With insider trading back in the news, is it time to revisit your insider trading policy?06.14.18
Recent insider trading charges are shining a renewed spotlight on the need for companies to take a fresh look at their insider trading policies.
On May 31, 2018, the SEC issued a press release announcing that it has filed civil charges against an executive of a bulge bracket investment banking firm in an insider trading scheme based primarily on the “misappropriation theory” of insider trading. On the same day, the FBI and the U.S. Attorney for the Southern District of New York announced the arrest of this executive and the unsealing of the criminal complaint filed against him.
General Legal Framework of Insider Trading
Trading on material, non-public information is unlawful if it is in breach of a duty of trust or confidentiality that is owed directly, indirectly, or derivatively to a company, a company’s shareholders, or the source of the information. Generally, the legal framework of insider trading can be broken down into three principal types:
- “Traditional/Classical” where an insider trades securities in breach of his or her duty to disclose or abstain from trading while in possession of material, non-public information.
- “Misappropriation Theory” where a corporate outsider (e.g., investment banker, accountant, attorney) misappropriates a company’s confidential information for securities trading purposes, in breach of a duty owed to the source of the information.
- “Tippers/Tipees” where a corporate insider passes material, non-public information to others who then trade on that information. This practice, known as “tipping,” involves providing material, non-public information to any person who might be expected to trade while in possession of that information. Similarly, the “tippee,” or person who receives the inside information from a tipper will be held liable for insider trading.
Why Do You Need an Insider Trading Policy?
Regulated entities such as broker-dealers and investment advisers are required under federal securities laws to adopt, maintain, and enforce policies and procedures to prevent insider trading. However, what about companies engaged in businesses not required by law to have insider trading policies? Although it is obvious corporate employees are subject to liability for insider trading, the SEC may also impose liability on employers who “control” securities law violators. The term “control” has been broadly defined and is likely to include corporate employers, employees who have supervisory authority, controlling shareholders, and parent corporations. In addition to the bad press that will likely be generated if one of your employees were to be successfully prosecuted for insider trading, the SEC may also turn its attention to your company and other “control persons.”
The good news is that “controlling persons” may avoid liability by demonstrating that they acted in good faith and did not directly or indirectly induce the securities law violator. In other words, an insider trading policy, if effectively implemented, can not only minimize the likelihood that insider trading will occur within your organization, it can provide companies with a good faith defense against controlling person liability for any securities law violations committed by your employees. Further, the existence of an insider trading policy can be a mitigating factor in the sentencing phase of a criminal proceeding as evidence of the corporate employer’s efforts in seeking to prevent or detect insider trading.
Therefore, your insider trading policy can be an important tool designed to protect both the company and your employees. Companies should ensure that all employees, not just those subject to pre-clearance or blackout periods, fully understand corporate insider trading policies and the types of transactions that are prohibited. Although these exercises can potentially require a meaningful amount of time and resources, annual compliance certifications and periodic internal training courses can serve to bolster the effectiveness of your insider trading controls.
Photo By I, Aude, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=2438142