Insider trading occurs when someone uses privileged information about a company to influence investment decisions. Not all instances of insider trading are illegal. Some may be legal, provided that the person buying, selling, or holding securities follows guidelines established by the U.S. Securities and Exchange Commission (SEC).
However, if the securities trading does not adhere to the SEC’s rules or it violates the law, insider trading is a federal felony. An individual (or corporation) found guilty of the offense could be penalized by decades in prison and/or millions of dollars in fines.
Understanding Illegal Insider Trading
Illegal insider trading involves buying, selling, or holding securities based on material, non-public information about a company. Generally, the act is done by a person in a close relationship with the corporation (such as an employee or corporate officer), and their conduct violates their fiduciary duty or undermines the position of trust they held with the company.
However, insider trading is not limited to instances of a corporation’s employees making investment decisions because of their access to privileged information. It may also be committed by “outsiders” unlawfully given or privy to certain details about a company.
Insider trading may also occur under the following circumstances:
- Tipping: A director, corporate officer, or other persons with substantial, private information about a company might provide a “tip” to a friend or family member about the corporation’s performance to encourage them to buy or sell securities in that company.
- Trading securities based on a tip: Friends, family members, or business associates might use material, non-public information about a company to guide their trading decisions. Although these individuals do not have a fiduciary duty to the corporation, they may still face consequences for acting on information that members of the public did not have.
- Trading securities based on misappropriated information: Privileged details about a company might be unlawfully obtained by a representative from a separate agency doing business with the corporation. Using the information to make investment decisions may still be considered insider trading even though the individual was not directly linked to the company for which the securities were bought or sold.
Insider trading is illegal because it undermines the public’s confidence in the financial markets. When people make trading decisions based on non-public, material information, it creates an imbalance because they are influenced by details other investors don’t have.
Still, some situations exist where securities trading by a company’s employees or directors may not be considered illegal. Legal insider trading occurs when an individual with a fiduciary duty to a corporation buys or sells stock, but they report their actions to the SEC or publicly.
Defining Insiders and Non-Public, Material Information
In many cases, illegal insider trading is done by people considered “insiders” of a company.
Insiders include those with some close relationship with the corporation, such as:
- Corporate officers,
- Employees, and
- 10%+ stockholders.
Because of their position or association with the company, they have inside information about various dealings and financial performance.
Insider trading concerns decision-making based on non-public, material information. Information is considered non-public if others in the community, specifically those participating in the investment markets, do not have access to it.
Non-public information can include a range of details, including:
- Strategic or investment plans,
- New contracts,
- Financial developments and results, and
- Change in control or of management personnel.
This data is not public until it is disseminated through proper channels and investors have a chance to consider it.
Information is material if it substantially relates to the company and may influence the corporation’s value. Additionally, it is such that it can affect an investor’s trading decisions.
Insider Trading Carries Serious Consequences
Depending on the facts, the SEC and/or the FBI may investigate allegations of insider trading. If the SEC is involved, the alleged offender may be exposed to civil penalties, including high fines.
If the FBI handles the case, the individual may face criminal prosecution and penalties. The potential sentence for insider trading includes a maximum of 20 years in prison and/or up to $5,000,000 in fines (if the alleged offender is an individual) or $25,000,000 in fines (if the alleged offender is a corporation).
Schedule a Consultation with Keegan, Tindal & Jaeger
The laws concerning what’s legal and illegal insider trading can be complex. If you have been criminally charged for allegedly engaging in unlawful conduct, speak with our team about your options for challenging the accusations.
Get started on your Iowa City case by calling us at (319) 499-5524 or submitting an online contact form today.