What Is Insider Trading?
Although most of us have heard the term “insider trading,” few of us have a solid understanding of exactly what constitutes insider trading. The markets for publicly traded stocks are meant to be open and fair. This means that no single trader or investor should have an advantage over another by using information that is not public.
Insider trading occurs when private information that is not available to everyone is used to buy or sell a stock. As an example, suppose you work for Triple J Energy. As an employee, you happen to know that your company is about to merge with another energy company. You also know that your uncle owns stock in Triple J, so you give him a call to tell him about the merger.
Your uncle then uses that private information to buy or sell his stock in Triple J, either to make a profit or to avoid losing money. Any time confidential stock information, not available to the public, is used by a person to make money, then insider trading has occurred, and in this scenario, you could also be deemed guilty for passing the non-public information along. In reality, insider trading probably occurs on a regular basis—even the most experienced executive might occasionally give in to the impulse to profit or avoid a loss by making a stock trade based on confidential information. That being said, one instance of insider trading could land you in jail, prison, or facing thousands of dollars in fines.
When an individual is charged with insider trading, he or she may also be facing other crimes associated with buying and selling stocks, including investment fraud, securities fraud, late-day trading, foreign currency fraud, Ponzi or pyramid schemes, high-yield investment fraud, advanced fee schemes, or hedge fund-related fraud. While these are all considered white-collar crimes, they are all very serious, bringing severe penalties that could alter your life forever.
The SEC has made prosecuting insider trading offenses a top priority, working with the U.S. Justice Department and local U.S. attorneys to ensure those engaging in securities trading violations are prosecuted. The federal government operates under Section 32(a) of the Securities Exchange Act of 1934 as amended by the 2002 Sarbanes-Oxley Act when prosecuting insider trading.
Insider Trading in Pennsylvania
In the state of Pennsylvania, the criminal penalties for insider trading and other types of securities fraud can be severe, because even though these are white-collar crimes, they can result in devastating financial losses to individuals, families, and businesses. Pennsylvania considers securities fraud a second-degree felony, punishable by a maximum prison term of 10 years and/or fines of up to $1 million.
There are certain circumstances, however, when the charges can be increased to a first-degree felony, which is punishable by a maximum prison term of 20 years, and/or fines up to $5 million. For Pennsylvania white-collar crimes, in addition to facing harsh court-ordered penalties, there is also the risk of professional sanctions, civil claims or lawsuits, and, of course, the burden of having a felony criminal record. A Pennsylvania conviction for insider trading can literally derail your personal and professional life, therefore, highly skilled legal representation is crucial.
Federal Charges of Insider Trading
There is a myth that only the “Wolves” of Wall Street—those traders that made significant amounts of money and are very high profile—are ever targets of federal prosecution for insider trading. This is simply not true and can be a dangerous assumption if you are engaging in insider trading on a much smaller scale. In fact, insider trading seems to draw the ire of the U.S. Attorney and Federal Court judges almost as often as violent crimes. Allegations of insider trading spark emotions related to greed and gluttony, and, as such, are prosecuted with the full force of the law. Because of this, both federal and state law enforcement have made insider trading prosecutions a priority, targeting individuals, corporations, families, small businesses, and professionals who have obtained non-public information then used that information to trade stocks and make money.
What is a Security?
The federal criminal statute regarding insider trading—usually charged federally under the Securities Fraud Title 18, United States Code, Section 1348—involves intentionally trading any “security” based on non-public information. A security is defined as any common stock, preferred stock, treasury stock, security-based swap, note, bond, certificate of interest, option, straddle, call, debenture, or any other “derivative” instrument.
When is Trading Information Considered “Material?”
If you are charged federally with insider trading the prosecution must show the information you received had a significant likelihood that another reasonable investor would consider it important in making a trade decision. As you might imagine, this test is fairly subjective, and the determination is made on a case-by-case basis. Remember, it is not illegal to make stock trades based on non-public information that is considered non-material.
Public vs. Non-Public Information
What if you were unaware the information you received had not been released to the public? Again, this can be a subjective area. When information has not been broadly disseminated to investors in the marketplace, it is likely to be considered non-public. In other words, if you had access to the information, but most other individuals did not, then it was likely non-public information.
The goal of insider trading laws is to ensure a level playing field for all, therefore, once the information is out to the public, enough time must pass to ensure the information has been incorporated into the security market price. The prosecution must show you were aware the information was non-public, and you traded quickly to take advantage of the information you had—but few others had.
Does an “Insider” Have to Be an Employee of the Company or Entity Being Traded?
While insider trading does usually involve an employee or someone else with proprietary information regarding the company or entity, an “insider” is essentially anyone with a fiduciary duty to his or her company or entity. This means that any information known or overheard that has not yet been made public when used to trade securities is illegal. Yes, even non-public information that you overhear can potentially get you in legal trouble when you use that information to make stock trades.
As an example, assume your neighbor works for Microsoft. One day you are out watering your lawn when you overhear the neighbor talking on her phone about a major upcoming change to Microsoft. You take that information and either purchase or sell your Microsoft stocks (depending on the information overheard). You have just engaged in insider trading. Further, if you repeat that information to another person who makes trades based on non-public information, you could still be guilty of insider trading.
Federal Penalties for Insider Trading
The criminal federal penalties for Insider Trading are even harsher than those of the state of Pennsylvania. It is important to note that in some cases insider trading can be handled civilly, meaning there would be no criminal conviction, therefore, no prison or jail time. If the matter is handled in a civil suit, the penalties could include restitution, fines, and debarment. If insider trading charges are handled criminally, a conviction for an individual could result in up to 20 years in prison, and fines of up to $5 million for each violation ($25 million for a corporation).
Witness, Person of Interest, Subject, or Target?
If you have information related to a criminal act such as insider trading, the federal government will consider you a witness. This does not always mean that you actually observed the criminal offense taking place. Perhaps you watched your own neighbor eavesdrop on another neighbor, then heard him phone his broker to place a trade. In this case, you might be considered a witness for the federal government. Even as a witness you have the right to legal counsel, and this is likely a good idea, so you do not end up as a person of interest, subject, or target of the same investigation.
The next level is a “person of interest.” This means federal law enforcement wants to talk to you regarding an ongoing investigation. Underneath that relatively mild definition is the fact that when federal law enforcement designates someone as a person of interest it usually means they believe that person was involved in a crime, but do not have sufficient information to file charges. If you are a person of interest you should never speak to law enforcement without the benefit of legal representation.
A person of interest can quickly transition into the “subject” of a federal criminal investigation. Even though the federal entity (FBI, IRS, etc.) may tell you that you are not in trouble, but they want to speak to you, the subject of an investigation is one whose conduct is within the scope of a Grand Jury investigation. If the government has significant evidence linking you to a criminal act, then you become a “target.” If the FBI has a warrant for your arrest, it is highly likely a Grand Jury has already indicted you for the alleged criminal offense, or a Judge has already approved the criminal complaint against you.
Whether you are a witness, a person of interest, a subject, or a target of an insider trading investigation, the end result could be that you lose your career, your professional license, your financial security, and your personal liberty. Protect yourself and your future by discussing the situation with an experienced criminal defense attorney.