Regulators like the Securities and Exchange Commission (SEC) have stepped up enforcement of insider trading in recent years, with New York Rep. Chris Collins the latest big name to face charges. According to prosecutors, Collins, who served as an independent director of Innate Immunotherapeutics Ltd., tipped his son, Cameron Collins, after receiving confidential information about negative clinical trial results.
While big names like Rep. Collins make the news, “regular” people are most often the targets of SEC enforcement. The majority of cases involve executives or employees of public companies who trade in anticipation of market-moving news (positive or negative) or provide nonpublic information to friends and family members (“tipper”). Because companies can sometimes be held liable for their employee’s misdeeds, it is essential to have comprehensive policies and procedures in place to monitor trading compliance.
Insider Trading Basics
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 trading on inside corporate information by persons bound by a duty of trust and confidence not to exploit that information for their personal advantage. 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 disclosure breached the tipper’s duty may be liable for securities fraud for undisclosed trading on the information.
Liability for Insider Trading
Insider trading violations can lead to costly 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. Criminal prosecution is also possible. The maximum prison sentence for an insider trading violation is now 20 years, while the maximum criminal fine is $5,000,000.
Companies can also face liability. 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 deemed to have direct or indirect control.
Entities who are deemed to be “controlling persons” of the violator face a civil penalty not to exceed the greater of $1,000,000 or three times the profit gained or loss avoided as a result of the violation. However, liability may only be imposed if the company knew or recklessly disregarded the fact that the controlled person was likely to engage in the acts constituting the insider trading violation and failed to take appropriate steps to prevent the acts before they occurred.
While prosecutions under the control person theory of liability are rare, insider trading can nonetheless cause significant harm to a company’s reputation. Accordingly, it is imperative to have a compliance plan in place.
Insider Trading Policies and Procedures
Companies should have policies and procedures in place that educate all employees about what constitutes material, nonpublic information and how to handle it. With regard to trading in the company, it should be clear that directors, officers and employees of the company may not pursue any transaction in the company’s securities if they possess material, nonpublic information about the company.
Given the intense scrutiny on insider trading by both state and federal authorities, corporate insiders should make sure that they understand what types of conduct cross the line after receiving access to significant, confidential corporate developments. At the same time, businesses should ensure that they have insider trading policies and training programs in place to monitor trading compliance.
One of the most effective approaches is to have the company’s legal counsel review and approve all insider trades to ensure that the trader doesn't possess insider information. Imposing “blackout periods” for insiders’ ability to make transactions also provides protection and can help avoid inadvertent insider trading violations.
Finally, it is important to emphasize that insider trading policies and procedures are not one-size-fits-all. They must be tailored to a company’s industry, operations, and employee structure.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Paul Lieberman, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.