018, these data analytics led to SEC charges against an investment banker who allegedly misused access to confidential information.
Meanwhile, the SEC and prosecutors continue to develop legal theories to reach nonemployees who trade on a company's misused confidential information. These include the "misappropriation" and "temporary insider" theories. The SEC is now routinely scrutinizing hedge funds for evidence of insider trading. The SEC may pursue you for insider trading even if secret inside information did not influence your decision to trade.
Alert: An insider-trading case in 2016 involving professional golfer Phil Mickelson and a corporate director (see the related SEC press release and SEC public statement) shows that when the SEC finds insider trading somewhere in a chain of events, all who profited will be forced to pay back their gains, even if they did not know that the information in question was tainted. In the SEC's action, Mr. Mickelson was named as a "relief defendant," i.e an individual who must turn over ill-gotten gains arising from schemes perpetrated by others.
Another risk for officers and directors is that they can be liable as controlling persons if they are reckless in not preventing insider trading by their employees.
Expanding Definitions
Insider-trading law has grown extensively out of the general antifraud provision of Rule 10b-5 in the Securities Exchange Act of 1934. In addition to stocks and bonds, which are clearly securities covered by insider-trading law, the SEC has expanded the interpretation of the law to include more sophisticated financial instruments, such as credit default swaps.
Even the definition of confidential material information is expanding beyond just straightforward good news (e.g. mergers, dividend increases, new products) and bad news (e.g. poor earnings, dividend cuts). Recent cases have involved types of information that can move a company's stock price in less obvious ways, and the SEC often brings these cases to test the edges of the law's reach. See, for example, the insider-trading case that the SEC brought against Mark Cuban, owner of the Dallas Mavericks basketball team (SEC Litigation Release No. 20180). He sold stock in a public company when, allegedly, he knew that it was about to raise private financing. After the SEC brought a civil suit against him, the jury in his trial found him not guilty.
Alert: The decision in Mark Cuban's case will not alter the SEC's enforcement practices when it brings insider-trading cases that fall into gray areas of the law. Moreover, it illustrates the fact-specific nature of insider-trading cases and the expensive process involved in challenging the SEC by taking a case to trial.
Cybersecurity Breaches
In guidance on cybersecurity disclosures that it issued in 2018, the SEC formally expanded its definition of material nonpublic information to include knowledge about cybersecurity risks and incidents, including vulnerabilities and breaches (see pages 20–21). The SEC enforcement action and Justice Department criminal action against a former Equifax CIO for insider trading shows that they view knowledge of a massive cyber-intrusion and data breach as material information. In a commentary on his law firm's blog, an attorney at McGuireWoods points out that while the defendant was not told that Equifax had a data breach, the SEC and DOJ alleged that for corporate insiders it is enough to have "constructive knowledge" (i.e. strong suspicions based on information learned at work) of nonpublic material information, and that "actual knowledge" (i.e. direct awareness) is not needed.
As detailed in an SEC legal complaint and the related press release, the SEC has brought an insider-trading case against an Equifax software engineer under the same theory of "insider guessing." The employee was not told that a data breach had occurred but purchased put options on Equifax stock and sold them for a profit of $75,000.
Corporate Rules And Prearranged Plans
In addition to the laws against insider trading and tipping, you should follow your company's rules about blackout and window periods.
Also, consider setting up a Rule 10b5-1 trading plan for prearranged sales if you know you want to sell stock in the future but may know secret inside information at those times.
