What is Insider Trading?
Using insider information to make investment decisions on the stock market is illegal and can lead to serious financial penalties. This type of investment fraud is commonly referred to as insider trading. In this article, we will cover the definition of insider trading, how it is detected and prosecuted when insider trading is illegal, and the potential penalties that a person may face if convicted. What is insider trading? Insider trading is the practice of trading a company’s stocks or other securities by an individual to one’s own advantage through having access to confidential or non-public information. Need Legal Help? Let’s talk. or, give us a ring at 561-338-0037. For example, if a company insider tells his or her friend about an upcoming merger that has not been made public, both the company insider and the friend could be held liable for insider trading if the friend buys the stock. IMPORTANT: The definition of an “insider” for insider trading purposes is far broader than most people realize. While it includes corporate officers and directors, it also covers employees at lower levels, friends and family members, and other persons who have access to nonpublic information. Who is an “insider”? An “insider” is anyone who is an officer, director, 10% stockholder or has access to inside information as a result of his or her relationship with the Company or an officer, director, or principal stockholder of the Company. According to SEC Rule 10b-5, the definition of an “insider” goes considerably beyond these key company personnel. In fact, this rule also covers ANY employee who has access to confidential information as part of his or her job duties. In addition, if ANY person outside of the company has received a “tip” from an “insider” about the material, nonpublic information, that person would also be considered an “insider” under this rule. Lastly, Rule 10b-5 also covers any family members or close friends of an “insider.” For example, if the CEO of a company tells his son about an upcoming merger, and the son then buys stock in the company before the merger is public knowledge, both the CEO and his son would be considered “insiders” under this rule. Who can be charged with insider trading? An individual is liable for insider trading when they have acted on privileged knowledge or confidential information that is not available to the general public to attempt to make a quick/easy profit. This may include using information about: Upcoming mergers or acquisitions; Unreleased financial reports; New product releases; Changes in company leadership; and any other information that could give an individual an unfair advantage in the marketplace. Identifying insider threats might be simple at times: CEOs, executives, and directors are immediately exposed to important information before it’s made public. However, lower-level employees may also have access to this type of information, which means that anyone from an entry-level analyst to a janitor could be susceptible to committing insider trading. Note: If you are under investigation or have been charged with insider trading, it is important to seek legal counsel immediately. An experienced SEC defense attorney can help you understand the charges against you and build a strong defense. How is insider trading detected? Both companies and regulators try to prevent insider trading to ensure the integrity of a fair marketplace. Despite what you may have read before, not all insider trading is illegal. Directors, workers, and management of a corporation may buy or sell the company’s stock with special knowledge as long as they notify the Securities and Exchange Commission (SEC) about those transactions; these trades are then made public. Unfortunately, not all insider trading is this transparent. Illegal insider trading happens when people use confidential information to make profits in the stock market. The SEC investigates and prosecutes these cases as they are a form of securities fraud. Here are a few of the ways that the SEC detects insider trading: Monitoring Trading Activity The government tracks stocks that are being bought and sold to look for patterns that may be indicative of insider trading. The SEC monitors trading activity, especially around the time when significant events happen, such as a major announcement or earnings release. This practice of surveillance can lead to the discovery of large, irregular trades around the time of these events. The SEC may then investigate the people behind those trades to see if they had access to nonpublic information. Complaints From The Public The SEC also relies on tips from the public to help detect insider trading. When the SEC receives a large number of complaints from investors who lose substantial sums of money around the same time, it can be an indication that insider trading has taken place. Since the insider trader has special knowledge, they can leverage investment tactics like options trading on the company’s stock to make a lot of money in a short period. When this occurs, it can lead to other investors losing money and filing complaints with the SEC. Whistleblowers The SEC’s Office of the Whistleblower was created in 2011 to reward people who come forward with information about securities law violations, including insider trading. The SEC gets tips from whistleblowers who come forward with information about potential violations. Whistleblowers can be current or former employees, lawyers, accountants, or anyone else with knowledge of insider trading. Whistleblowers have incentives to come forward, as they may be eligible for a portion of the money recovered by the SEC. The maximum award is 30% of the amount recovered, and it can be higher if the SEC takes action based on the information provided. Which regulatory agencies are involved in investigating insider trading? The SEC is the primary federal regulator that investigates and prosecutes cases of insider trading. The agency has a division, called the Division of Enforcement, which is responsible for bringing enforcement actions against individuals and companies who violate securities laws. The Department of Justice (DOJ) also plays a role in investigating and prosecuting insider trading cases. The DOJ can bring criminal charges against individuals...
Continue Reading