Insider trading means buying or selling securities on the basis of material nonpublic information. A willful violation is a federal crime: under 15 U.S.C. 78ff(a) an individual faces up to 20 years in prison and a fine of up to $5 million, and a company faces a fine of up to $25 million. The SEC can separately ask a federal court for a civil penalty of up to three times the profit gained or the loss avoided, under 15 U.S.C. 78u-1(a)(2).
Several defense strategies can be employed to counter insider trading accusations, such as demonstrating an independent reason for the trade or establishing that the information used was already public. These cases turn on what you knew and when you knew it, which is decided from trading records, emails and phone logs that exist already. That is why people who learn they are under investigation call a fraud defense lawyer before they answer any questions.
Understanding Insider Trading and the Law
Insider trading is trading in securities while in possession of material nonpublic information (MNPI). Information is material if a reasonable investor would consider it important in deciding whether to buy or sell, and it stays nonpublic until the company has released it broadly. Pending merger talks, unreleased earnings and an unannounced regulatory decision are the usual examples. Trading on that information becomes a federal crime when the trader owed a duty of trust or confidence to the source of the information.
Which law makes insider trading illegal?
Insider trading is prosecuted under section 10(b) of the Securities Exchange Act of 1934, codified at 15 U.S.C. 78j(b), and under the SEC's Rule 10b-5, 17 C.F.R. 240.10b-5. Neither one contains the phrase insider trading. The offense comes from court decisions holding that trading on material nonpublic information is securities fraud when the trader breached a duty of trust or confidence owed to the source of that information. Rule 10b5-1 is a different rule that is often confused with the prohibition itself: it defines when a trade counts as having been made on the basis of MNPI, and it sets out the affirmative defense for trades made under a plan adopted before the trader learned the information.
The Securities and Exchange Commission (SEC) enforces insider trading laws and investigates allegations of violations to ensure market integrity and fairness.
Roles and Responsibilities of Executives and Employees
Company employees, officers, directors, and corporate executives have fiduciary duties towards shareholders and the company itself. This includes safeguarding confidential information and preventing its misuse for personal gain.
Corporate Executives and Directors
Executives such as CEOs, CFOs, and board directors have access to MNPI and must adhere to strict ethical guidelines and legal obligations when dealing with such information. They are prohibited from:
- Trading in the company's securities based on MNPI.
- Disclosing MNPI to unauthorized parties, including family members or friends.
- Giving trading advice based on MNPI.
Company Employees
Employees at various levels may also come across MNPI as part of their job duties. They, too, must uphold the company's policies regarding the handling of confidential information and avoid:
- Trading based on MNPI.
- Passing on confidential information to others.
- Using MNPI for personal benefit or in any way that violates company policy or the law.
Most insider trading cases against employees start with a company's own trading surveillance or with a FINRA referral to the SEC, not with a tip.
Legal Consequences and Enforcement
Insider trading is enforced on two tracks at once. The Department of Justice brings the criminal case and the Securities and Exchange Commission brings the civil case, and settling with one does not end exposure to the other.
Criminal Prosecutions and Civil Enforcement Proceedings
Enforcement against insider trading may involve both criminal prosecutions and civil enforcement proceedings. The DOJ brings criminal prosecutions, while the SEC leads civil enforcement proceedings. In many cases, the SEC and DOJ may coordinate their efforts to crack down on insider trading, especially in high-profile cases or those involving multiple defendants.
Securities and Exchange Commission (SEC) Enforcement Actions
The SEC is the main governmental agency responsible for enforcing laws and regulations related to securities trading in the United States. These enforcement actions often consist of investigations, civil lawsuits, and administrative proceedings. One of the key tools available to the agency is the Securities Exchange Act of 1934, which regulates securities trading on behalf of shareholders and aims to protect investors from fraud.
When the SEC identifies a potential case of insider trading, it can initiate an enforcement action. This may involve a probe into the conduct, such as seeking evidence to support allegations of securities fraud or insider trading. The SEC may also file civil actions against those accused of such conduct, seeking remedies such as disgorgement of ill-gotten gains and civil penalties, among others.
Potential Sanctions and Penalties for Insider Trading
Insider trading can lead to a variety of sanctions and penalties, depending on the nature of the case, the defendant’s conduct, and the extent of harm caused. Sanctions may include:
- Fines. A criminal conviction under 15 U.S.C. 78ff(a) carries a fine of up to $5 million for an individual and up to $25 million for a company. An SEC civil penalty under 15 U.S.C. 78u-1(a)(2) can reach three times the profit gained or the loss avoided.
- Disgorgement: Defendants may be ordered to return any profits gained through insider trading.
- Civil injunctions: Courts may issue restraining orders to prevent future violations of securities laws.
- Prison. The maximum term for a willful violation of the Exchange Act is 20 years under 15 U.S.C. 78ff(a).
- Bars or suspensions: Professionals in the securities industry may face disciplinary action, such as being barred or suspended from practicing in the industry.
The SEC and the DOJ often build parallel cases out of the same records, so resolving the SEC matter does not close the criminal one. Anyone who receives an SEC subpoena, a Wells notice or a call from the FBI should treat it as the start of both.
Defenses and Preventative Measures
Common Defenses Against Insider Trading Charges
When defending against insider trading claims, several common defenses can be employed, which sometimes help to mitigate liability:
- Lack of material nonpublic information (MNPI): Defendants may argue that the information they possessed was neither material nor nonpublic; thus, they didn't have an unfair advantage.
- Independent research: Defendants can claim that their trading decisions were made based on their own research, unrelated to confidential information.
- A Rule 10b5-1 plan adopted before you learned the information. Since the SEC's 2022 amendments the defense also requires a cooling-off period before the first trade under the plan: for a director or officer, the later of 90 days after adoption or two business days after the company discloses results for the quarter in which the plan was adopted, capped at 120 days, and 30 days for everyone else, under 17 C.F.R. 240.10b5-1(c)(1)(ii)(B).
Implementing Compliance Programs and Training
Companies can take proactive measures to prevent and detect insider trading by implementing comprehensive compliance programs:
- Training employees on what insider trading is and on how to handle sensitive information builds a culture of compliance.
- Systems that monitor employee trading, track who accesses sensitive information, and flag suspicious activity catch potential violations early.
- Written policies that bar employees from trading on or sharing MNPI, or that require adherence to Rule 10b5-1, reduce the risk of insider trading.
Seeking Legal Advice For Insider Trading Charges
If you’ve been charged with insider trading, one of your first calls should be to a defense attorney with experience in federal crimes. Attorneys defend insider trading claims and advise on what to do before one is filed.
Call the Weinstein Legal Team at 888.626.1108 or click here to schedule a free case review with an attorney today.
