If you are under investigation by the SEC for insider trading, you likely have serious concerns and many questions.
This article explains how insider trading investigations typically work, what the SEC looks for, and how an experienced defense lawyer can protect your interests during the investigation.
I spent years investigating insider trading cases as Senior Counsel in the SEC’s Division of Enforcement. In private practice, I have spent the last 25 years defending individuals in SEC insider trading investigations. Having worked on both sides of these cases, I have developed a unique perspective on how the SEC identifies, investigates, and evaluates potential insider trading violations. I leverage this knowledge to protect my clients to seek them being charged.
Below are answers to some of the most common questions concerning SEC insider trading investigations.
What Is Insider Trading?
At its core, insider trading involves buying or selling a security while possessing material,non-public information about that security from a source that the trader knows breached a fiduciary duty in providing it.
Although the federal securities laws do not contain a single statutory definition of “insider trading,” courts have developed two primary theories:
- Classical insider trading
- Misappropriation theory
Classical Insider Trading
The classical theory generally applies to corporate insiders who obtain material, non-public information through their employment and owe fiduciary duties to the company and its shareholders.
For example, suppose a CEO learns that his company will soon announce unexpectedly strong earnings. If he tips a friend with the expectation that the friend will trade and the CEO receives a personal benefit from providing the information, the CEO may be considered the tipper and the friend, the tippee.
If the friend subsequently passes the information to another person who trades, the chain can continue through so-called remote or downstream tippees.
Misappropriation Theory
The misappropriation theory generally applies to individuals outside the company who obtain material, non-public information legally through a relationship involving a duty of trust or confidence.
For example, a lawyer representing a client in a corporate takeover may learn confidential information about the transaction. If the lawyer uses that information to trade in the target company’s stock for personal benefit, the lawyer may violate the securities laws by misappropriating the information.
Insider Trading Is Often a Gray Area
Insider trading may sound straightforward, but these cases are often highly fact-intensive and legally complex. The SEC frequently must prove its case through circumstantial evidence rather than direct evidence of a tip or agreement.
That complexity creates critical opportunities for sec defense counsel.
What Are the Consequences of Insider Trading? Can I Go to Jail?
Yes. Insider trading can result in both civil and criminal consequences.
The SEC is a civil federal law enforcement agency and does not itself prosecute criminal cases. However, the SEC can and does refer matters to criminal authorities, typically the Department of Justice, for potential investigation and prosecution.
Potential SEC Civil Remedies
In an insider trading case, the SEC may seek:
- An injunction prohibiting future violations of the federal securities laws
- Disgorgement of profits or losses avoided
- Prejudgment interest
- Civil penalties
- For securities professionals, suspension or a permanent bar from the securities industry
Criminal prosecution can also result in incarceration.
For that reason, even an investigation that initially involves only the SEC must be handled carefully and strategically. Defense counsel must consider not only the potential SEC case, but also whether particular actions taken in it could increase or lessen the risk of a criminal referral.
Where Does the SEC Get Insider Trading Leads?
The SEC receives insider trading leads from many sources, including:
- Market surveillance, including ARTEMIS (Advanced Relational Trading Enforcement Metric Investigation System)
- FINRA referrals
- Market professionals
- Whistleblowers
- Anonymous complaints
- Press reports
- Disgruntled employees
- Other individuals or entities familiar with the trading
How Does the SEC Conduct an Insider Trading Investigation?
Although every investigation is different, the SEC often follows a similar process.
- The SEC Reviews the Trading
After receiving a lead, SEC staff will typically examine the trader’s records and reconstruct the timeline leading up to the relevant corporate announcement.
The SEC will look at such issues as:
- When the trade occurred
- The size and nature of the trade
- Communications between the trader and potential sources of information
- Prior trading activity
- The trader’s relationship with corporate insiders or other potential sources of information
- The SEC May Make an “Ambush Call”
The SEC may unexpectedly contact the trader and ask why the trades were made.
These calls can be particularly legally perilous because the trader may be unrepresented by counsel and unprepared for detailed questioning. Statements made during the call can and will likely later become important evidence used against the trader.
If the SEC contacts you about suspected insider trading, you should consult an experienced SEC insider trading defense lawyer before answering substantive questions.
- The SEC May Request or Subpoena Documents
Depending on the circumstances, the SEC may seek documents such as:
- Trading and brokerage records
- Bank records
- Telephone and cell phone records
- Text messages
- Emails
- Calendars and day planners
- Documents explaining the reasons for the trades
- Internet search history
- The SEC May Take Sworn Testimony
The SEC may require the trader to appear for testimony under oath.
Questions may concern:
- The trader’s securities trading history
- The reasons for the trades
- Relationships with corporate insiders
- Communications with potential sources of inside information
- The trader’s financial circumstances
- Communications with other traders or tippees
A trader’s attorney is permitted to attend the testimony to protect applicable privileges, object when appropriate, seek clarification, and protect the client’s interests throughout the proceeding.
- The SEC Investigates Other Individuals
The SEC may also interview or subpoena information from:
- Corporate insiders
- Financial advisors
- Business associates
- Friends or family members
- Other individuals who possessed the information
- Individuals who communicated with the trader
The SEC may also obtain a chronology from the company describing who knew the material, non-public information, when they learned it, how they learned it, and with whom they shared it.
The SEC can then compare that information with the identities of people who traded before the public announcement.
What Happens When the SEC Completes Its Investigation?
After reviewing documents and testimony, SEC staff will evaluate whether charges should be brought.
If the SEC does not intend to recommend charges, it may send defense counsel a letter stating that it does not presently intend to recommend enforcement action. Such a letter reserves its right to reconsider its position later.
What Is a Wells Notice?
If SEC staff believes there is sufficient evidence to recommend charges, it may issue a Wells Notification, advising the target that the staff intends to recommend enforcement action.
The target then has an opportunity to respond through a written or oral Wells submission, explaining why the proposed charges should not be brought or, in the alternative, lesser charges.
The Wells process can be a critical opportunity for defense counsel to identify weaknesses in the SEC’s case before a lawsuit is filed.
I have successfully persuaded SEC staff at the Wells stage not to pursue charges. Although this is challenging—particularly after the SEC has invested substantial resources in an investigation—it can be done.
What If the SEC Brings a Lawsuit?
If SEC staff remains persuaded that enforcement action is appropriate and the matter is not settled, the SEC may seek authorization to file a civil action in federal court.
At that point, the individual becomes a named defendant and can defend the case through the litigation process, including:
- Obtaining documents and evidence
- Taking depositions
- Challenging the SEC’s evidence
- Presenting defenses
- Ultimately trying the case before a jury when appropriate
Insider trading cases can be difficult for the SEC to prove at trial, particularly when the case depends primarily on circumstantial evidence rather than recordings, communications, or cooperating witnesses, i.e. direct evidence.
Should I Talk to the SEC or Assert My Fifth Amendment Rights?
It depends on the facts. One of the most important strategic decisions in an SEC investigation is whether to speak with the SEC or assert the Fifth Amendment privilege against self-incrimination.
Every individual has a constitutional right to invoke the Fifth Amendment. But there can be significant consequences as well as advantages for doing so in a civil SEC investigation.
Unlike in a criminal prosecution, the SEC may draw a negative inference from the assertion of the Fifth Amendment.
At the same time, making false statements to the SEC during an official investigation can create criminal exposure.
However, if the trader asserts the Fifth Amendment, it may make it harder for the SEC to prove its case.
The decision whether to speak or invoke the Fifth Amendment therefore requires a careful, fact-specific analysis of the potential civil and criminal consequences.
Be Very Careful During an SEC Insider Trading Investigation
Individuals under SEC investigation must be extremely careful about their communications and conduct during the investigation.
Statements or actions taken after the trading occurred can themselves become evidence. In some circumstances, conduct during an investigation can lead to what I refer to as “process violations”—separate offenses such as obstruction of justice, witness tampering, or perjury.
- Do Not Discuss the Investigation Without Counsel
As a general matter, an individual under investigation should avoid discussing the investigation with anyone other than his or her attorney.
Communications with counsel are protected by the attorney-client privilege, subject to important exceptions. Communications with other individuals are not protected and may later become discoverable and used against you.
Particularly risky are communications with individuals who participated in the trading or may have knowledge of the underlying events.
In many situations, the most prudent strategic course is to stop talking about the investigation except with counsel.
- Preserve All Documents and Communications
Do not destroy, alter, delete, or conceal potentially relevant documents or electronic communications.
This includes:
- Emails
- Text messages
- Phone records
- Trading records
- Financial records
- Calendars
- Paper documents
- Other electronic communications
The SEC may ask detailed questions about document preservation and the steps taken to locate responsive records.
Deleting or altering relevant documents can create serious additional legal exposure. Lying to the SEC about document preservation can create additional criminal exposure as well.
Importantly, individuals have faced criminal consequences for conduct during an SEC investigation—even when the underlying insider trading allegations did not result in civil charges.
What Does the SEC Consider When Evaluating an Insider Trading Case?
The SEC will examine numerous factors, including:
- Is There a Link to a Source of Inside Information?
This is often the most important question.
The SEC will look for evidence connecting the trader to someone who possessed the material, non-public information.
That evidence may include:
- Telephone calls
- Text messages
- Emails
- Physical meetings
- Personal or business relationships
- Timing of communications and trades
- Testimony from witnesses
In many cases, there is no direct evidence of a tip. The SEC must instead build its case through circumstantial evidence.
- How Close Were the Trades to the Public Announcement?
The timing of the trade can be important.
Trading shortly before a major corporate announcement may strengthen the SEC’s inference that the trader possessed inside information. A longer period between the trade and announcement may provide a potential alternative explanation, depending on when the information became known.
- Did the Trader Have a History of Trading the Stock?
Prior trading history may provide an alternative explanation for the transaction.
For example, a trader who regularly trades a particular company stock based on publicly available information may have a more credible explanation for a transaction than someone who suddenly makes an unusual, one-time trade immediately before a major announcement.
- How Much Money Was at Risk?
The SEC may examine the size of the trade relative to the trader’s financial resources.
An investment that represents a substantial percentage of the trader’s available assets may strengthen the SEC’s inference that the trader possessed inside information.
- Whose Account Was Used?
The SEC may scrutinize trades placed through accounts that do not appear to belong to the trader.
Trading through another person’s account or an entity that obscures the trader’s identity may be viewed as evidence of an attempt to conceal the trading.
- Were Options Used?
Options transactions can receive particular scrutiny because of their leverage and potentially speculative nature.
The SEC may examine:
- Whether calls or puts were purchased
- The expiration dates
- Whether the options were in or out of the money and, if so, how far
- The size of the position
- The amount of price movement required to make the trade profitable
- Is the Trader’s Explanation Credible?
Ultimately, the SEC will assess whether it believes the trader’s explanation for the transaction.
Credibility can be critical. Even when the SEC’s circumstantial evidence is substantial, a credible, documented alternative explanation for the trade can affect the staff’s assessment of the case.
My Experience Defending SEC Insider Trading Investigations
In my over 25 years of defending insider trading investigations nationwide, I have found that understanding how the SEC investigates these cases—and what the SEC considers weaknesses in its own theory—can make a significant difference in the outcome.
What makes an effective defense to insider trading?
- A credible alternative explanation for the trading
- A history of similar trading activity
- Weaknesses in the alleged chain of information
- Inconsistencies in the timeline
- Lack of evidence connecting the trader to a source of inside information
- Problems with the credibility of witnesses
- Other gaps in the SEC’s circumstantial case
- Old conduct
The objective is to identify those weaknesses before the investigation progresses to an enforcement action.
My experience as a former SEC Enforcement Division attorney provides me with a unique perspective on these cases. Having investigated insider trading from inside the SEC and subsequently defended individuals under investigation, I understand both how the SEC builds insider trading cases and how those cases can be challenged. This allows me to best protect my clients.
