No federal security law prohibits or defines insider trading per se. Rather, insider trading prohibitions have evolved from case law interpreting the various anti-fraud provisions of the Securities Exchange Act of 1934 (Exchange Act). Those provisions broadly prohibit trading in securities on the basis of material, non-public information (MNPI) with an intent to deceive (known as scienter) and in breach of a duty of trust or confidence. Because insider trading relies heavily on case law, many concepts change frequently and may be subject to a narrower or broader interpretation depending on the court and the specific facts of the case. Relevant statutes and regulations include:
- Section 10(b) of the Exchange Act, prohibiting manipulative and deceptive devices in connection with the purchase and sale of securities;
- Rule 10b5-1 of the Exchange Act, prohibiting the purchase or sale of a security of any issuer, on the basis of MNPI about that security or issuer, in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the MNPI;
- Rule 14e-3 of the Exchange Act, prohibiting insider trading in connection with tender offers;
- Section 20(a) of the Exchange Act, creating secondary control person liability over any entity that has control over another person engaged in insider trading;
- Section 17(a) of the Securities Act of 1933, prohibiting fraud in connection with the offer or sale (but not purchase) of securities;
- The Sarbanes-Oxley Act of 2002, prohibiting any director or executive officer of an issuer of any equity security from directly or indirectly trading any equity security of the issuer during a blackout period;
- Regulation Fair Disclosure (also known as Reg FD), prohibiting issuers from making selective disclosures; and
- The Stop Trading on Congressional Knowledge (STOCK) Act of 2012, prohibiting members of Congress and other government employees from trading based on MNPI obtained during the course of their duties.
Recently, legislators have pushed to expressly prohibit insider trading via statute. In April 2021, Representative James Himes (D-CT) introduced H.R. 2655, the “Insider Trading Prohibition Act,” which purports to codify the current law on insider trading as articulated by the courts. In May 2021, the House of Representatives passed the bill with bipartisan support, and it has since been referred to the Senate Committee on Banking, Housing, and Urban Affairs. If passed, the bill would prohibit securities trading, as well as related communications to others, by a person aware of MNPI. The bill further provides, for purposes of establishing a violation, that it is unnecessary for such a person to know specifically how such MNPI was obtained or whether a personal benefit was paid or promised.
Both the DOJ and SEC have jurisdiction to enforce insider trading regulations.
Generally speaking, liability for insider trading arises when:
(1) a person traded while in possession
(2) of material non-public information
(3) in breach of a fiduciary duty or other relationship of trust and confidence
(4) in exchange for value
(5) with knowledge and scienter.
Parties potentially liable for insider trading include the trader, the person who misappropriated the information, the person who provided the information (the tipper), the information recipient (the tippee), and the person (or entity) who controls a person who commits a violation.