Is It Insider Trading If I Didn't Sell??

Unlawful Purchase

The concept of “insider trading” is neither expressly defined in the Securities Exchange Act nor by the Supreme Court. Most insider trading liability is essentially a form of Rule 10b-5 fraud liability. As such, an unlawful purchase is complete without any later sale or liquidation. An individual who has purchased shares unlawfully is liable regardless of whether he sells his shares later.

Mere Possession

Generally, simply possessing material nonpublic information while retaining shares does not supply a Rule 10b-5 transaction. The question has been debated among the appellate courts, and there is limited Supreme Court authority addressing the subject directly. However, it generally requires proof that the violation was in connection with a transaction.

Tipping

Tipping can create insider trading liability independently of any personal purchase or sale. To establish liability for tipping, the federal government must prove that (i) the information was nonpublic, (ii) the information was material, (iii) the information was used by the recipient to execute a purchase or sale, and (iv) the tipper acted with scienter.

Section 10(b) of the Securities Exchange Act

Section 10(b) of the Securities Exchange Act targets all activities that constitute “any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.”

SEC Rule 10b-5

The U.S. Securities and Exchange Commission adopted Rule 10b-5 to give Section 10(b) force. Rule 10b-5 prohibits (i) employing any “device, scheme, or artifice to defraud,” (ii) making any “untrue statement of a material fact,” or (iii) engaging in any “act, practice, or course of business which operates or would operate as a fraud or deceit upon any person” in connection with a securities transaction.

Mere Possession and Rule 10b-5

Mere possession of material nonpublic information is generally not a completed Rule 10b-5 violation. To pursue criminal charges or seek enforcement action in the district courts, the federal government must prove that the individual used the information in a purchase or sale.

When Does Holding Stock Become Illegal Insider Trading?

Q: When does trading stocks on the stock market (whether by purchasing shares or selling shares previously purchased) become illegal “insider trading”?

The federal government generally must establish that (i) the individual possessed “material nonpublic information,” (ii) the individual breached a duty (either a duty of confidence or a fiduciary duty), and, (iii) the individual used the information to execute a securities transaction in violation of that duty.

Q: What is “material nonpublic information”?

Under federal law, “material” means that the information in question “substantially change[s] the information mix available to a reasonable investor.” “Nonpublic” means that the information has not yet been made available to the general investing public.

Q: How is the “public” status of information determined under federal law?

Under federal law, determine whether information is “public” based on (i) how widely disseminated it has been, (ii) how kolay accessible it is, and, (iii) how widely known it has become among reasonable investors.

Q: Does the issuer’s announcement of information determine its “public” status?

While the issuer’s announcement of information is typically sufficient to make it public, it is not dispositive. If, for example, the issuer makes a public announcement but does not disseminate the information broadly enough or make the information reasonably available to investors, the information may still be considered nonpublic.

Q: Is there a federal waiting period?

No federal statute mandates a universal waiting period after information is announced in order for the announcement to be “effective” for purposes of insider trading.

Q: Does the issuer’s determination matter for purposes of insider trading liability?

Depending on the circumstances, the issuer’s determination of when information becomes public may determine whether an employee can be disciplined for trading in violation of company policy. However, the issuer’s determination will generally not determine whether executing a trade constitutes a violation of federal law.

Q: Can violating a company’s trading policy lead to federal insider trading liability?

Most publicly traded companies have policies (or employment contracts) restricting employees’ and executives’ ability to trade in the company’s stock. Violating a company policy is a contractual breach and can lead to termination of employment. However, violating a company policy will not constitute federal insider trading liability unless the transaction also violates federal securities laws.

Q: Does cancelling a trade in anticipation of news constitute insider trading?

Whether cancelling a planned trade in anticipation of news can constitute insider trading remains a legally unsettled question. If the act of cancelling the trade itself is viewed as the transaction, then canceling a trade in anticipation of news may create liability. However, making a decision not to trade (or, in other words, making an unexecuted decision to trade) generally does not constitute a securities purchase or sale.

Q: Is there a comprehensive federal definition of “insider trading”?

There is no comprehensive federal definition of “insider trading.” A number of federal statutes (including the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010), as well as SEC regulations, all provide the legal foundation for federal insider trading liability.

Can I be Liable If Someone Else Traded?

Question: Can trading on confidential information received from someone else be prohibited as “insider trading”?

Yes. In United States v. O’Hagan, the Supreme Court recognized the misappropriation theory of insider trading liability. Under this theory, it can be illegal to trade in securities based on confidential information in breach of a duty of trust or confidence owed to the source of the information.

Question: Who can be held to owe a duty of trust or confidence to a source of confidential information?

While anyone could potentially owe a duty of trust or confidence to a source of confidential information, lawyers, accountants, consultants, and former employees are typically held to owe such duties. In the context of misappropriation liability, the individual who trades is referred to as the “tippee,” and the individual who discloses the information is referred to as the “tipper.”

Question: When can “tippees” be held liable for insider trading?

A tippee can be held liable for insider trading when the tippee receives material nonpublic information from a tipper, understands that the tipper has disclosed the information in breach of a duty of confidence (either as a “corporate insider” or “misappropriator”), and then trades on that information (or, alternatively, tips someone else).

Question: When can “tippers” be held liable for insider trading?

In conventional insider trading liability based on a breach of a fiduciary duty, the Supreme Court’s decision in Dirks v. SEC imposes a personal benefit test. Specifically, in Dirks, the Supreme Court stated, “the test is whether the insider personally will benefit, directly or indirectly, from his disclosure.” In other words, a tipper cannot be liable for insider trading unless the tipper accepts (or is perceived to accept) a personal benefit.

Question: Does tipper liability require a duty to supervise the recipient’s future trading?

No. To establish insider trading liability for a tipper, the government does not need to show that the tipper had a separate duty to supervise the recipient’s future trading.

Question: Does friendship or being an acquaintance create insider status or a fiduciary duty?

No, friendship or being an acquaintance (on its own) creates neither insider status nor a fiduciary duty. While certain relationships (such as being married or being in a familial relationship) can implicate fiduciary duties, friendship or acquaintance on its own generally will not impose a duty to corporate shareholders, and it also will not create the appearance of a duty.

Question: What are “classical insider trading liability” and “misappropriation liability”?

In United States v. O’Hagan, the Supreme Court distinguished between “classical” insider trading liability and misappropriation liability. Classical insider trading liability is a form of fraud that arises when corporate insiders (officers, directors, and large shareholders, among others) breach their duties to the shareholders of the issuer company. On the other hand, misappropriation liability arises when individuals breach duties they owe to sources of information.

Question: Does gifting confidential information to a relative create a “personal benefit”?

The Supreme Court’s decision in Salman v. United States recognized that gifting confidential information to a trading relative can create a personal benefit, which can establish tipper liability.

Todd Spodek and the attorneys at Spodek Law Group handle federal cases of this kind from New York, Brooklyn, Queens and Los Angeles.

What Happens During an SEC Insider Trading Investigation?

How can the SEC determine whether a suspected insider trader had a personal relationship with a suspected tipper?

The SEC staff can examine the suspected insider trader’s communication patterns (e.g., email, text, and messaging communications) for evidence that the suspected insider trader knows the suspected tipper personally or has a personal relationship with the suspected tipper.

How can the SEC determine whether a suspected insider trader had “insider status” due to employment or consulting?

The SEC staff can examine the suspected insider trader’s employment and consulting records, pay records, benefits records, and contract records. It may also check with the suspected insider trader’s employers and clients for records of work product, meeting dates, or calendar dates showing that the suspected insider trader had contact with the suspected tipper or contact with the suspected tipper’s corporate entity.

How can the SEC investigate suspected insider trading if the suspect does not appear to have an apparent insider relationship?

If the suspected insider trader does not appear to have an apparent insider relationship with the source of the material nonpublic information, the SEC staff can investigate whether the suspected insider trader has a personal relationship with an “outsider” who may have misappropriated material nonpublic information and then provided it to the suspected insider trader.

Does the SEC always need a formal investigation order in order to investigate suspected insider trading?

No. The SEC staff can conduct “preliminary inquiries” before obtaining a formal investigation order.

When can the SEC issue subpoenas in insider trading investigations?

The SEC staff can issue subpoenas in the course of informal preliminary inquiries or formal investigations. In formal investigations, the SEC staff’s authority to issue subpoenas is based on a formal investigation order from the SEC Commission, which is a “delegation” from the Commission (rather than delegation from the United States Congress).

What can the SEC demand via subpoenas issued during formal insider trading investigations?

SEC subpoenas in formal investigations are subject to the same limitations as other SEC subpoenas issued pursuant to federal law. The SEC staff may demand any documents or other information that it believes to be relevant to the investigation, and it may also demand that the suspected insider trader appear at a deposition or other formal proceeding to provide sworn testimony.

What is a “Wells Notice”?

A Wells notice is a document from the SEC staff to the target of an enforcement action in which it communicates the preliminary staff recommendation to proceed with charges. However, the receipt of a Wells notice is not a finding of liability, it is not an indication that the SEC will pursue charges, and it is not an indication that charges have been filed or that action is pending.

What can an individual do in response to a Wells notice?

Once an individual receives a Wells notice, he or she has the opportunity to submit a written “Wells response” to the SEC staff before the SEC staff presents the proposed enforcement case to the SEC Commission. The Wells response can argue that the SEC staff has failed to identify any viable charges, that the SEC staff lacks the evidence to establish liability, and/or that pursuing charges would not serve any meritorious law enforcement purpose.

When are SEC enforcement proceedings initiated?

At the SEC’s enforcement offices, SEC staff attorneys present recommendations to the SEC Commission, and, if the SEC Commission approves of the staff’s recommendation, enforcement proceedings are then initiated. This can occur either by: (i) filing a complaint against the suspected insider trader in a federal district court; or, (ii) issuing an “Order Instituting Proceedings” for administrative proceedings before an administrative law judge.

When must individuals preserve documents in order to respond to an SEC insider trading investigation?

Preservation duties in SEC insider trading investigations can be an area of significant litigation. Broadly, preservation duties (which individuals and companies both have, in certain circumstances) begin at the point at which litigation is “reasonably anticipated.” This is before a subpoena arrives, but after evidence indicating potential liability has come to light.

How Are Penalties Calculated If I Never Sold?

How can the SEC calculate the “profits gained” or “losses avoided” in an insider trading enforcement action?

Under Section 21A of the Securities Exchange Act, the SEC can seek a civil penalty for “profits gained or losses avoided” (or “avoided losses”) which can be up to three times (or “trebled”) the total profits gained or losses avoided by the suspect. Under Section 21C of the Securities Exchange Act and the Insider Trading Sanctions Act of 1984, in addition to this statutory civil penalty, the SEC can also seek “disgorgement” of profits gained. (Note: Disgorgement is separate from a civil penalty, and it is not part of Section 21A’s calculated civil penalty).

What constitutes the “avoided losses” that can give rise to insider trading civil-penalty exposure?

Just as with “profits gained,” avoiding losses can give rise to insider trading civil-penalty exposure as well. As a result, if insider information has caused an individual to delay selling shares that he or she should have sold, and if this delay has caused an increase in value of that individual’s portfolio, the individual may be held to have “avoided losses” in an insider trading enforcement action.

If an individual sells shares after purchasing them with insider information, how is the “profits gained” calculated?

If an individual sells shares after purchasing them with insider information, the individual’s gains can be determined by subtracting the individual’s purchase price from his or her sale price.

If an individual has not yet sold the shares that he or she purchased with insider information, how are the “profits gained” calculated?

In SEC v. MacDonald, the U.S. Court of Appeals held that, “if the information was misused to acquire stock, the misuse occurs at the time of purchase, and that person is liable for disgorging his gain, which is measured at the time of the disclosure.” However, the court also held that, “it is an undue windfall if the investor gets more than what he could have earned by selling at the first moment in which he could have sold after receiving public disclosure.” As a result, if an insider trader has not yet sold the shares that he or she purchased, the individual’s “profits gained” should be calculated at the first moment when the information became available to other investors, allowing them enough time to act in response.

Can the SEC seek “disgorgement” of profits in addition to disgorgement of “losses avoided”?

No. In Liu v. SEC, the U.S. Supreme Court held that disgorgement should be limited to “net profits” or “net losses avoided,” meaning the individual gets to keep his or her “legitimate” investment and expenses.

Are “treble damages” mentioned in Section 21A the same as treble damages for private plaintiffs?

No. The “trebled” damages under Section 21A are statutory penalties under the federal securities laws, not “treble damages” for private plaintiffs under the Securities Exchange Act.

What other penalties can be imposed in insider trading enforcement actions?

In SEC insider trading enforcement proceedings, the SEC can seek (and courts have the authority to grant) injunctions and a broad range of nonmonetary sanctions, including bars on individuals serving as a public company officer or director and/or broker-dealer, investment adviser, and trading broker.

How Do SEC and DOJ Insider Trading Cases Differ?

What is the role of the SEC?

The SEC is the principal civil enforcement agency for insider trading liability under federal securities laws. While the SEC staff can also participate in criminal investigations and prosecutions, the SEC is a civil enforcement agency that works on behalf of the U.S. Department of Justice in criminal cases.

What is the role of the DOJ?

The DOJ is responsible for prosecuting criminal insider trading cases. The DOJ typically works with the SEC staff to collect evidence and prove criminal liability, and it may work with the SEC staff on either individual or separate parallel enforcement actions.

What are the differences in standards of proof?

In SEC civil insider trading enforcement actions, the SEC must prove civil Rule 10b-5 claims by a preponderance of the evidence. By contrast, DOJ prosecutors must prove criminal charges beyond a reasonable doubt.

What are the differences in showing scienter for civil and criminal insider trading liability?

Civil Rule 10b-5 scienter may be proven through “recklessness,” while criminal insider trading scienter must be shown to be intentional (i.e., “willful”). Furthermore, criminal willfulness requires more than just showing the defendant knew he or she should have known the conduct was unlawful, though this has been subject to substantial debate and a series of mixed appellate court results.

What is the statute of limitations for civil and criminal insider trading liability?

In SEC civil insider trading enforcement actions, the statute of limitations for seeking civil penalties is five years under 28 U.S.C. § 2462. While most criminal insider trading charges have a five-year statute of limitations, the statute of limitations for prosecuting securities-fraud offenses generally lasts six years under 18 U.S.C. § 3301.

How differ in the relief that is available for SEC civil and DOJ criminal insider trading prosecutions?

As discussed above, civil Rule 10b-5 penalties are calculated as disgorgement plus up to triple profits gained (or losses avoided), but disgorgement alone can be at issue, and courts can impose a broad range of nonmonetary sanctions. In criminal insider trading prosecutions, defendants convicted of insider trading violations can be sentenced to substantial federal prison time and incur fines for each offense.

What are the roles of the courts in civil and criminal insider trading prosecutions?

For civil insider trading cases involving shareholders, the courts play a minimal role. For DOJ criminal cases, the courts have the role of overseeing proceedings, presiding over jury trials (if appropriate), and sentencing.

What are the roles of the courts for SEC civil proceedings?

In SEC civil proceedings against individuals who are not shareholders, the courts play a more substantive role. However, the courts generally lack the authority to impose prison time or federal fines.

Speak With a Federal Defense Lawyer

If you are dealing with any part of what this article describes, the next step is a conversation with a lawyer who handles these cases. Spodek Law Group is a second generation criminal defense firm practicing since 1976, representing clients nationwide from offices in New York, Brooklyn, Queens and Los Angeles. Call 212-300-5196 to speak with our team.