Liability for Insider Trading Under Rule 10b5 - Explained
Rule 10b5 - Insider Trading
If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.
- Marketing, Advertising, Sales & PR
- Accounting, Taxation, and Reporting
- Professionalism & Career Development
Law, Transactions, & Risk Management
Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
- Business Management & Operations
- Economics, Finance, & Analytics
What is insider trading under Rule 10(b)(5)?
Insider trading is the sale or purchase of securities by individuals privy to non-public, material information of a firm based upon her special relationship with the firm. Generally, anyone who has material, non-public information must either disclose that information prior to trading the securities or abstain from trading in the effected or related security. Normally, insiders include officers, directors, and professionals in fiduciary relationships with the firm. The negative aspect of insider trading is that it provides individuals an advantage over others in the sale or purchase of securities and undermines the integrity of the market and the confidence of those investing in securities. Section 10 of the 34 Act has been broadly interpreted to prohibit the practice of trading securities based on material, non-public information received as an insider or from an insider of a company.
Note: Trading securities on non-public information is most commonly addressed in 10(b)(5) actions. The SEC is charged with bringing civil actions under Rule 10(b)(5), while the Department of Justice is charged with bringing criminal actions against violators.
Next Article: Defenses to Rule 10(b)(5) Actions Back to: SECURITIES LAW
What are the Elements of a 10(b)(5) Action?
The insider or an individual receiving information from an insider is liable for trading securities based on the information. A tippee is a person who learns of nonpublic information from an insider. Upon receipt, this person is considered to be a legal, temporary insider. As a temporary insider, the tipee is subject to the prohibitions of Section 10(b) prohibiting the insider from trading securities based upon the inside information. The elements of a 10(b)(5) action are the same for criminal and civil actions and are as follows:
Information - The insider must have material, non-public information.
Note: This type of information is generally the result of detailed knowledge of business performance or long-term plans that will affect the corporations value in the market if it were publicly known.
Example: I am a director on the board of ABC Corp. I receive a report that demonstrates that the corporations cost of production is going to drop dramatically in the near future due to a drop in materials cost. This information is not public and it will certain increase corporate profits.
Fiduciary Duty - A core element of a 10(b)(5) action is the breach of a fiduciary duty. Insiders and third parties may have a fiduciary with regard to the material, non-public information.
Insiders - Corporate insiders have a fiduciary duty to the company.
Example: Corporate insiders who have a fiduciary duty include: board members, major shareholders, employees, and so-called temporary insiders, such as lawyers and investment bankers who are doing deals for the company.
Third Parties - A fiduciary duty exists for third parties in a personal relationship with an insider if:
the third party receives information and promises to keep the information secret;
the insider has a reasonable expectation that the recipient will not tell; or
the recipient has obtained the information from her spouse, parent, child or sibling.
Trading and/or Misappropriation - Either the insider or third party may breach a fiduciary duty by trading on (i.e., using the information to make stock trades) or misappropriating the information.
Insiders (Tippers) - The insider breaches a fiduciary duty by trading on the information. Further, an insider misappropriates and breaches his fiduciary duty by transmitting information if:
he knows the information was confidential, and
he expected some personal gain.
Third Parties (Tippees) - Third parties misappropriate information obtained through a professional or personal relationship from an insider. Therefore, a third party violates a fiduciary duty to the rightful owner of the information by trading on the information if she knows:
- the information is confidential,
- that it was transmitted in breach of a fiduciary duty, and
- the insider expected a personal gain from transmitting the information.
The idea of holding a third-party, recipient of material, non-public information liable for trading on that information is based on theory that the information is misappropriated from the rightful owners (shareholders). The third party has no duty to reveal the nonpublic information to the public, since she was not in a fiduciary position with respect to company. Trading on that information, however, is effectively breaching a duty owed to those shareholders to either disclose that information or refrain from trading. In summary, anyone who has material, non-public information must either disclose the information prior to trading the securities or abstain from trading in the effected or related security.
What are some Examples of Insider Trading?
ImClone case of 2001 - Martha Stewart sold around 4000 shares of a biopharmaceutical company, ImClone systems, after she received information from a broker at Merrill Lynch, whose name was Peter Bacanovic. The information was shared by the broker to Martha when the company was awaiting FDAs decision on Erbitux, an anti-cancer. The information was that ImClone systems CEO, Samuel Waksal, was selling all his shares of the company. Shortly after selling of the shares by Martha, FDA rejected the drug application and the company's shares fell by 16% in a day. Since Martha sold her shares earlier, she was saved from a loss of more than $45,000. Since the sale was made on a tip of the CEO selling his shared which was not public at that time, it was considered as insider trading and Martha was changed by SAE with obstruction of justice and securities fraud and insider trading in 2003. Directors of companies are not the only people who have the potential to be convicted of insider trading. In 2003, Martha Stewart was charged by the SEC with obstruction of justice and securities fraud including insider trading for her part in the 2001 ImClone case. After a case in 2004, Marthas charges were reduced to crime of obstruction of a proceeding, conspiracy and making false statements to federal investigators. She served five months as punishment in a federal corrections facility. Amazon Insider Trading Case - In September 2017, former Amazon.com Incs one of the financial analyst Brett Kennedy was charged with insider trading. Kennedy was believed to have provided information regarding the quarterly sales to Maziar Rezakhani before they were released to the public. Rezakhani made a profit of $115,977 as per SEC, by trading Amazon shared based on this information and paid $10,000 to Kennedy in return for the information.
How do you feel about holding a tippee of insider information liable under Section 10(b)? Is it fair to consider a tippee to be a temporary insider? Why or why not? Do you think the knowledge requirement for third parties is fair? Why or why not?
Arnold is a director of ABC Corp. He is specifically involved in a committee that evaluates potential mergers and acquisitions. He becomes aware that a group of managers are considering a manager buyout that would allow the managers to purchase all corporate shares and make the company private (i.e., no longer publicly traded). This would ease the regulatory burdens of reporting to the SEC. Also, the buy-out will drive up the price of shares temporarily. What Arnold face liability if he purchased a large block of ABC shares based upon this knowledge? What if he provided this information to his brother-in-law who subsequently purchased a large block of shares?
- Securities Law (Intro)
- What are Securities Laws?
- What is a Security?
- What qualifies as an Investment contract?
- What are the primary federal securities laws?
- What are the regulatory goals of security laws?
- What is the Securities and Exchange Commission?
- What is an Initial Public Offering?
- What is a Direct Public Offering?
- What is Crowdfunding?
- Securities Act of 1933
- What is an Offer to Sell securities?
- Who are the parties regulated in an offer to sell securities?
- What are the primary disclosure documents required in an offer to sell securities?
- Forward Looking
- Red Herring Prospectus (Securities) Definition
- Registration of Securities
- What is an issuer allowed to do at each stage of the registration process?
- How are issuers classified for purposes of the registration and offering process?
- What is an issuer allowed to do during the Pre-filing Period?
- What are the limitations on the issuer during the Post-filing, Waiting Period?
- What is an issuer allowed to do during the Post-Effective Period?
- What is an Emerging-Growth Company?
- What type of information must an issuer disclose?
- What laws govern the mechanics of disclosure in a securities offering?
- Deficiency Letter (Securities Law)
- Registration Exemptions Securities Act of 1933
- What are Exempt Securities and Exempt Transactions?
- What are Restricted Securities?
- Section 3(a)?
- Section 3(b)?
- What is a Rule 147 Exemption?
- What is a Section 4(a) Exemption?
- Section 4(a)(5)?
- What is a Regulation A Exemption?
- What are Regulation D Exemptions?
- What is a Rule 504 Exemption?
- What is a Rule 505 Exemption?
- What is a Rule 506(b) Exemption?
- What is a Rule 506(c) Exemption?
- What is Rule 502(d) and the Rule 144 Safe Harbor?
- Rule 144a
- What are the disclosure requirements for companies employing an exemption?
- What is the requirement to file Form D?
- What is the effect of failing to register an offering under Section 5?
- Liability Under the Securities and Exchange Act of 1933
- What is civil liability under Section 11 of the 33 Act?
- What is civil liability under Section 12 of the 33 Act?
- What are defenses available to charges under Sections 11 and 12?
- What is civil liability under Section 17 of the 33 Act?
- What is potential criminal liability under the 33 Act?
- The Security Exchange Act of 1934
- When must an issuer register pursuant to the 34 Act?
- What disclosures are required of reporting companies under the 34 Act?
- What is liability under Section 10(b) and Rule 10(b)(5)?
- What is insider trading under Rule 10(b)(5)?
- What damages are available under Section 10 and Rule 10(b)(5)?
- What is insider trading under Section 14 of the 34 Act?
- What is liability under Section 16 of the 34 Act?
- What is liability under Section 18 of the 34 Act?
- What is criminal liability under the 34 Act?
- Liability under the Securities Enforcement Remedies Act?
- Blue Sky Laws State Securities Laws
- What are Blue Sky Laws?
- When is an issuer required to comply with state securities laws?
- What are the registration requirements under state law?
- What is Coordinated Registration under state law?