Insider trading takes place when an “insider” uses information about a specific security as an advantage when trading in that security. Because the information is not available to others, the “insider” is using such knowledge in gaining an unfair advantage over the rest of the market. Insider trading schemes generate millions of dollars in illegal profits which is not only unfair, but it is also disruptive to a properly functioning market.
Under Rule 10b5-1, the Securities and Exchange Commission (SEC) defines insider trading as any securities transaction made when the person behind the trade is aware of nonpublic material information, and is hence violating his or her duty to maintain confidentiality of such knowledge. Information is defined as being material if its release could affect the company’s stock price. Insider trading violations may also include “tipping” such information to friends about non-public information.
The SEC tracks insider information in the following ways:
- Market Surveillance Activities: The SEC uses sophisticated tools to detect illegal insider trading, especially around the time of important events such as earning repots and key corporate developments.
- Tips and Complaints: The SEC regularly receives phone calls and tips about insider trading from whistleblowers who can collect between 10% and 30% of the money collected from those who break securities laws.
Once the SEC suspects of a security violation its Division of Enforcement launches a full investigation that is conducted privately. SEC interviews witnesses, examines trading records and subpoenas phone records. If enough evidence is obtained to indict someone from insider trading he or she will be arrested and the case will then be handed over to a U.S. Attorney.
A U.S. attorney must be able to prove beyond a reasonable doubt the following elements:
- You purchased or sold a security;
- You possessed material aka private information;
- The information was not publicly known; and
- The information was material (Meaning that if there is substantial likelihood that a reasonable investor would consider it important in making investment decisions)
If found of insider trading one can be subject to a maximum of $5 million in fines, up to 20 years imprisonment, or both fines and imprisonment.
If you have been charged with Insider Trading or have additional questions, please be sure to consult with a local attorney near you such as the criminal defense attorney Redwood City CA locals turn to.
Thanks to authors at The Morales Law Firm for their insight into Criminal Defense.