Is Insider Trading A Felony? Legal Insights - Securities - United States (2024)

For corporate executives and others wondering “Is insidertrading a felony,” the short answer is yes. Insider tradingviolations are often criminallyprosecuted as felonies. Accordingly, thepenalties can be extremely serious, leading not only toprofessional and financial ruin but also significant jail time.

Insider trading is the trading of a public company's stockor other securities based on material, nonpublic information aboutthe company. Specifically,Section 10(b) of the Securities Exchange Act of1934and theSecurities and Exchange Commission's Rule10b–5prohibit undisclosed trading on insidecorporate information by persons bound by a duty of trust andconfidence not to exploit that information for their personaladvantage.

Under the classical theory of insider trading, corporateinsidersviolate federal anti-fraud regulations by trading inthe securities oftheir own companyon the basis ofmaterial, non-public information in breach of their duty owed tothe company.Corporate insiders includethe officers,directors, and employees, as well as fiduciaries who work for thecorporation, such as attorneys and accountants.

Corporate insiders are also prohibited from sharing insideinformation to others for trading. An individual who receives suchinformation (often called a “tippee”) with theknowledge that its disclosure breached the tipper's duty mayalso be liable for securities fraud for any undisclosed trading onthe information. Under themisappropriationtheoryofinsider trading, corporate outsiders may be held liable fortrading based on material, nonpublic informationobtained inbreach of a duty owed to the source of the information.

Big names that have faced allegations of insider trading includeMartha Stewart, former Enron President Jeffrey Skilling, and golferPhil Michelson. Most targets of insider trading, however, areeveryday people. Cases frequently involve executives or employeesof public companies who trade in anticipation of market-moving newsor pass along nonpublic information to friends and family members.For example, the husband of a former BP merger and acquisitionsmanager pleaded guilty to securities fraud relating to insidertrading based upon information he obtained by eavesdropping on hiswife's private work calls. And with the post-COVIDremote/hybrid work environment, these “at-homebreaches” are likely to become far more commonplace.

In order to successfully prosecute a case of insider trading,prosecutors must generally be able to prove the following elementsbeyond a reasonable doubt:

• The defendant engaged in an actual purchase or sale ofa security:This element is often not in disputebecause monthly account statements and trade confirmationscanbe used to readily establish whether or not a security waspurchased or sold. However, the element has become more relevant asregulators expand the prosecution of insider trading to digitalassets, such as cryptocurrency and non-fungible tokens (NFTs). In2022, the Securities and Exchange Commission (SEC) and Departmentof Justice (DOJ) brought their first action involving digitalassets, charging Nathanial Chastain, a former product manager atOzone Networks, Inc. d/b/a OpenSea (OpenSea), with wire fraud andmoney laundering in connection with a scheme to commit insidertrading in NFTs by using confidential information about what NFTswere going to be featured on OpenSea's homepage for hispersonal financial gain.
• The defendant was in possession of material non-publicinformation: Prosecutors must prove that thedefendant was in possession of the material, non-publicinformation, but not necessarily that the information served as thebasis of the trade.
• The information was material: Nonpublicinformation is material if there is a substantial likelihood that areasonable investor would consider it important in makinginvestment decisions.Examples include a change in companyleadership, financial performance data, an upcoming merger oracquisition, and the release of a new product/service.
• The information was non-public:Information is “nonpublic” until it has beendisseminated or is generally available to themarketplace.

Insider trading cases are notoriously complex and challenging toprove. Defendants facing insider trading charges can raise severaldefenses. To start, because individuals may only be criminallyprosecuted for insider trading if they committed a “knowingor willful” violation of the securities laws, defendants canassert that they lacked the required intent. Trades may also belegal if they were made pursuant to a pre-existing plan to tradesecurities or contractual obligations for trading. Anotheravailable defense is that the information was not material and/oralready public.

Insider trading violations can lead to significantcivilandcriminal liability. Individuals whoviolate insider trading laws may be forced to disgorge any profitsgained or losses avoided. They may also be subject to a civilpenalty in an amount up to three times the profit gained or lossavoided as a result of the insider trading violation.

Companies can also face liability for insider trading.Section 15(f) of the ExchangeActandSection 204 of the Investment AdvisorsActimpose affirmative obligations on broker-dealers andinvestment advisors to adopt, maintain, and enforce policies andprocedures intended to prevent illegal insider trading. Publiccompanies may be subject to insider trading penalties forviolations by persons that they have been deemed to have directlyor indirectly controlled.

Criminal prosecution is also possible and has become moreprevalent in recent years, with the DOJ makingwhite collar criminalprosecutionsa priority. The maximum prison sentence foran insider trading violation is now 20 years, while the maximumcriminal fine for individuals is $5,000,000. The maximum criminalfine for non-natural persons (such as an entity whose securitiesare publicly traded) is $25,000,000.

Allegations of insider trading can result in seriousconsequences, including criminal prosecution, civil liability, orboth. To reduce the risk of serious insider trading penalties, youneed anexperienced attorneyin your cornerwho not only understands the complexity of the charges but willfight tirelessly on your behalf. Scarinci Hollenbeck's whitecollar criminal defense attorneys can provide experiencedrepresentation through all phases of an insider trading case,including investigations, trials, and appeals. We have successfullydefended businesses, individuals, and corporate executives facingcriminal allegations by various agencies, including the Securitiesand Exchange Commission, U.S. Attorneys' Offices, and theU.S. Department of Justice.

The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circ*mstances.

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