There are two legal theories of insider trading recognized by the Securities and Exchange Commission: (1) the classical theory, and (2) the misappropriation theory.
Under the classical theory, corporate insiders, like officers, directors, and/or employees, violate the federal securities laws by trading in their company’s stock on the basis of material non-public information (MNPI) in breach of their fiduciary duty owed to their company and its shareholders. The core of this theory is that corporate insiders should not be able to capitalize on confidential information for personal gain at the expense of corporate shareholders.
Examples of insider trading under the classical theory are:
- Company Executives Trading on Unreleased Earnings Reports. A CEO is in possession of information that the company will report better-than-expected earnings in the upcoming quarter and purchases the company’s stock before the public release of the news fully expecting a sharp rise in the share price and the realization of substantial profits from when he sells into the news.
- Employee Trading on Upcoming Mergers or Acquisitions. An employee of a publicly traded company becomes aware through internal communication that the company will imminently be acquired by a competitor. Prior to the public release of the transaction, the employee purchases company shares of the acquiree anticipating its shares to increase and fully expecting to personally profit from it.
- Employee Trading Based on Pending, Non-Public FDA Clinical Drug Trial Results. An employee working for a pharmaceutical company learns of a new drug’s approval prior to its official announcement and buys options on the company’s stock, fully expecting the stock to spike on the release of the drug trial results.
Under the misappropriation theory, potential legal liability transcends traditional corporate insiders to include those individuals who came into possession of MNPI legally, but who then wrongfully trade upon it for personal financial benefit. For example, if an outside consultant lawfully acquires MNPI in connection with his work for a publicly traded company but then trades on it for personal gain, thus breaching his duty to the source of the information, he can be held liable for insider trading. The misappropriation theory is grounded in the law of agency, which is predicated upon the notion that agents should not exploit confidential information for their personal financial benefit.
Examples of insider trading under the misappropriation theory are:
- A Lawyer Trades on an Upcoming Corporate Merger or Acquisition. An attorney working on a corporate merger lawfully comes into possession of MNPI and, in breach of his duty to his law firm and client, trades on the upcoming, yet non-public merger news and personally profits. In the event the lawyer provides the MNPI to a close friend who, in turn, trades on it, then the lawyer (now a “tipper”) and his close friend (the “tippee”) can both be held liable for engaging in illegal insider trading, with the tipper responsible to pay back not only the trading profits he made, but those made by the tippee as well.
- A Family Member Who Obtains MNPI and Trades On It. A husband discusses with his wife an upcoming product launch at her technology company, and, without his wife’s knowledge, purchases company shares prior to the public release of the product launch. In that scenario, the husband misappropriated the MNPI from his wife who shared the information in the context of a relationship of trust and confidence never expecting the husband to use the inside information for trading purposes. (In fact, she fully expected that he would hold the information in confidence, not share it with others and certainly not trade on it). Under these facts, the husband may likely face SEC insider trading liability under a misappropriation theory, but the wife should not.
The SEC investigates and prosecutes under both theories of insider trading, which ensures that its legal net is sufficiently broad to capture those situations involving both traditional corporate insiders as well as outsiders who are entrusted with, but misuse, material, confidential information.
If you have received a SEC Subpoena for insider trading, contact insider trading attorney David Chase, Esq. of the Law Firm of David R. Chase. David, an SEC defense attorney, has achieved numerous successful results for his clients under SEC investigation for more than twenty-five years after having worked at the SEC’s Enforcement Division as a Senior Counsel. You may contact David at: 800-760-0912 or e-mail him at: david@davidchaselaw.com. Visit the Firm’s website for valuable content and to review the firm’s prior successful SEC defense results at: www.securitiesfrauddefense.net. Legal representation is available nationwide, including St. Louis, Phoenix, Atlanta, Dallas or Boca Raton.
