Insider trading is illegal. It occurs when someone knows important but secret information about a company and then trades that company's securities (e.g. stocks, bonds, call options) to gain an advantage when the stock price moves after the information is released. Insider tipping is also illegal. It means telling others about secret stock-price-moving information. Another FAQ explains why financial regulators oppose both trading on and tipping inside information.

The laws of insider trading and tipping apply to everybody. They do not apply only to company insiders or executives, though their positions tend to put them at more risk than ordinary employees. Pursuing insider-trading violations is a high priority of the Securities and Exchange Commission (SEC), which enforces US securities law.

Also, the SEC has agreements with many countries throughout the world, giving it access to people who violate US securities law outside the US.

Extensive Scope

The insider-trading laws apply to market-moving information not only about a company you work for but also about any company you may know through a special or personal relationship: e.g. through a family member who works for that company, or through a vendor, supplier, or client of your company.

Courts and the SEC continue to develop approaches to reach nonemployees, such as the misappropriation and temporary-insider theories. For example, the SEC is now aggressively scrutinizing hedge funds for evidence of insider trading. The SEC may pursue you for insider trading even if secret inside information did not influence your decision to trade.

Alert: An insider-trading case in 2016 involving professional golfer Phil Mickelson and a corporate director (see the related SEC press release and SEC public statement) shows that when the SEC finds insider trading somewhere in a chain of events, all who profited will be forced to pay back their gains, even if they did not know that the information in question was tainted. In the SEC's action, Mr. Mickelson was named as a "relief defendant," i.e an individual who must turn over ill-gotten gains arising from schemes perpetrated by others.

Another risk for officers and directors is that they can be liable as controlling persons if they are reckless in not preventing insider trading by their employees.

Expanding Definitions

Insider-trading law has grown from the general antifraud provision of Rule 10b-5 in the Securities Exchange Act of 1934. In addition to stocks and bonds, which are clearly securities covered by insider-trading law, the SEC has expanded the interpretation of the law to include more sophisticated financial instruments, such as credit default swaps.

Even the definition of confidential material information is expanding beyond just straightforward good news (e.g. mergers, dividend increases, new products) and bad news (e.g. poor earnings, dividend cuts). Recent cases have involved types of information that can move a company's stock price in less obvious ways, and the SEC often brings these cases to test the edges of the law's reach. See, for example, the insider-trading case that the SEC brought against Mark Cuban, owner of the Dallas Mavericks basketball team (SEC Litigation Release No. 20180). He sold stock in a public company when, allegedly, he knew that it was about to raise private financing. After the SEC brought a civil suit against him, the jury in his trial found him not guilty.

Alert: The decision in Mark Cuban's case will not alter the SEC's enforcement practices when it brings insider-trading cases that fall into gray areas of the law. Moreover, it illustrates the fact-specific nature of insider-trading cases and the expensive process involved in challenging the SEC by taking a case to trial.

Cybersecurity Breaches

In guidance on cybersecurity disclosures that it issued in 2018, the SEC formally expanded its definition of material nonpublic information to include knowledge about cybersecurity risks and incidents, including vulnerabilities and breaches (see pages 20–21). The SEC's enforcement action again the former Equifax CIO for insider trading shows that it views knowledge of a massive cyber-intrusion and data breach as material information. In a commentary on his law firm's blog, an attorney at McGuireWoods points out that while the defendant was not told that Equifax had a data breach, the SEC and DOJ are alleging that for corporate insiders it is enough to have "constructive knowledge" (i.e. strong suspicions based on information learned at work) of nonpublic material information, and that "actual knowledge" (i.e. direct awareness) is not needed.

As detailed in an SEC legal complaint and the related press release, the SEC has brought an insider-trading case against an Equifax software engineer under the same theory of "insider guessing." The employee was not told that a data breach had occurred but purchased put options on Equifax stock and sold them for a profit of $75,000.

Corporate Rules And Prearranged Plans

In addition to the laws against insider trading and tipping, you should follow your company's rules about blackout and window periods.

Also, consider setting up a Rule 10b5-1 trading plan for prearranged sales if you know you want to sell stock in the future but may know secret inside information at those times.