What is insider trading?

General Reference (not clearly pro or con)
The Columbia Encyclopedia, 6th edition (2007), in an entry titled "Insider Trading," provided the following:

"[S]tock market transactions made with knowledge of [material] nonpublic information about corporate activity. In the United States, it has been illegal since 1934. The Securities and Exchange Commission regards it as unfair to investors who are not privy to such information. Several insider trading scandals shook Wall Street in the mid-1980s."

2007 - Columbia Encyclopedia 

The U.S. Securities Exchange Commission (SEC), on the page "Insider Trading," updated Apr. 19, 2001, of its website, explained:

"'Insider trading' is a term that most investors have heard and usually associate with illegal conduct. But the term actually includes both legal and illegal conduct. The legal version is when corporate insiders—officers, directors, and employees—buy and sell stock in their own companies. When corporate insiders trade in their own securities, they must report their trades to the SEC...

Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include 'tipping' such information, securities trading by the person 'tipped,' and securities trading by those who misappropriate such information...

The SEC adopted new Rules 10b5-1 and 10b5-2 to resolve two insider trading issues where the courts have disagreed. Rule 10b5-1 provides that a person trades on the basis of material nonpublic information if a trader is 'aware' of the material nonpublic information when making the purchase or sale. The rule also sets forth several affirmative defenses or exceptions to liability. The rule permits persons to trade in certain specified circumstances where it is clear that the information they are aware of is not a factor in the decision to trade, such as pursuant to a pre-existing plan, contract, or instruction that was made in good faith.

Rule 10b5-2 clarifies how the misappropriation theory applies to certain non-business relationships. This rule provides that a person receiving confidential information under circumstances specified in the rule would owe a duty of trust or confidence and thus could be liable under the misappropriation theory."

Apr. 19, 2001 - US Securities Exchange Commission (SEC) 

Investopedia, an online portal for investor education, in its article "Uncovering Insider Trading" posted on its website (accessed Apr. 24, 2008), wrote:

"There are two types of insider trading: legal and illegal...Illegal insider trading is the buying or selling of a security by insiders who possess material that is still not public. The act puts insiders in breach of their fiduciary duty...

A common misconception is that only directors and upper management can be convicted of insider trading. Anybody who has material and non-public information can commit such an act. This means that nearly anybody - including brokers, family, friends and employees - can be considered an insider.

There is an important thing to emphasize here: insiders don't always have their hands tied. Insiders legally buy and sell stock in their own company all of the time...

The SEC considers insiders to be company directors, officials or any individual with a stake of 10% or more in the company. Insiders are required to report their insider transactions within two business days of the date the transaction occurred (before the 2002 Sarbanes-Oxley Act it used to be the tenth day of the following month)...

Insiders are prevented from buying and selling their company stock within a six-month period: therefore, insiders buy stock when they feel the company will perform well over the long-term."

Apr. 24, 2008 - Investopedia 

Stephen M. Bainbridge, MS, JD, William D. Warren Professor of Law at the University of California, Los Angeles (UCLA) School of Law, in his article "Insider Trading" published in the 2000 Encyclopedia of Law and Economics, wrote:

"Insider trading, generally speaking, is trading in securities while in possession of material nonpublic information. Under current United States law, there are three basic theories under which trading on inside information becomes unlawful. The disclose or abstain rule and the misappropriation theory were created by the courts under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Pursuant to its rule-making authority under Exchange Act Section 14(e), the Securities and Exchange Commission (SEC) adopted Rule 14e-3 to proscribe insider trading involving information relating to tender offers. (Insider trading may also violate other statutes, mail and wire fraud laws...)"

2000 - Stephen M. Bainbridge, MS, JD 

Nic Heuer, Articles and Notes Editor, Les Reese, Annual Survey Editor, and Winston Sale, Articles and Notes Editor, of the American Criminal Law Review, in the Spring 2007 article "Securities Fraud" published in the journal, wrote:

"In United States v. O'Hagan, the Supreme Court stated that there are two separate fiduciary relationships that can serve as the basis for an insider trading violation of Rule 10b-5. The first is the relationship between corporate 'insiders' and the corporation's shareholders, which is known as the classical theory of insider trading. The second is the relationship between corporate 'outsiders' and the 'inside' source of the material, non-public information, known as the misappropriation theory. The classical and misappropriation theories provide the theoretical underpinnings for criminal liability in most insider trading cases...

Under the classical theory of insider trading, a Rule 10b-5 violation exists when a corporate insider purchases or sells securities on the basis of material, non-public information. Under this theory, only corporate insiders who have a fiduciary duty to the corporation's shareholders can be found criminally liable...

In addition to traditional insiders, the classical theory also applies to both 'temporary' insiders and 'tippees.' 'Temporary' insiders, such as underwriters, attorneys, accountants, consultants, or others who temporarily gain access to any 'inside' information, have a duty to disclose or abstain from trading on that information because they are temporary fiduciaries of the corporation.

'Tippees' are individuals who trade based on non-public information (i.e. tips) received from insiders. A tippee is liable for insider trading under [section] 10(b) if: (i) the tipper possessed material, non-public information regarding the corporation; (ii) the tipper disclosed that information to the tippee; (iii) the tippee traded in the corporation's securities while in possession of that non-public information provided by the tipper; (iv) the tippee knew or should have known that the tipper violated a relationship of trust by relaying the information; and (v) the tipper benefited from disclosure of the information to tippee.

In United State v. O'Hagan, the Supreme Court resolved a conflict among the circuits by adopting the misappropriation theory, under which a party trading no wrongfully obtained non-public information is liable solely for 'misappropriating' that information...In O'Hagan, the Supreme Court found that the misappropriation theory falls within the provisions of Rule 10b-5 which requires (i) a deceptive device; (ii) breach of a fiduciary duty; (iii) use of material, non-public information in connection with the purchase or sale of a security; and (iv) willfulness on the part of the defendant...

In direct response to the Supreme Court's holding in Chiarella, the SEC promulgated Rule 14e-3 to prohibit insider trading in connection with tender offers. This Rule prohibits anyone in possession of material, non-public information concerning a tender offer from trading on or 'tipping' that information. For a violation to occur, Rule 14e-3 does not require the offender to have knowledge that the information relates to a tender offer, as long as the offender is aware of the forbidden nature of the conduct. Rule 14e-3 imposes an absolute duty to disclose the confidential information or to abstain from trading, regardless of whether or not a trader obtained the information through a breach of a fiduciary duty."

Spring 2007 - Winston Sale 
Les Reese 
Nic Heuer 

The "Eleventh Circuit Pattern Jury Instructions" (2005) for civil cases provided:

"Under the 'classical theory' of insider trading, Rule 10b-5(a) is violated when a corporate insider trades in the securities of [his] [her] corporation on the basis of material, non-public information. 'Material' information is any information that would be important for a reasonable investor to know in making the decision to buy or sell a security. Non-public information is that information which is not available to the public. Corporate 'insiders' are the officers, directors, and other permanent employees of the corporation. Additionally, accountants, attorneys, consultants, and others who temporarily become fiduciaries of the corporation are also corporate insiders...If an insider wishes to trade in [his] [her] corporation's securities [he] [she] must first disclose that information to the public...

Under the 'misappropriation theory' of insider trading, a person commits fraud in connection with a securities transaction, and thus violates Rules 10b-5(a) and 10b5-1, when [he] [she] misappropriates material and confidential information for securities trading purposes in breach of a duty owed to the source of the information. Under that theory, a fiduciary's undisclosed, self-serving use of a principal's information to purchase or sell securities in breach of a duty of loyalty and confidentiality defrauds the principal of the exclusive use of that information.

A duty of loyalty or confidence arises between a recipient of material, non-public information and the source of the information when the recipient agrees to maintain information in confidence or when the recipient and the source have a history of sharing confidential information such that a reasonable person would expect the recipient to maintain the confidentiality of the information. [In this case, the recipient of the information was the [spouse] [parent] [child] [sibling] of the source of the information. A duty of loyalty or confidence usually arises in such situations.] [However, Defendant has offered evidence that, due to the facts and circumstances surrounding the relationship between [himself] [herself] and [his] [her] [spouse] [parent] [child] [sibling], [he] [she] neither knew nor reasonably should have known that [his] [her] [spouse] [parent] [child] [sibling] expected Defendant to keep the information confidential...

The law also forbids a person from indirectly violating Rules 10b-5(a) and 10b5-1 by doing any prohibited act by means of another person. A person who receives material and confidential information [as an insider] [through a fiduciary relationship with the source of the information] may not provide that information to another person (i.e. a 'tip') in breach of the duty owed [to the shareholders of the corporation] [to the source of the information] with the expectation that [he] [she] will personally benefit, directly or indirectly, from the disclosure."

[Editor's Note: Instructions for other circuit courts or criminal cases may vary.]

2005 - Eleventh Circuit Pattern Jury Instructions (Civil Cases) (1.8MB)