One of the foundational elements the Government must prove in an insider trading case is called materiality.  The Government must demonstrate that the information used to execute the trade was “material” — meaning there was a substantial likelihood that a reasonable investor would consider it important when making a decision to buy or sell securities.  Classic examples of “material information” are a corporate acquisition, quarterly earnings results, or FDA drug approvals or rejections.

Defense Strategy: If the information traded upon is too vague, speculative, or insignificant, then it may not meet the required threshold of materiality.  For example, if the non-public information merely pertained to internal, preliminary discussions in the absence of final determinations, or if access to financial numbers was early on and not definitively indicative, such information can be argued to be immaterial and thus would not support a meritorious insider trading charge.  

Another viable defense is demonstrating that the individual accused of insider trading did not actually possess the alleged material, non-public information at the time the trade was executed.

Defense Strategy: his can be proven in a variety of ways:

• Showing that the information was not communicated to the individual.
• Establishing that the accused had no access to relevant internal documents or conversations.
• Demonstrating that the trade occurred before the information was obtained.

If the individual did not know or could not have known the inside information at the time of the transaction, the SEC’s insider trading theory collapses.

In some situations, the “material” information that the SEC claims was “non-public” had, in fact, already been made publicly available through legitimate channels, such as investor forums, blogs, social media, podcasts, press releases, earnings calls, SEC filings, or the financial media.

Defense Strategy: By compiling documentary evidence showing that the information was already disseminated through public sources prior to the trade, this defense can be powerful. If the government cannot establish that the trade was based on exclusive, non-public information, then the claim of insider trading fails.

Intent, also legally referred to as scienter, is another crucial element in proving an insider trading case. The SEC must show that the accused acted with the intent to defraud by trading on the material, non-public information and knowingly, or extremely recklessly, breached a duty in so doing.

 Defense Strategy: A strong, viable defense is that the trade was done pursuant to a rational trading strategy (particularly if there is a history of doing so), or assessment of the company’s fundamentals (including price and empirical movements).  From this, the defense may argue that the trader acted in good faith, lacked fraudulent intent, and was unaware of the inside information, thus raising serious litigation risks for the Government in its prosecution.

The mosaic theory is based on the concept that a savvy investor can intelligently draw conclusions from piecing together data points of public and non-material, non-public information (thus creating a “mosaic” of information), upon which he will then make his trading decision(s). 

Defense Strategy:  If it can be shown that, for example, a trader’s investment decision resulted from analyzing a combination of earnings reports, industry trends, analyst calls, and other publicly available data – and not material, non-public information — then the SEC’s theory is legally baseless.  The mosaic theory defense advances the notion that the decision-making behind the suspicious trade was legitimate, grounded in technical research and deduction, and thus not illegal.

SEC Rule 10b5-1 provides a defense for individuals who set up pre-scheduled trading plans before they acquire material, non-public information.  By design, these plans allow corporate insiders to make trades on a predetermined schedule, even if they later come into possession of inside information.

Defense Strategy: If the accused had an active and valid 10b5-1 plan in place before gaining access to any inside information, trades executed under that plan may be shielded from liability. However, it is important to note that the SEC recently imposed stricter requirements on 10b5-1 plans, including mandatory cooling-off periods and enhanced disclosure obligations.