For corporate executives and others wondering “Is insider trading a felony,” the short answer is yes. Insider trading violations are often criminally prosecuted as felonies. Accordingly, the penalties can be extremely serious, leading not only to professional and financial ruin but also significant jail time.
Insider trading is the trading of a public company's stock or other securities based on material, nonpublic information about the company. Specifically, Section 10(b) of the Securities Exchange Act of 1934 and the Securities and Exchange Commission's Rule 10b–5 prohibit undisclosed trading on inside corporate information by persons bound by a duty of trust and confidence not to exploit that information for their personal advantage.
Under the classical theory of insider trading, corporate insiders violate federal anti-fraud regulations by trading in the securities of their own company on the basis of material, non-public information in breach of their duty owed to the company. Corporate insiders include the officers, directors, and employees, as well as fiduciaries who work for the corporation, such as attorneys and accountants.
Corporate insiders are also prohibited from sharing inside information to others for trading. An individual who receives such information (often called a “tippee”) with the knowledge that its disclosure breached the tipper's duty may also be liable for securities fraud for any undisclosed trading on the information. Under the misappropriation theory of insider trading, corporate outsiders may be held liable for trading based on material, nonpublic information obtained in breach of a duty owed to the source of the information.
Big names that have faced allegations of insider trading include Martha Stewart, former Enron President Jeffrey Skilling, and golfer Phil Michelson. Most targets of insider trading, however, are everyday people. Cases frequently involve executives or employees of public companies who trade in anticipation of market-moving news or pass along nonpublic information to friends and family members. For example, the husband of a former BP merger and acquisitions manager pleaded guilty to securities fraud relating to insider trading based upon information he obtained by eavesdropping on his wife's private work calls. And with the post-COVID remote/hybrid work environment, these “at-home breaches” are likely to become far more commonplace.
In order to successfully prosecute a case of insider trading, prosecutors must generally be able to prove the following elements beyond a reasonable doubt:
- The defendant engaged in an actual purchase or sale of a security: This element is often not in dispute because monthly account statements and trade confirmations can be used to readily establish whether or not a security was purchased or sold. However, the element has become more relevant as regulators expand the prosecution of insider trading to digital assets, such as cryptocurrency and non-fungible tokens (NFTs). In 2022, the Securities and Exchange Commission (SEC) and Department of Justice (DOJ) brought their first action involving digital assets, charging Nathanial Chastain, a former product manager at Ozone Networks, Inc. d/b/a OpenSea (OpenSea), with wire fraud and money laundering in connection with a scheme to commit insider trading in NFTs by using confidential information about what NFTs were going to be featured on OpenSea's homepage for his personal financial gain.
- The defendant was in possession of material non-public information: Prosecutors must prove that the defendant was in possession of the material, non-public information, but not necessarily that the information served as the basis of the trade.
- The information was material: Nonpublic information is material if there is a substantial likelihood that a reasonable investor would consider it important in making investment decisions. Examples include a change in company leadership, financial performance data, an upcoming merger or acquisition, and the release of a new product/service.
- The information was non-public: Information is “nonpublic” until it has been disseminated or is generally available to the marketplace.
Insider trading cases are notoriously complex and challenging to prove. Defendants facing insider trading charges can raise several defenses. To start, because individuals may only be criminally prosecuted for insider trading if they committed a “knowing or willful” violation of the securities laws, defendants can assert that they lacked the required intent. Trades may also be legal if they were made pursuant to a pre-existing plan to trade securities or contractual obligations for trading. Another available defense is that the information was not material and/or already public.
Insider trading violations can lead to significant civil and criminal liability. Individuals who violate insider trading laws may be forced to disgorge any profits gained or losses avoided. They may also be subject to a civil penalty in an amount up to three times the profit gained or loss avoided as a result of the insider trading violation.
Companies can also face liability for insider trading. Section 15(f) of the Exchange Act and Section 204 of the Investment Advisors Act impose affirmative obligations on broker-dealers and investment advisors to adopt, maintain, and enforce policies and procedures intended to prevent illegal insider trading. Public companies may be subject to insider trading penalties for violations by persons that they have been deemed to have directly or indirectly controlled.
Criminal prosecution is also possible and has become more prevalent in recent years, with the DOJ making white collar criminal prosecutions a priority. The maximum prison sentence for an insider trading violation is now 20 years, while the maximum criminal fine for individuals is $5,000,000. The maximum criminal fine for non-natural persons (such as an entity whose securities are publicly traded) is $25,000,000.
Allegations of insider trading can result in serious consequences, including criminal prosecution, civil liability, or both. To reduce the risk of serious insider trading penalties, you need an experienced attorney in your corner who not only understands the complexity of the charges but will fight tirelessly on your behalf. Scarinci Hollenbeck's white collar criminal defense attorneys can provide experienced representation through all phases of an insider trading case, including investigations, trials, and appeals. We have successfully defended businesses, individuals, and corporate executives facing criminal allegations by various agencies, including the Securities and Exchange Commission, U.S. Attorneys' Offices, and the U.S. Department of Justice.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
