Understanding Insider Trading: Definition, Laws, and Compliance

Insider trading is a term that often surfaces in discussions about financial markets and regulations. It refers to the trading of a company’s securities by individuals who have access to confidential or material nonpublic information about the company. Taking advantage of this privileged access is considered a breach of the individual’s fiduciary duty.

Who is an Insider?

Federal law defines an “insider” as a company’s officers, directors, or someone in control of at least 10% of a company’s equity securities. A company is required to report trading by corporate officers, directors, or other company members with significant access to privileged information to the Securities and Exchange Commission (SEC).

Classical Theory of Insider Trading

Under the classical theory of insider trading, insiders who “tip” friends about material nonpublic information that may influence the company’s publicly traded stock price may be liable. Because friends do not satisfy the definition of an insider, a problem arose regarding how to prosecute these individuals. Today, a friend who receives such a tip has the same duty as the insider imputed onto them.

In other words, a friend may not make a trade based upon that privileged information. Failure to abide by the duty constitutes insider trading and creates grounds for liability. The person receiving the tip, however, must have known or should have known that the information was company property to be convicted.

Dirks v. SEC: Supreme Court decision regarding this type of insider trading. In Dirks, the Court held that a prosecutor could charge tip recipients with insider trading liability if the recipient had reason to believe that the disclosure of such information violated another’s fiduciary duty and if the recipient personally gained from acting upon the information. Dirks also created the constructive insider rule, which treats individuals working with a corporation on a professional basis as insiders if they come into contact with non-public information.

Misappropriation Theory of Insider Trading

The emergence of the misappropriation theory of insider trading in O’Hagan has paved the way for the passage of 17 CFR 240.10b5-1, which permits criminal liability for an individual who trades on any stock based upon the misappropriated information. Previously, the prosecutor could only charge the insider if the stock of the insider’s company had been traded.

The misappropriation theory of insider trading is referenced in United States v. O’Hagan, 521 U.S. 642 (1997).

SEC Monitoring and Compliance Tools

While proving insider trading can be difficult, the SEC actively monitors trading, and reviews for suspicious activity.

To ensure compliance and governance, comprehensive platforms provide essential tools for investor relations, including:

• Simplify shareholder management.
• Robust insider list management.
• Employee trade monitoring tools.
• Secure reporting channels.
• LEI solutions.
• Advanced reputation management and crisis response tools.

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