Rule 10b-5 of the Securities Act of 1934 prohibits trading stocks based on important, secret information in violation of a fiduciary duty. The US Supreme Court explains the fiduciary relationships important to this statue as “insider” and “outsider” relationships. The first sort of relationship is the touchstone the classic theory of insider trading. Secret information is traded between a corporate “insider” and the shareholders. The second sort of relationship underpins the “misappropriation theory”, where a corporate “insider” misappropriates secret information and transmits it to an “outsider” who then trades based on that information.
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Corporate insiders have a fiduciary duty to reveal that inside information to the shareholders if they intend to base their stock trades on that information, otherwise they must remain silent and not execute the trades. Courts have held that corporate insiders’ failure to disclose insider information to stockholders and trading on that information violates Rule 10b-5 and thus violates insider trading laws.
Can a person be held criminally liable for insider trading even if they only worked for a company for a short time? The classic theory of insider trading extends beyond the typical corporate insider. There are also temporary insiders and “tippees”. A temporary insider is somebody like a lawyer, insurance underwriter, bookkeeper, business efficiency expert, temporary executive, or other person who gains access to secret insider information. Those temporary insiders still hold a duty to either disclose their secret information or refrain from trading based on it.
A tippee is a person who executes trades based on the tips the receive from an insider. Under Rule 10(b) there are 5 elements that must be met in order for the a tippee to be found guilty of insider trading: 1) The tipper must have had secret information that was not available to the public 2) the tipper transferred the information to the tippee, 3) the tippee executed trades in the company’s securities while they possessed the secret information that was received from the tipper 4) the tippee knew or should have known that the tipper breached their fiduciary duty to the company by transferring the information. 5) the tipper gained or otherwise reaped some benefit from providing information to the tippee. It is especially important to note that although other parties may not be convicted of securities fraud criminally, without a willful violation of securities laws tippees may still be convicted even if they did not act willfully. A tippee triggers this lower threshold of intent by acting on information that they knew was provided in a transgression of the tipper’s fiduciary duty of secrecy. Despite this expansive view of who tippers and tippees are, courts and the Department of Justice still have a difficult time prosecuting insider trading of this type.
In the landmark case of United States v. O’Hagan the US Supreme Court harmonized the differences in the federal circuits on the issue of misappropriation theory and recognized it’s validity. The Supreme Court proscribed 4 elements to prove insider trading under the misappropriation theory, 1) a lie or deception 2) a transgression of a fiduciary obligation 3) the use of secret information in relation to a securities transaction 4) willfulness by the defendant. Illegally misappropriating secret information for one’s own benefit while pretending to be loyal to the company are violations of securities law. Lies of omission are therefore particularly important to the misappropriation theory. Misappropriation theory greatly expands the type of transactions that the government can prosecute for insider trading because of expansive fiduciary duties of corporate insiders. The vagueness of what constitutes insider trading can be unwieldly and difficult for a financial professional or investor to deal with. What may seem like an attractive and innocent way to make a bit of money can end up costing one their freedom.
If you have been accused of Insider Trading, violating Rule 10b-5 or another securities related criminal case, call our New York insider trading lawyers today to help you today. Our experienced New York insider trading lawyers may be able to help you get your charges reduced or dropped. Call us today for a free consultation.