As Gordon Gekko demonstrated in the 1987 blockbuster hit movie, Wall Street, insider trading refers generally to the buying or selling of securities based on material non-public information. Such conduct is illegal because the misuse of privileged information undermines investor confidence, threatens the fair functioning of the markets, and is considered a breach of fiduciary duty.
Is insider trading an important enforcement focus of the U.S. Securities and Exchange Commission (SEC)? Absolutely. To illustrate, in Fiscal Year 2019, the SEC brought significant enforcement actions involving insider trading against 42 individuals who misappropriated or traded on material, nonpublic information.
In many cases, corporate insiders are “in the know” based on their position inside the organization. The employee or individuals close to them then buy or sell the securities based on that important and non-public information. Insider trading may also occur when a corporate insider tips, directly or indirectly, someone outside the organization who then buys or sells securities. In that case, both the “tipper” of the information and the “tippee” (the person receiving the information) are liable for illegal insider trading.
Types of Insider Trading
What might an insider trading scheme look like?
- An executive learns, prior to a public announcement, that her company will be taken over. She buys shares in the company knowing that its share price will likely rise.
- Company A confidentially consults with an accountant for tax advice in advance of a merger. The accountant subsequently executes trades based on that misappropriated, non-public merger information.
- An employee phones an old friend from business school to share information about his company’s earnings reports that have yet to be made public for the friend to profitably execute trades.
Importantly, insider trading is not limited to sophisticated financiers or corporate insiders. A flight attendant might overhear two passengers discussing a damaging announcement soon to be released by their company’s CEO. A savvy investor, the flight attendant leverages that secret information and puts his chips all in on a stock drop. That is insider trading, and it’s illegal.
Read some examples of notorious insider trading cases from the last decade.
How does the SEC spot Insider Trading?
The SEC conducts market surveillance using sophisticated tools to detect suspicious trades and potential illegal insider trading. The Commission also receives numerous tips regarding potentially illegal insider trading from wronged investors, rival traders, whistleblowers, and self-regulatory organizations, like FINRA.
The Difference Between Civil & Criminal Convictions
Keep in mind, the SEC deals with civil actions – it cannot send an individual to jail for a criminal conviction. Nevertheless, law enforcement agencies work closely with one another to hold wrongdoers accountable. In an insider trading case, for example, once the SEC has opened an investigation, if the matter is significant and the Department of Justice believes there is enough evidence for a criminal conviction, it may embark on a parallel criminal prosecution. (In fact, if an SEC whistleblower’s tip assists the DOJ in a parallel action, the whistleblower can receive an award based on monies recovered in the DOJ enforcement action as well.)
Want to learn more? In an article in Forbes, our partner Jordan Thomas explains the difference between a criminal violation of insider trading and a civil one.
For further details about other common securities violations, see our Securities Law Primer.
