Tips on Avoiding Insider Trading Violations for In-House Counsel
Insider trading violations can bring highly negative publicity to a company. As an in-house lawyer, you need to ensure appropriate risk management protocols are in place in order to prevent insider trading from occurring. Suspicious trading activities by company executives or other employees should be handled promptly upon discovery. In addition to causing reputational harm, insider trading violations can lead to severe civil and criminal penalties for the parties involved.
Insider trading refers to purchasing or selling securities based on material, nonpublic information. It is considered a breach of a fiduciary duty or other trusted relationship. Insider trading violations most commonly involve publicly traded stock, but it is important to keep in mind that insider trading laws also apply to private companies.
In order to be a vigilant in-house lawyer, you should be aware of the legal framework underpinning insider trading, the essential elements of an insider trading claim, the enforcement actions that can be taken, and the potential defences to a claim.
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There are a number of laws in place for preventing the misappropriation of material, and nonpublic information and for enforcing violations of insider trading laws. Some of these laws are narrowly tailored to specific contexts, while others are broader in scope.
- Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and the key anti-fraud provision in Rule 10b-5: this is only of the main rules for regulating insider trading activities.
- Sarbanes-Oxley Act of 2002: this prohibits directors and officers of a company from trading the company’s securities during a defined blackout period
- Regulation Fair Disclosure (“Regulation FD”): this prevents selective disclosure of material, nonpublic information to analysts, institutional investors, or other company outsiders without an accompanying full disclosure to the general public
- Rule 14e-3 under the Exchange Act: this is only applicable in connection with tender offers
The Securities and Exchange Commission (“SEC”), Department of Justice (“DOJ”), and Financial Industry Regulatory Authority (“FINRA”) are the main investigative authorities involved to look further into insider trading allegations.
Elements for Bringing an Insider Trading Claim
Corporate insiders may pass along material, nonpublic information to outsiders for personal gain. This behavior can constitute securities fraud under Section 10(b) of the Exchange Act. As an in-house counsel, you should be aware of the four required elements for a securities fraud charge:
- Breach of fiduciary duty
- Use or possession of material, nonpublic information in connection with the trading of securities
- Personal benefit in tipper-tippee claims
For civil cases, the government must prove each of these four elements based on a “preponderance of the evidence” standard. For criminal cases, the government must prove its case “beyond a reasonable doubt,” a higher evidentiary standard.
Civil and Criminal Enforcement Actions
Technological advances have made it significantly easier for law enforcement to crackdown on insider trading activities. The SEC also has a whistleblower program that offers attractive incentives for disclosing tips about misconduct to authorities. This whistleblower program was established under the Dodd-Frank Act in 2010.
In criminal investigations, the FBI and other law enforcement agents can use more aggressive techniques to obtain evidence of insider trading. Some common tools used in criminal investigations include judicially approved wiretaps, search warrants, undercover surveillance, and cooperating witnesses. A criminal conviction can result in severe penalties, including imprisonment for up to 20 years.
Defences to Insider Trading Liability
As an in-house lawyer, you should have a solid understanding of the viable defences available to a defendant accused of insider trading.
Under the mosaic theory defence, the defendant can argue that collecting individual pieces of immaterial, nonpublic information does not violate insider trading laws. To successfully assert this defence, the defendant must demonstrate that each piece of information is immaterial. This defence has been used less frequently in recent years. This is partly a result of the SEC’s adoption of Regulation FD. This regulation specifically calls out attempts to “render material information immaterial simply by breaking it into ostensibly non-material pieces.”
The establishment of Rule 10b5-1 trading plans offer a workaround insider trading laws under certain circumstances for a company’s directors and executive officers. Rule 10b5-1 plans permit a company’s insiders to sell the company’s stock despite the fact that they are in possession of material, nonpublic information.
The knowledge defence can be asserted to claim that the defendant lacked awareness of a breach of fiduciary duty. The resistance to insider trading claims based on claiming a lack of knowledge can be brought under the tipper-tippee theory or under the misappropriation theory. The standard for liability under the tipper-tippee theory is whether the tippee had awareness of the tipper’s breach of fiduciary duty. Under the misappropriation theory, liability rests on whether a trusted relationship has been breached. The analysis is highly fact-specific.