Understanding insider trading fraud

On Behalf of | May 1, 2024 | Firm News

Insider trading is a term that most investors have heard, but not everyone understands its implications or the defenses available to those accused of it. Insider trading involves buying or selling a security in breach of a fiduciary duty or other relationship of trust and confidence while in possession of material, nonpublic information about the security.

Insider trading is illegal because it is considered unfair to other investors who do not have access to the information, as the insider can potentially make profits or avoid losses that are not available to the public.

The federal regulations involved

Insider trading is primarily governed by the U.S. Securities Exchange Act of 1934, specifically Rule 10b-5, which prohibits fraudulent activities concerning securities trading. The Securities and Exchange Commission (SEC) enforces insider trading laws. Federal penalties for insider trading can be severe, including fines, restitution, and imprisonment. The maximum criminal penalties for individuals can be up to $5 million in fines and up to 20 years in prison.

Nonpublic information is the issue

The legal elements of insider trading center on the concept of material nonpublic information. Information is “material” if a reasonable investor considers it essential in deciding to buy or sell a security. Information is “nonpublic” if it has not been widely disseminated. A “breach of fiduciary duty” occurs when an individual entrusted with confidential information about a company uses that information for personal gain.

Common defense strategies

Defendants accused of insider trading often employ several strategies to defend themselves:

  • Lack of intent to commit insider trading: The defendant may argue that they did not know the information was material and nonpublic or did not intend to trade on it.
  • Publicly available information defense: The defense may be that the information was already available to the public when they made the trade, and therefore, no insider trading took place.
  • Pre-planned trade defense: This involves using 10b5-1 plans, which are pre-arranged trading plans set up when the individual does not have material nonpublic information. These plans can demonstrate that the trades were planned before the individual had access to insider information.

These are complex cases

The federal laws are complex and can change. Attorneys working on insider trading trials must understand securities laws, adeptly analyze financial and trading records and be skilled in constructing a defense strategy that aligns with their client’s situation. Traders potentially facing charges may understand the financial components of their situation, but their attorney can offer a strong defense that presents the client’s side of the story.