Preventing Employee Insider Trading

Managers like you are juggling many tasks throughout the day, from supervising your direct reports to following-up with your most important suppliers or customers. Having said all of this, one of the most important tasks under your purview is compliance.

Compliance is a charged word that can encompass many different things. Because of this, we are going to focus on one key area of compliance that affects you and all of your colleagues. Specifically, we’re talking about illegal insider trading.

When you hear the words insider trading, your mind may immediately think of Wall Street hedge managers who are exchanging sensitive information in order to make millions for their investors. However, insider trading doesn’t just happen on Wall Street. Employees of your organization or competitor organizations can also engage in insider trading. The risk is real, and the US Department of Justice (“DOJ”) and Securities and Exchange Commission (“SEC”) will not hesitate to prosecute insider trading cases. According to the SEC, individuals can face up to 20 years in prison for an insider trading violation. The maximum criminal fine for individuals is $5 million and $25 million for businesses, but the total penalty can be much higher.

The stakes are high. Because of this, you must take active steps now to deter and prevent insider trading in your organization.

Illegal Insider Trading

Before proceeding, it is important to discuss what insider trading is. In fact, there are two forms of insider trading: legal and illegal insider trading. Legal insider trading occurs when corporate officers, insiders, directors, employees, and other large shareholders buy and sell stock in their own companies, per certain rules and regulations promulgated by the SEC. As for illegal insider trading, it refers “to buying or selling of a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security.” It may also constitute “‘tipping’ such information, securities trading by the person ‘tipped,’ and securities trading by those who misappropriate such information.”

The definition of illegal insider trading is quite lengthy, but one of the most important parts of that definition centers on “material, nonpublic information.” There have been many court rulings on the limits of this definition, but essentially, it is “information that would affect the market value or trading of a security and that has not been disseminated to the general public.” One classic example is a lawyer or corporate employee being aware of an impending acquisition between two companies and buying shares in the soon-to-be-acquired company (as shares of acquired companies often rise after a merger announcement). Ultimately, whether an employee is actually doing the trading or is tipping off another individual to do the trading, buying or selling shares on the basis of material, nonpublic information constitutes insider trading.

Insider trading is a complicated subject. This is just a brief description of the practice. To learn more, we recommend speaking with your organization's attorney or, if necessary, outside counsel.

Anticipatory Steps

While there isn’t a bulletproof strategy, your organization can take the following steps to minimize insider trading:

1. Circulate a Prohibition Statement: At the very least, your organization should publish a written statement explaining that insider trading is illegal and that your employees (and family members) should not do it. In that statement, you can also provide definitions and examples of concepts like a “security” and “material nonpublic information” to make it easier for employees to understand. The goal is to put employees on notice and ensure that they understand what illegal insider trading is so that they don’t commit it. 

2. In-Person Training: In addition to the prohibition statement, your organization should conduct mandatory training on insider trading. Whether it is organized by your organization’s attorney or someone else, mandatory training—including an exam that every employee must pass—will further internalize the basics of insider trading and why everyone should take it seriously.

3. Internal Protocols: Your organization should also have internal protocols if it suspects that an employee is engaging in insider trading. Ultimately, your chief compliance officer and in-house counsel should be notified of any allegations in order to take appropriate investigatory steps. You should also consider implementing certain disciplinary steps—including termination—if an employee is found to have engaged in insider trading.

Take Precautionary Action

Insider trading is a serious allegation that can have massive consequences for the employees in question and for your organization itself. Therefore, the time is right to start taking precautionary action, whether that is educating your employees about insider trading or monitoring your organization’s protocols to handle insider trading allegations. Doing this now will save you from massive headaches in the future.