Imagine you have a cool new social-media job, at a hot baby tech company, charged with coming up with the next ironic Tumblr meme. This morning, while skateboarding past the mini-golf conference room, you get brought in for a few holes to consult on the likely 4chan backlash from the company accepting the offer recently made by Big Tech Giant.com, Inc. that is going to make everyone, from the 17 year old founder to the guy whose job it is to Flavor-aid the water-cooler, billionaires.[pullquote_left]You need to have a walking around knowledge of what insider trading is, who can be liable and how you avoid even the appearance of inappropriate conduct.[/pullquote_left]
What are you going to do now that you are one of the few people outside of the board of directors to have this bit of information? Post the news in your anonymous (*wink, wink*) secret sharing app to let those in your circle know of your impending wealth and greatness? Do you call Uncle Jose, the day-trader, to brag about the awesome trajectory your career is likely to take once Big Tech Giant gets a load of your skills? Do you make sure you drop the info into every conversation you have with vendors, mail carriers, and guy who sells you toner (you’re going to need a lot of toner) so that they know how well placed and important you are? Do you dial up your E-trade app and short the stock of Big Tech Giant—because, as sure as death and taxes, the acquirer in a merger has their stock drop?
Whether you are a corporate insider, a toner salesman (transactional lawyer), or the Uncle of corporate insider (or his personal trainer), receiving confidential information about a publicly traded company can expose you to serious criminal and civil liability—and you don’t even have make any money or intend to break any law. Responding to the Securities and Exchange Commission (“SEC”), the Department of Justice (those guys in blue jackets arresting you in your boxer shorts in front of your crying wife, terrified children and iPhone video-graphing neighbors) is a serious and expensive proposition. No matter how the case is resolved the consequences can be a ruined career, a failed marriage and amateur prison tattoos. You need to have a walking around knowledge of what insider trading is, who can be liable and how you avoid even the appearance of inappropriate conduct.
Insider trading refers to three ways in which a person may become liable for civil or criminal violations of United States securities laws. The first is classic theory insider trading, where a corporate insider trades securities of his corporation based on material, non-public information. Like the social media consultant in our story, a person, through their employment learns of information they use to gain a competitive advantage against the market, trading and profiting from it. That shorting of Big Tech Giant’s stock is an example of classic insider trading, but it is by no means the only way.[pullquote_right]If you have information that the market doesn’t based on your duty (contract, legal, equitable, spiritual, mystical, comical, or otherwise) to the source of that information—that’s it, you can’t trade on it.[/pullquote_right]
The second theory of insider trading liability is the misappropriation theory. A person who trades on the basis of material, non-public information in breach of a duty owed to the source of the information is liable for misappropriating the information for their own purposes. A company’s confidential information is their property, to which they have the exclusive right to use. This is where our toner salesman can become exposed. He gets a new large order for toner, and because he has familiarized himself with the company from public sources and from conversations with employees he has gained an insight on what toner orders can mean is occurring within the company—and he trades based on that insight, and his inside knowledge of toner orders. He has misappropriated the company’s confidential information for his own use. You think this is gray area? You think you’re just smarter and that’s why you have the world figured out? If you have information that the market doesn’t based on your duty (contract, legal, equitable, spiritual, mystical, comical, or otherwise) to the source of that information—that’s it, you can’t trade on it.
The third theory of insider trading liability is the tipper/tippee theory of liability. When a person in possession of confidential information breaks their duty (however formed) and discloses it to another they are in effect stealing that information and misappropriating for their own use, even if they do not trade on it themselves. The receiver, may be liable by through their duty to the tipper, and breaks their confidence when they trade on the confidential information or tip it to another. This can create a chain of tippers and tippees, each link carrying liability for violations of the law and passing it along to next person.
Our toner salesman, mentions to his wife that he was going to pitch a new darker black toner to the general counsel of Tech Baby, Inc. for use on their contracts and legal memoranda, but right before the pitch the general counsel got was called away on important business. The wife then buys as much as Tech Baby, Inc.’s stock as she can afford (not much, as the toner industry has been devastated by the continued economic down turn combined with the emergence of technologies that make a paperless office practical), believing the general counsel’s absence indicated that the company is about to be acquired by a large tech company boosting Tech Baby Inc.’s stock through the roof—what else could pull someone away from such an important meeting? The wife was right, and her purchase and subsequent sale of Tech Baby, Inc. stock saves the family by paying the overdue mortgage, capitalizes the retooling of the family toner businesses into smart refrigerator software development and all the kids get to buy new shoes this year (one even gets money to take college entrance exams with the added bonus of the requisite quantity of number two pencils). Toner salesman is exposed to liability as tipper, wife as a tippee. You think this is gray area? Do you want to litigate this to find out? Have your life, liberty, and property depend upon it? Have your marriage depend upon it? Spend your life savings, mortgage your house, and ruin your financial future—even if you are right, for the privilege of litigating this?
Easy rule: If you possess material inside information, regardless of the source, do not trade on it. Is it material? Materiality means that the inside information would change the way a hypothetical investor would see the total mix of information. Would you taste it in the stew? If you are using it trade, then it is material. Our hypothetical investor lets all kinds of information change the way she views the total mix–she is not very discerning at all. If the inside information is floating inside your brain entering from your eyes, ears, taste, touch, or faith-healer, then you possess it and are using it—the SEC/FBI do not mind-read, they assume you are using it if you have it, and the courts let them. [pullquote_left]If the inside information is floating inside your brain entering from your eyes, ears, taste, touch, or faith-healer, then you possess it and are using it—the SEC/FBI do not mind-read, they assume you are using it if you have it, and the courts let them.[/pullquote_left] But you are really smart, and understand the industry like no one else, and the information as special meaning to you because of your own research and super-corduroy-smarty-pants? Does it mean something to the mix of information? Do you want to really want to pay to litigate this?
Gordon Gekko, tells us that greed is good. The desire to accumulate wealth motivates us, rewards us, and drives the Baker to create high-carb goodies. We recognize Jobs’ brilliance by Apple’s balance sheet and cheer Google’s genius using the proof of the founders’ billionaire status. In the movie Wall Street Bud Fox (Charlie Sheen) learns from his father Carl Fox (Martin Sheen) over a couple beers that the union Carl belongs to is about to settle their contract dispute with a major airline. To impress and get a job with Gekko (Michael Douglas), Bud tells him about the settlement, which is not public knowledge. Gekko trades on that information, not knowing that Bud’s daddy told him the information–or daddy’s connection to the union though his patronage of dues and role as the union’s faithful political foot soldier, not knowing the credibility of the shiny haired youngster standing in his office. The fictional Gekko becomes the poster boy of corporate corruption for his insider trading. Gray area? Not at all.[pullquote_right]When people are judged on their numbers they have an incentive to push those numbers—that’s the point of tracking them. No careers are made on dismissed cases. [/pullquote_right]
The SEC has been out and about touting their increased enforcement actions in the realm insider trading. The SEC has lost a lot of face in failing to detect wide spread fraud that took place on its watch. Times such as these may pressure public officers to become numbers driven, judging enforcement efforts by the number of cases brought, cases resolved, money collected from settlements, and cases referred for criminal prosecutions. When people are judged on their numbers they have an incentive to push those numbers—that’s the point of tracking them. No careers are made on dismissed cases. There is a personal incentive, in all criminal and civil enforcement to bring and settle gray area cases rather than not bring the case or dismiss them.
Gray area cases are, inter alia, those cases where the facts and law are defendable but that people involved cannot personally or professionally bear the weight of protracted and expensive litigation, especially with the risk of harsh criminal enforcement looming behind its civil stalking horse. There is an incentive to bring evidentiary weak cases in heavy handed enforcement actions against small dollar investors to force quick settlements. You are not a high profile person and you do not make millions in the market, but you are just as ripe a target for enforcement because you are a soft target. Even the incredibly wealthy rarely fight the SEC. Do you have Mark Cuban money, balls, luck, and lawyers? No? Maybe you shouldn’t trade in the gray area…
You may never be able to hold a position of trust or confidence within any publicly traded company. You may lose your licenses to practice law or to trade securities and/or groom dogs. Lawyer’s bills are incredibly expensive, white collar defense work is document intensive and requires specialized legal experience, which takes time and time means money. Good legal representation is not cheap—even great legal representation does not guarantee that you will emerge from the situation unscathed. At the very least to settle a case the target will have to pay the amount of their gain—a number that may end up being based more on art than math. Now double that number and we are getting in the neighborhood. Hope you can afford to buy your way out of this.
Criminal punishment is based on upon the amount of your gain, and the Federal Sentencing Guidelines suggest the courts incrementally increase the range of possible prison time to correspond with amount of your gain–courts tend to follow the guidelines and hand out prison time. Just a $5,000 gain (the jurisdictional minimum) can land you a year in prison. In the Federal prison system you will serve your time, no half-sentence probation, no holiday furloughs, no over-taxed system putting criminals back out on the street as fast as they can (this isn’t California)–count on spending almost every day of your sentence in Federal prison. Go smell one. Seriously. Feel how every surface is coated with greasy funk, and then go home and shower ten times with a pumas-stone to try and rid yourself of the stench. One million dollars can land you more than five years in there. As a felon, do not plan on getting another job that requires trust. I hope you don’t have soft hands. You cannot own a gun (another felony if you possess one) or vote in elections in many states. If you are not a citizen of the United States you may be deported for committing a crime of moral turpitude—not kidding. Imagine explaining federal prison in job interviews, to your spouse, kids, hamster. Now, look in the mirror and call yourself a criminal and felon. Now, turn off the lights and say Gordon Gekko three times.
Simple rules for most people.
1. Don’t trade stock based on information you hear about your company or affiliated companies
2. Beware of what you tell others about your company or companies that your company has an affiliation with.
3. If you have to be cute, play with words, explain the nuance, etc. then your rational for insider trading is unlikely to get you a pass with law enforcement.
4. The risk is not worth the reward, when its gray stay away.
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