Insider Trading Laws: What You Need to Know.

To prove insider trading under federal law, the government must typically prove that the information used to make a trade was both (i) material and (ii) nonpublic.

Materiality of information is an important factor in most civil and criminal cases, particularly those involving securities. Material information is information that would cause a reasonable investor to conclude that there is a substantial likelihood that the information would be important for making an investment decision. With respect to insider trading, such information includes:

• Acquisition of a public company by another public company
• Product failure or development
• Pending litigation or legal proceeding
• Insider buys and sells
• Any other facts affecting a company’s stock price

This is non-exhaustive, and other information may be material under circumstances such as those presented in SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), where the company discovered a vast copper deposits in the U.S. but did not announce this finding promptly to investors. While some insiders purchased company stock before releasing news of the discovery, the Court found that this was material but that insiders were unable to trade on this information because of their obligations to the company.

Once materiality is established, the next step is to determine whether the information is nonpublic. Material information remains nonpublic until it has been adequately disseminated through a public channel, after which time insiders and other individuals are free to trade on that information.

Generally, the government will need to show that the individuals in question breached a duty of trust or confidence (or otherwise obtained the material information through an improper act) in order to trigger insider trading liability. A federal court confirmed this principle in Securities and Exchange Commission v. Texas Gulf Sulphur Co. in which it stated:

“While the company’s officers, directors, and majority stockholder were entitled to their confidential information, they did not have the right to use this information for their benefit while continuing to keep it secret. If they wished to make use of this information, they had the duty to do so on terms that would make it available to the investing public. In short, they had the choice of either disclosing or abstaining.”

What Federal Rules Define Insider Trading?

No single federal statute defines insider trading, and the SEC does not explicitly define it in the rules issued under the Securities Exchange Act of 1934 (Exchange Act). Instead, there are a set of rules and provisions that define this type of offense, and in some cases, the definition has come from the federal courts through case law.

The Securities Exchange Act of 1934, Section 10(b), codified at 15 U.S.C. § 78j(b), generally prohibits the use of “any manipulative or deceptive device or contrivance in connection with any purchase or sale of any security affecting interstate commerce, or the use of any manipulative or deceptive device or contrivance, direct or indirect, with respect to any security registered on a national securities exchange.”

The SEC issued Rule 10b-5, 17 C.F.R. Section 240.10b-5, to clarify what conduct constitutes a violation of Section 10(b). Three separate subsections of Rule 10b-5 make it unlawful, for any person, directly or indirectly, “to employ, to use, or to attempt to employ, to use, or to attempt to employ, any device, scheme, or artifice to defraud, directly or indirectly, to make any untrue statement of a material fact or any omission that makes an untrue statement of a material fact, or to commit or attempt to commit a violation of this Rule, directly or indirectly, by the means or practices of fraud, misrepresentation or deceit. While Rule 10b-5 does not explicitly define “insider trading,” the federal courts and the SEC have construed it, and in subsequent rules and federal court decisions, to encompass transactions involving MNPI.

Rule 10b5-1, 17 C.F.R. Section 240.10b5-1, generally states that if an insider or a tippee trades a security while in “aware” possession of MNPI, then this generally constitutes a violation of Rule 10b-5 as “information-based trading.” However, Rule 10b5-1 also allows an insider to execute trades according to a pre-arranged trading plan adopted by the insider at a time when the insider was not aware of MNPI. The SEC promulgated Rule 10b5-1 in response to the concerns of insiders and companies about the implications of being “aware” in the context of insider trading.

There is also a requirement to prove that the individual made a culpable decision to act; this is the scienter requirement, and it remains a separate requirement of Rule 10b-5. Here, you can read more about proving scienter in an insider trading case.

To establish federal insider trading liability, the government must prove that the defendant acted with “specific intent to deceive, manipulate or defraud.” This also includes a “knowing or willful” use of MNPI to achieve a deceptive trading transaction. In order to avoid this liability, the prosecution must prove that this element was present.

Can I be liable for someone else’s confidential information?

The SEC takes a broad view of insider trading liability. In addition to insiders who trade in their company’s securities while breaching duties owed to the company (known as classical insider trading liability), the SEC and federal courts also target:

• Individuals who breach a duty of confidentiality with respect to confidential information in order to trade in that information for their own benefit or the benefit of others;
• Individuals who trade in securities of companies in which they have no apparent connection, but obtained MNPI that gives them an unfair advantage;
• Individuals who obtain MNPI from an insider or another individual who has misappropriated the information;
• Individuals who obtain MNPI from an insider who has breached his or her duty to the company;
• Individuals who receive MNPI from an insider who has breached his or her duty, while knowing that the information was given in breach of this duty; and
• Individuals who facilitate transactions involving MNPI.

Below, we discuss the different forms of insider trading liability in more detail:

Classical Insider Trading Liability

This is the type of insider trading that most people are familiar with. This type of liability arises when an individual obtains MNPI in the course of his or her employment as an executive or employee, or in some cases, a consultant, or other corporate insider. When that individual trades in the company’s securities in order to profit from the MNPI or avoid a loss, he or she is liable for insider trading if he or she has breached his or her fiduciary duty or duty of trust and confidence to the company.

Misappropriation Liability

The SEC and courts also punish individuals who obtain confidential information from an employer or other confidential source and trade in the securities of companies, often the company’s competitors, based on this information. This is known as misappropriation liability because these individuals misappropriated confidential information, and used this information to trade in securities against the interests of the source that provided the confidential information. SEC v. Panuwat, No. 3:21-cv-06322 (N.D. Cal.) It held that a corporate insider, who learned about a corporate acquisition from his employer, could use this information to buy options in the acquiring company’s stock. This is known as “shadow trading,” and the Ninth Circuit affirmed Panuwat’s civil liability on April 22, 2025.

Tippee Liability

If you obtain MNPI from someone else, you can be held liable under federal law in two main scenarios. First, if you are the “tippee” to the “tipper,” and the tipper received some type of personal benefit in order to give you the information, and you traded on it. In the case of Dirks v. SEC, it was held that the tipper must receive a personal benefit for tippee liability to be found. However, the Supreme Court later expanded this to include gifts in Salman v. United States. The second scenario is if you obtain MNPI from someone who obtained it in breach of a duty, and you trade on it while knowing about this breach of duty.

Contractual Obligations

Insider trading liability can arise out of an individual’s contractual confidentiality obligations as well. For example, when an employee signs an employer policy or other contracts, he or she may become privy to MNPI that would not otherwise be considered MNPI. If the employee then trades on this information, he or she will be in breach of his or her contractual duty.

When Can a Corporate Insider Lawfully Trade His or Her Company’s Securities?

There is no universal answer to this question. There are three situations where corporate insiders can execute transactions in company securities without becoming liable for insider trading:

• When the insider does not possess MNPI, or when no duty to the company or to a confidential source is triggered;
• When the insider has the required information but that information is not nonpublic because it has been disseminated to the general public and has been adequately absorbed by the market; and,
• When the insider has adopted a trading plan pursuant to Rule 10b5-1 and has not yet become “aware” of information that would trigger insider trading liability.

How Long Does Information Have to Be Public Before It Is Adequately Absorbed by the Market?

Federal law does not establish a universal waiting period. Instead, the information must be disclosed through “adequate channels” and must have time to be absorbed by the market. The time required to adequately absorb the information varies from disclosure to disclosure and will depend on the method and timing of disclosure and the facts and circumstances involved.

Do Rule 10b5-1 Trading Plans Offer Automatic Immunity?

No. While Rule 10b5-1 trading plans offer an affirmative defense for insider trading charges, they do not offer automatic immunity from liability for executing these plans. One aspect of insider trading liability that is often the most difficult to prove is whether the insider “used” the MNPI to execute the transaction. If an insider executes a transaction pursuant to a Rule 10b5-1 trading plan, then he or she cannot have used the MNPI because the decision to execute the transaction was made before the insider became aware of the MNPI. In order to utilize this affirmative defense, the insider must have adopted the trading plan while not aware of any information that would require either the trading plan to be adjusted or cancelled.

How Long Does the Cooling-Off Period for Rule 10b5-1 Trading Plans Last?

For directors and officers of publicly traded companies, Rule 10b5-1 plans have a mandatory cooling-off period. This period is generally whichever of these two periods is longer: (i) 90 days from the date the Rule 10b5-1 plan was adopted; or, (ii) two business days after the disclosure of the company’s financial results for the fiscal quarter that ended before the Rule 10b5-1 plan was adopted. In either case, the period can be at most 120 days. After the cooling-off period, the director or officer may trade pursuant to the plan unless he or she becomes aware of information that would make the plan improper. Once aware, the director or officer must either cancel or amend the plan. In these cases, the cooling-off period will start again with respect to either the modified or new plan.

If you are facing this situation, Spodek Law Group handles federal criminal defense matters nationwide, from offices in New York and Los Angeles.

How Difficult is it to Prove Insider Trading under Federal Law?

The Securities and Exchange Commission and federal prosecutors use circumstantial and direct evidence to prove the elements of insider trading in civil and criminal cases. As we discussed above, the SEC has a preponderance of the evidence standard to meet, and criminal prosecutors have a beyond a reasonable doubt standard to meet.

Circumstantial evidence, such as the timing of suspicious trading relative to the timing of a market-moving announcement, can raise an inference of knowledge of MNPI. However, other reasons for trading (e.g., pre-existing trading plans) can also be used to undermine an inference that MNPI motivated misconduct.

In addition to analyzing the evidence and any potential defenses, investigators will also analyze the methods and sources through which the individual allegedly obtained MNPI. Examples of means and sources that investigators will likely examine include:

• Emails and other communications between co-conspirators and those that facilitated the flow of MNPI;
• Trading records;
• Company policies, ethics agreements, and other relevant documents, which may be relevant to determining whether the insider had a duty to keep the MNPI confidential;
• Preclearance documents and related disclosures; and,
• Witness testimony from colleagues, coworkers, and others.

When an insider is charged under Rule 10b-5, the prosecution must also prove scienter. Here, we discuss what it takes to establish the requisite state of mind in a civil insider trading case.

When is Scienter Required for Insider Trading Offenses?

Most federal courts have held that scienter is a requirement for all civil actions under Rule 10b-5. In other cases, some courts have held that scienter is only required for civil actions under Rule 10b-5 that the SEC brought against a defendant; in these cases, the SEC is the one that must prove that scienter is an element of the insider trading violation.

What Does it Take to Prove Scienter in a Civil Insider Trading Case?

Establishing scienter is a key component of proving a civil insider trading case under Rule 10b-5. Scienter is the mental state of the actor, and it can be established by proving that the individual either knowingly or recklessly committed an act of misconduct. Negligence alone is not enough to establish scienter for a civil insider trading case under Rule 10b-5. However, witness testimony can connect suspicious trading with the actor’s access to confidential information and thereby indirectly establish scienter in cases where it is difficult to directly establish the actor’s intent.

What Happens When the SEC Suspects Insider Trading?

The SEC brings civil insider-trading enforcement actions. These are civil lawsuits, so there is no risk of criminal sentencing if an insider trading investigation remains in civil court. The SEC, along with FINRA and other self-regulatory organizations (SROs), monitors the markets for signs of insider trading. When a self-regulatory organization identifies unusual trading activity that may indicate a violation of federal securities laws, it refers the lead to the SEC. The SEC, then, if appropriate, conducts an insider trading investigation.

Does the SEC Issue Subpoenas at the Beginning of Insider Trading Investigations?

Not necessarily. If the SEC issues a subpoena to you early in its insider trading investigation, it does not necessarily mean that you are the target of the investigation. You could be a witness to information that would facilitate a full investigation of the insider trading violation at hand.

What is a Wells Notice?

A Wells notice is a notification that is sent to a defendant by the SEC before filing a complaint. It is not a civil complaint, and it is not a finding of liability. It merely informs the defendant that the SEC has collected evidence and is considering filing a complaint. At this point, the defendant will have the opportunity to respond to the evidence and explain why it does not establish liability. The SEC will then use this information to decide whether or not to move forward with a civil complaint.

What is a Civil Complaint?

A civil complaint is an initiating document that is filed by a plaintiff in a lawsuit. The civil complaint will detail the allegations and grounds for civil liability. Here, we discuss the difference between civil complaints and grand-jury subpoenas issued by prosecutors at the Department of Justice.

What is a Grand-Jury Subpoena?

A grand-jury subpoena is a legal demand for evidence that must be produced to a grand jury before a felony criminal case will be tried. Unlike a civil complaint, a grand-jury subpoena does not accuse the individual of a crime.

• If the SEC staff closes its insider trading investigation without filing an enforcement action, then the investigation ends there.
• If the SEC brings a civil action for insider trading, then the SEC files a civil complaint against the accused. While the SEC and the Department of Justice (DOJ) share information in many cases, an SEC civil action does not require the DOJ to initiate a criminal prosecution against the same defendant.

What Penalties and Deadlines Apply to Insider Trading Cases?

There are five main types of civil and criminal penalties for insider trading cases. The penalties available to the SEC and DOJ for each insider trading offense are as follows:

• Section 21A of the Securities Exchange Act of 1934, 15 U.S.C. Section 78u-1, allows for a civil penalty in the amount of three times the amount of a defendant’s illicit gain or loss avoided. However, if an individual’s illicit gain or loss avoided is zero, then there is a statutory minimum. For controlling persons, Section 21A(a)(3) sets the maximum civil penalty at the greater of an inflation-adjusted $1 million or three times the profit gained or loss avoided by the controlled person. Controlling-persons can also be liable in some circumstances. To face liability for a controlling-person’s illegal act, a plaintiff must show that the controlling-person had a “culpable disregard” for its subordinate’s conduct or that it failed to take “appropriate and preventive steps.”
• The SEC may seek disgorgement of a defendant’s net profits and illicit gains attributable to the wrongdoing.
• Disgorgement is a removal of profits, so the civil penalties under Rule 10b-5 generally serve to further punish defendants.
• There is a limitation period for disgorgement and civil penalty claims brought by the SEC under Rule 10b-5. A general limitation period of five years applies under 28 U.S.C. § 2462 unless there is an applicable statutory exception. While SEC civil penalty claims generally face a five-year limitation period, Section 21(d)(8) of the Exchange Act allows for disgorgement claims up to 10 years in cases involving scienter.
• The criminal statute for insider trading is 18 U.S.C. Section 1348. A criminal securities-fraud offense under Section 1348 can carry up to 25 years of imprisonment. This is a criminal statute that carries criminal sentencing and is not available for SEC civil prosecution.
• The Securities and Exchange Commission pursues civil enforcement actions. Federal prosecutors at the DOJ pursue criminal charges. These two agencies share information in order to pursue civil and criminal cases involving fraud, bribery, tax evasion, and the other types of financial crimes and fraud. If the SEC finds evidence of criminal wrongdoing, it may refer an enforcement action to the DOJ for criminal prosecution.

Does the SEC Conduct Civil Insider Trading Prosecutions?

No. The SEC is a civil enforcement agency, and it pursues civil insider trading enforcement actions. Once an investigation leads to an enforcement action, the SEC files a civil complaint. If the SEC believes that criminal charges are also warranted, it will refer an insider trading case to the DOJ, which may then initiate a criminal investigation and prosecution. The DOJ and SEC are both federal agencies, but both have a key role in upholding the federal securities laws. For example, the SEC uses its resources to maintain market transparency and protect investors from fraudulent and manipulative trading, while the DOJ pursues criminal enforcement when a government agency or private citizen brings an insider trading case or another securities fraud case to its attention.

Talk to Spodek Law Group

Every case turns on its own facts, and general information is no substitute for advice about yours. Todd Spodek, managing partner of Spodek Law Group, and the firm's attorneys defend federal criminal and white collar matters nationwide. Reach the firm at 212-300-5196.