Federal Insider Trading Defense: SEC Enforcement and Criminal Charges.

We separate our clients’ SEC civil and DOJ criminal exposure when warranted due to the significant differences between the two types of government enforcement proceedings, including the authority to pursue federal criminal charges (and the authority to punish criminally) and the standards and elements of proof applicable. With the SEC, a civil resolution in which defendants admit no wrongdoing could still potentially be followed by DOJ prosecution.

With the SEC, the government has the authority to bring civil or administrative actions. While the SEC does not have the authority to impose federal criminal imprisonment or fines, it has the ability to refer civil matters to DOJ for criminal investigation.

With the DOJ, defendants must be proven guilty of a crime beyond a reasonable doubt at trial. Civil securities proceedings, on the other hand, use different burdens and elements than criminal prosecutions, and it is critical to pursue a comprehensive securities defense that addresses both sources of federal exposure when necessary.

Defendants at the center of insider-trading investigations need to keep a close eye on the status of their civil and criminal liability because, as noted, a civil settlement with the SEC does not necessarily end the matter, and federal authorities could later initiate criminal charges based on the same allegations.

We approach federal insider-trading defense by treating the SEC’s civil or administrative allegations and the DOJ’s allegations of criminal misconduct separately.

While this is usually the most prudent strategy, we make informed decisions based on the specific facts at hand. Along with other strategic considerations, our primary goal is to preserve our clients’ liberty, livelihoods, and reputations; as a result, we take a strategic and highly detailed approach to federal insider-trading defense.

Which Government Demand Changes What You Should Do With Records, Testimony, and Silence?

The types of demands that federal authorities make can vary depending on the nature of the investigation, and it is important to determine what the nature of the demand is.

An SEC investigation may begin with the SEC making a voluntary request for records, inspecting a regulated entity, or issuing a subpoena; SEC staff generally does not enter private premises and seize records, computers, or other devices. Subpoenas from the SEC generally demand the production of documents, trading records, communications, depositions, and other evidence.

When the SEC makes a voluntary request for records, it is not the same as being served with a subpoena. Defendants should consult with counsel promptly, as refusing to comply with a voluntary request may create issues with the SEC in the future.

A Wells Notice is issued when SEC staff has preliminarily determined to recommend that the Commission bring an enforcement action against an individual or entity in a securities proceeding. The Wells Notice generally gives the proposed respondent an opportunity to submit a response explaining why the Commission should not recommend taking action.

In cases where the DOJ is investigating a suspected federal insider-trading offense, defendants may receive a federal target letter. A target letter is used to identify someone the prosecuting attorney considers to be the target of a grand-jury investigation.

Unlike criminal investigations where defendants may (and often should) invoke the Fifth Amendment, an SEC civil proceeding allows for an adverse inference against defendants that invoke their Fifth Amendment privilege.

When facing potential criminal charges, defendants must do everything possible to protect their liberty while also avoiding unnecessary liability. An informed, strategic defense requires a clear understanding of the government’s theories of liability, the evidence in their possession, and the consequences of compliance, so that informed decisions can be made.

What Liability Theory Fits Classical Insiders, Tippees, Misappropriators, and Shadow Traders?

The concept of “insider trading” generally falls into one of several categories:

In the classical theory of insider trading liability, a corporate insider has a fiduciary duty to the company’s shareholders that prohibits trading on material non-public information, i.e., a violation of a fiduciary or similar duty.

In the misappropriation theory of insider trading liability, liability can arise if a person obtains confidential information in breach of a duty of trust or confidence (e.g., a duty to an employer, lawyer, spouse, or client) and then uses that information to trade, even if the defendant is not an insider to the company whose securities are being traded. Unlike the classical theory, misappropriation liability does not depend on an insider’s breach of a fiduciary duty owed to the company’s shareholders, but instead depends on the insider’s breach of a duty owed to the information’s source.

Tippee liability is another significant theory of liability that involves a tipper and a tippee. Generally, tipper-tippee liability requires both a qualifying tipper breach and a tippee who has the requisite knowledge (i.e., who knows or should know that the information was disclosed in breach of a fiduciary or similar duty). Additionally, in its Dirks decision, the Supreme Court indicated that a tipper’s personal benefit is relevant to tipper-tippee liability.

The shadow trading theory is a relatively new form of insider trading liability that involves using material non-public information from an insider in one company to trade in securities of a different company, one that is related to the insider’s company.

Along with the government’s proposed theories of liability, our insider trading lawyers focus on the government’s evidence. Depending on the facts and circumstances of the case, this may require challenging the government’s interpretation of the facts or demonstrating that the government lacks sufficient evidence to substantiate its allegations.

When the evidence supports the government’s allegations, we contest the government’s proposed penalties and consequences. In federal insider trading cases, this process may include challenging the government’s calculation of disgorgement in civil proceedings and seeking pre-trial motion practice to dismiss the government’s allegations.

When Does a Rule 10b5-1 Plan Protect a Trader, and When Can It Fail?

It is a Rule 10b5-1(c) affirmative defense to insider trading liability to establish that a trade occurred pursuant to a qualifying preexisting trading arrangement. This includes arrangements that cover “securities transactions” that are scheduled to occur on a particular date or which are based on a particular price or volume.

To qualify for the Rule 10b5-1(c) affirmative defense, a trading plan or arrangement must generally be adopted before the trader is aware of material nonpublic information.

Under the SEC’s 2022 amended Rule 10b5-1, Section 16 officers and directors who adopt a Rule 10b5-1 plan or enter into a qualifying preexisting trading arrangement are subject to a cooling-off period that is the later of 90 days after adoption or two business days after disclosure of the issuer’s financial results, but no more than 120 days.

Under the amended Rule 10b5-1, persons other than directors and officers who adopt a Rule 10b5-1 plan or enter into a qualifying preexisting trading arrangement are subject to a thirty-day cooling-off period.

Additionally, the amended Rule 10b5-1 requires good-faith operation of qualifying trading arrangements.

The U.S. government continues to scrutinize the use of Rule 10b5-1 plans to potentially defend against insider trading liability. Even when defendants rely on a Rule 10b5-1 plan, a comprehensive insider trading defense must also involve a focus on the government’s liability theories and evidence.

Along with challenging the government’s liability theories and evidence, defendants facing potential criminal charges must also make informed, strategic decisions about engaging with the U.S. government. This includes weighing the benefits and risks of cooperating with the government, exercising the Fifth Amendment privilege, and utilizing Rule 10b5-1 plans to support insider trading liability defenses.

How Can the Defense Attack Surveillance Evidence, Loss Calculations, and Asset Freezes?

The SEC’s Market Abuse Unit uses sophisticated market-surveillance systems and data to detect unusual trading activity. While these systems can identify unusual trading prior to corporate announcements and identify unusual trading correlations, alone they do not prove knowledge, reliance, or criminal intent. They may serve as red flags that warrant further investigation, but they generally lack sufficient evidence for civil liability or criminal prosecution.

The government’s evidence commonly includes:

• Trading records and other financial records
• Electronic messages
• Company policies
• Rule 10b5-1 trading plans and other documents

We challenge the government’s characterization of these materials in favor of an interpretation consistent with an insider trading defense, and we challenge the government’s use of these materials as evidence of a breach of fiduciary or similar duty.

In cases involving cooperating witnesses, we challenge their testimony as well. Defendants facing criminal prosecution often have the opportunity to rely on incentives for cooperation or other factors that may substantiate challenges based on bias or inconsistent statements.

When faced with a well-developed case, our securities lawyers can rely on financial and valuation experts to challenge the government’s evidence of materiality, valuation, market causation, and alleged loss calculations. We work with these experts to develop custom solutions that serve the needs of the case.

In cases involving criminal prosecution under the U.S.S.G., sentencing can depend substantially on the attributed gain, and defendants will have an opportunity to present evidence to the sentencing court. Our lawyers can use this information to argue for a downward departure or variance based on the specifics of the offense.

Additionally, we rely on the following to challenge the government’s attribution of intent when facing federal insider-trading charges:

• The absence of evidence to support the government’s intent and culpability allegations;
• Evidence of an honest mistake or a good-faith belief that information is not material or is public; or, and
• Lack of material non-public information when taking action.

We then seek to contest the government’s attribution of culpable intent by presenting evidence that demonstrates our client acted in good faith. This approach focuses on challenging the government’s interpretation of the evidence to show the absence of the requisite mental state for insider trading liability.

Talk It Through With a Lawyer

Every case turns on its own facts. Todd Spodek is the managing partner of Spodek Law Group, a second generation firm his father opened in 1976, and the firm takes federal criminal and white collar matters nationwide. Call 888 348 8028 to talk it through.