How the SEC Proves Insider Trading.

The SEC may prove insider trading through direct or circumstantial evidence. A civil insider-trading claim relies on the preponderance-of-evidence standard. With this standard, the SEC must show that liability is more likely than not. When a case goes to trial, the SEC may then connect surveillance evidence, relationship evidence, and other types of evidence to each individual element of liability.

Comparing this to a criminal case, the difference in the standard of proof is substantial. To sustain a criminal charge of insider trading, the government must prove guilt beyond a reasonable doubt. For this reason, the SEC will refer suspected criminal conduct to the Justice Department. While a civil insider-trading case differs from a criminal one, it may still lead to jail time. For example, an SEC enforcement proceeding and a DOJ criminal prosecution may run concurrently.

The SEC does not need a confession or equivalent “smoking gun” to build its case. While these are examples of the kind of evidence the SEC may rely on, it can build a civil insider-trading case based on circumstantial evidence as well. This means the SEC does not need to be able to pinpoint the exact moment someone learned of material nonpublic information, exactly when they bought or sold a security, or exactly how they received information from an insider.

What Is the Burden of Proof in an SEC Insider-Trading Case?

The burden of proof in an SEC insider-trading case depends on whether the case is civil or criminal. In civil enforcement proceedings, the SEC uses the preponderance-of-evidence standard. This is a lower standard than the beyond-a-reasonable-doubt standard used in criminal proceedings. For the civil standard, the SEC only has to prove that it is more likely than not that the individual or firm committed the insider-trading violation.

How Does the SEC Detect Suspicious Trading?

One of the first steps in an SEC insider-trading investigation is market monitoring. This can identify unusual trading volume prior to an announcement or substantial profits generated from trading based on an announcement. Once investigators have pinpointed these types of transactions, they compare them to the timing of the corporate announcement that triggered them. Then, the SEC will issue “electronic blue sheets” to the broker-dealers involved. These sheets provide the SEC with the detailed trade data and account information needed to identify the individuals and companies involved.

Does the SEC Rely on Other Agencies to Detect Suspicious Trading?

The SEC relies on other government agencies to detect suspicious trading in a variety of scenarios. This includes relying on FINRA to refer potentially unlawful trading detected through FINRA’s market surveillance, and relying on the Consolidated Audit Trail to maintain a comprehensive database of orders, cancellations, modifications, and executions across the equity and options markets. If this information reveals patterns of trading that raise red flags for insider trading or another securities fraud violation, then the SEC may open an investigation as a result.

Does the SEC Need Proof of an Insider-Trading Violation to Conduct an Investigation?

The SEC does not need evidence of a Rule 10b-5 insider-trading violation to begin its investigation. If the SEC discovers unusual trading that does not clearly follow the patterns of legal insider trading, it may open an investigation. This can be a helpful first step, as it allows the SEC to determine whether it should refer the matter to the Justice Department for criminal prosecution. With this in mind, the SEC’s ability to monitor the market for potentially unlawful insider trading is a critical component of its investigation process.

What Is the SEC’s Role in Federal Insider-Trading Investigations?

The SEC is the primary agency responsible for conducting federal investigations of insider trading. However, this does not mean that the SEC is the only agency that is interested in pursuing enforcement or criminal charges. With this in mind, the SEC often works alongside the DOJ, and it may refer a civil investigation to the DOJ for criminal prosecution.

How Does the SEC Become Aware of Potential Insider-Trading Violations?

While market monitoring allows the SEC to identify potentially unlawful trading, the SEC may learn of a violation through other means as well. For example, whistleblower programs have encouraged individuals to anonymously report the trading activities of insiders to the SEC. The SEC provides an online portal for making these anonymous submissions, and it also encourages individuals to submit tips and other information related to suspicious trading.

What Must the SEC Prove Under Each Insider-Trading Theory?

While there are different theories that establish liability for insider trading, each theory requires different elements of proof. In cases based on the classical theory of liability, the SEC must prove:

• Possession of material nonpublic information
• Possession of material nonpublic information acquired by an insider
• The insider must have traded securities issued by their own issuer
• This act must have constituted a breach of the insider’s duty to the issuer’s shareholders
• The insider must have committed fraud or made a false statement
• This act must have committed a Securities and Exchange Commission (SEC) fraud violation

What Does the SEC Need to Prove in Misappropriation Theory Cases?

Under the misappropriation theory, liability exists when a person improperly uses information for their own benefit. The government must show that the defendant:

• Possessed material nonpublic information
• He or she came into possession of material nonpublic information after she or he breached a duty of trust and confidence
• The breach of duty was a deceptive act
• The person used material nonpublic information to buy or sell securities for a personal benefit

What Does the SEC Need to Prove in Cases Involving Insider Trading Tippers and Tippees?

In insider-trading cases involving both tippers and tippees, the SEC can establish liability for both parties. In these cases, the government must show that the tipper:

• Possessed material nonpublic information
• Disclosed material nonpublic information
• This disclosure constituted a breach of the tipper’s duty
• The disclosure was for a personal benefit

As stated by the United States Supreme Court in Salman v. United States, 580 U.S. 39 (2016), “//the information must have been disclosed in breach of a fiduciary duty, and the tippee must have known or should have known that it was disclosed in breach of a fiduciary duty//.”

In order to hold a tippee liable for insider trading, the SEC must show that:

• The tippee possessed material nonpublic information
• The tippee used this information to buy or sell securities for a personal benefit
• The tippee knew or should have known that the insider disclosed material nonpublic information in breach of a fiduciary duty

What Does the SEC Need to Prove for General Rule 10b-5 Insider-Trading Liability?

While the theories that establish liability for insider trading differ, all Rule 10b-5 insider-trading cases require the government to prove that:

• The defendant committed fraud, a deceptive act, or a false statement
• The defendant committed a deceptive act or fraud in connection with a purchase or sale of securities
• The defendant acted with scienter

The government does not need to prove that the defendant knew that its actions would affect the market as a result of the insider-trading fraud.

What Are the Elements the SEC Must Prove in Misappropriation Theory Cases Involving Trading in a Company’s Competitor’s Securities?

In SEC v. Panuwat, the government successfully expanded the misappropriation theory of insider trading. In this case, Panuwat had been the head of business development at Medivation, Inc., when he learned from the company's CEO that Medivation was on track to sign a deal to be acquired by Pfizer. Panuwat immediately purchased call options of Incyte Corporation. He knew that Incyte also produced a cancer drug. In fact, he knew that Incyte was a competitor of Medivation and that the takeover of Medivation would likely increase Incyte’s share price.

The SEC had to prove that Panuwat violated Rule 10b-5 by trading on material nonpublic information he obtained in violation of a duty of trust and confidence owed to Medivation. In April 2024, a federal jury found Panuwat civilly liable for insider trading.

What Evidence Connects a Suspicious Trade to Inside Information?

To prove insider trading, the SEC must do more than identify a suspicious trade. It must also connect the suspicious trade to the alleged use of material nonpublic information. The SEC will rely on a variety of evidence for this purpose, including:

Trading Records

Trading records provide the SEC with the information it needs to identify potentially unlawful trades. These records will show:

• Which accounts traded
• What securities were traded
• When the trades were executed

Phone, Email, and Social Media Records

Phone, email, and social media records will help establish the connection between a trader and a source who may have had access to material nonpublic information. For example, an email, a text, or a direct message containing the alleged information could be used to prove both the transmission and receipt of material nonpublic information. Similarly, a phone record would prove that two parties spoke over the phone before trading occurred.

Access Logs

The SEC will review a company’s access logs in order to determine who had access to material nonpublic information. It will then be able to identify a list of potential insiders and potential tippers.

Surveillance Data

The SEC will utilize surveillance data to identify insiders who may have traded on material nonpublic information or provided an unlawful tip to someone else.

Timing of the Trade and Announcement

The timing of a suspicious trade in relation to a corporate announcement will also play a role. In general, the closer the trade is to the announcement, the stronger the inference of material nonpublic information misuse.

Trading Patterns

A suspect’s trading patterns can also serve as evidence against (or in favor of) the suspect. For example, if the suspect consistently traded in the same security prior to similar corporate announcements, this would support the inference that the suspicious trade was motivated by the misuse of inside information. On the other hand, if the suspect has a history of making similarly-timed trades with similarly-sized volumes based on publicly available information, this would provide a possible innocent explanation for the trades.

Evaluation of the Evidence

When evaluating the evidence against an insider-trading suspect, courts will assess all of the evidence collectively. Courts evaluate circumstantial evidence under the same standards that it uses to assess direct evidence; it does not assign circumstantial evidence categorically reduced weight.

Todd Spodek is the managing partner of Spodek Law Group, a second generation criminal defense firm that has been practicing since 1976.

When Is Information Material, Nonpublic, and Used with Scienter?

Under Rule 10b-5, for securities bought or sold to be illegal, they must have been bought or sold on material nonpublic information. In the same case, for this information to have been acquired by someone who owed a duty to either the issuer’s shareholders or someone else, it must have been acquired deceptively. And for this to have constituted a violation of Rule 10b-5, the actor must have acted with scienter.

What Is Considered Material Information?

Generally, information is considered material if there is a substantial likelihood that a reasonable investor would consider it important in deciding whether to buy, sell, or hold a security. In Basic Inc. v. Levinson, the U.S. Supreme Court explained that materiality “//will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity//.”

Information that may be material can include, for example, information about a company’s potential mergers and acquisitions, quarterly results, new products, and other such information.

When Does Information Become Public?

Information is considered public once it has been broadly disseminated, and there has been a sufficient amount of time for the investing public to absorb the information. As a result, Rule 10b-5 does not establish a fixed waiting period between a public disclosure and the time when the information may be legally traded upon.

What is Required to Establish Scienter in an Insider-Trading Case?

To establish Rule 10b-5 civil liability, the SEC must prove that the suspect acted with scienter. The U.S. Supreme Court has described scienter as “//a mental state embracing intent to deceive, manipulate, or defraud//.” Negligence or mistake are not enough to establish scienter in civil securities fraud cases.

In order to establish liability under Rule 10b-5, the SEC must also show that the insider trader traded on the basis of material nonpublic information. Under SEC Rule 10b5-1, a trader “is considered to be trading on the basis of material nonpublic information when the trader was aware of the information at the time of the trade.” The rule does not require the SEC to prove that the trader actually used the information to commit fraud or that the trader would have made a different decision but for their knowledge of the information.

However, the mere awareness of material nonpublic information is not enough to establish a deceptive breach of duty. Evidence of a deceptive breach of duty is also required.

Can a Rule 10b5-1 Plan Explain the Trade?

Trades that occur before a deal’s terms crystallize can weaken the SEC’s inference that they were made on material nonpublic information. For example, if a trader sells shares before a takeover agreement is even drafted, this could make it difficult to connect the transaction to material information about a specific takeover.

Rule 10b5-1 Plans

Rule 10b5-1 establishes an affirmative defense against insider-trading liability. To use a Rule 10b5-1 plan to protect against liability, however, the individual must establish that they adopted a written trading plan in good faith, and adopted the plan before they were aware of any material nonpublic information.

Cooling-Off Periods

While Rule 10b5-1 allows individuals to set up trading plans before they acquire nonpublic information, Rule 10b5-1 does not apply to trades executed under the a plan that was entered into within a certain number of days prior to the trade. Rule 10b5-1 plans adopted by directors and officers generally require a 90- to 120-day “cooling-off” period between when the plan was adopted and when any trade can occur under the plan. While directors and officers have a longer cooling-off period, other individuals who are covered by Rule 10b5-1 generally face a 30-day cooling-off period.

Contemporaneous Records of Liquidity Needs

Along with Rule 10b5-1 plans, contemporaneous records of liquidity needs can support the claim that an insider trader had an independent reason for making the trade. With this in mind, if the SEC is in possession of records showing a need for liquidity, and the suspected insider trader made the transaction based on those records, then the suspected insider trader will have a strong argument against the inference of unlawful misuse of inside information.

How Much Can the SEC Seek for Insider Trading?

The SEC cannot prosecute criminal insider-trading charges. However, the SEC can seek disgorgement of profits, disgorgement with prejudgment interest, prejudgment interest, civil monetary penalties, permanent injunctions, officer-director bars, and other types of remedies.

Disgorgement

In insider-trading cases, disgorgement is limited to net profits. In Liu v. SEC, the U.S. Supreme Court also stated that a disgorgement award under the SEC’s enforcement authority should be awarded to the victims, unless the court is convinced that the award is better spent on the general investing public.

Prejudgment Interest

Insider-trading disgorgement may include prejudgment interest. The Supreme Court in Liu v. SEC recognized the SEC’s authority to seek prejudgment interest, and it went on to describe this interest as being “//akin to disgorgement//.”

Civil Monetary Penalties

Section 21A of the Exchange Act grants the SEC authority to seek civil monetary penalties. The amount of an individual violator’s civil penalty under Section 21A is capped at “three times the profit gained or the loss avoided” as a result of the insider trading violation. With this in mind, the SEC will seek the maximum amount allowable in a civil insider-trading case whenever possible.

Permanent Injunctions

The SEC may request a permanent injunction against an individual or a business entity in an insider-trading case as well. A permanent injunction effectively bans the individual or the entity from buying or selling securities based on inside information in the future. However, requesting a permanent injunction will only be successful if the government can provide evidence that supports a reasonable likelihood of a future insider-trading violation.

Officer-Director Bars

A federal court may impose an officer-director bar against an individual under Section 21(d)(2) of the Exchange Act. To obtain an officer-director bar, the SEC must show that “//the conduct of the defendant demonstrates substantial unfitness to serve as an officer or director//.” While generally sought in criminal cases, the SEC may also seek officer-director bars in civil insider-trading cases.

Statute of Limitations

The statute of limitations for disgorgement and civil penalties in insider-trading cases differs. Under 28 U.S.C. § 2462, the SEC generally has five years to seek civil monetary penalties. However, under 28 U.S.C. § 78u(d)(8), the SEC can seek disgorgement from an insider trading violation dating back up to ten years, as long as it also established that the insider trader acted with scienter. With this in mind, a defendant’s defense strategy can be tailored to the timing of the events in question.

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