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As I tried to research and ponder this question, I couldn't help but wonder:

How many steps (i.e., persons) removed does one need to be from a source of material/non-public information regarding a company to avoid accusations of insider trading?

  • For example, if the CEO tells a trader that tells his brother who tells his barber who tells his son who tells his wife who invests in the company, is the last person guilty of anything illegal?

Or, is there no degree of separation that makes having the information legal?

  • In other words, is it always illegal as long as a court can prove the flow of insider information?

  • Does the final person's intent and/or ignorance that the information they received is material/non-public factor into the legality of any trades made following receipt of insider info?

Rodrigo de Azevedo
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theforestecologist
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    I would suggest you ask this on the law stack exchange site. Your get a more detailed answer and will have a higher confidence in it's accuracy there. – dsollen Jan 24 '18 at 18:45

2 Answers2

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It doesn’t matter how far away you are. If you have important information that the public doesn’t then it’s insider trading.

Obviously the distance makes it harder to prove or even to suspect.

The SEC defines illegal insider trading as follows:

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.

0xFEE1DEAD
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gnasher729
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  • Thanks! Could you point toward some evidence of this being the case? – theforestecologist Jan 23 '18 at 21:19
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    Also, could you speak specifically to one point from the question: if the person who uses received insider info does not know that the info is material/non-public, is that person really legally held accountable? (Or I guess intent, too, would need to be argued in a courtroom...?) – theforestecologist Jan 23 '18 at 21:21
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    @theforestecologist If you do not know what the speed limit on a road is, but still exceed it, are you not still speeding? Now, whether you will be prosecuted and/or convicted is a much grayer area, and it may be difficult to prove that you did not know the material is non-public. – D Stanley Jan 23 '18 at 21:55
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    Nitpick: "then it’s illegal insider trading. " Insider trading is not illegal in and of itself. – D Stanley Jan 23 '18 at 22:51
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    I don't entirely agree. Please see my discussion of SEC vs. Switzer here: https://money.stackexchange.com/questions/80409/insider-trading/80437#80437 Clearly, Switzer had important information not known to the public, traded on it with profits and was found not to be in violation of the rules prohibiting insider trading. – chili555 Jan 23 '18 at 23:53
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    Beyond any question of knowledge, just what "fiduciary duty or other relationship of trust and confidence" is the barber's daughter-in-law in breach of in the OP's example? Absent such a duty, I think you'd have to rely on the "tipping" part of the definition, which looks a lot less black-and-white ("may also include...securities trading by the person 'tipped' "). – 1006a Jan 24 '18 at 06:44
  • This sounds like a very effective way to disable someone from buying something you don't want them to; give them a tip and, iff they buy, report them for using that tip. Doesn't seem to matter if they wanted to buy with or without the tip. – Clearer Jan 24 '18 at 10:21
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    @Clearer per the quoted text, tipping is a violation in and by itself – 0xFEE1DEAD Jan 24 '18 at 11:05
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    Teeeeechnically, by the time you're seven billion links down the chain, the information is public because everybody on the planet knows it. ;-) – David Richerby Jan 24 '18 at 14:52
  • @DStanley There is a distinction between ignorance of the law and ignorance of facts. The latter is a valid defense, the former not so much. Also, traffic tickets are violations, not crimes, so lower mens rea standards are applied. – Acccumulation Jan 24 '18 at 20:16
  • @Acccumulation The concept of mens rea is largely arcane and obsolete in modern law enforcement. And it has to be given the tens of thousands of pages of federal criminal law currently on the books... there's also civil, administrative, state, county and local law, to boot. It would literally take a lifetime to read all the laws that apply to a person in the modern world. Which is why instead of mens rea, we now say "ignorance of law is no excuse under it." Some specific statutes still include a mens rea component, but in general, criminal convictions no longer require it. – HopelessN00b Jan 24 '18 at 20:23
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    @Clearer That also makes the assumption that the authorities care enough to devote resources to prosecuting a case. The reality is that they only have the resources to go after a very small percentage of violators, so they prioritize accordingly. An anonymous, probably unproveable tip about some small stock trade probably won't even rate enough priority to read all the way through, nevermind investigate or prosecute. – HopelessN00b Jan 24 '18 at 20:28
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The definition of "insider trading" is that it is taking advantage of information that is not available to "the public". Like many laws, this can be tricky to evaluate in real life.

At the extremes: If you see a news story on a major TV network saying that XYZ Company just got a big new government contract, and you then buy stock in XYZ, that's pretty clear public information. On the other hand, if your brother-in-law is president of XYZ and he tells you that he's just gotten a big new government contract, and an hour before the public announcement you rush out and buy stock, that pretty clearly IS insider trading.

But there are many tough questions. Suppose you are walking down the street and see someone that you recognize as the president of company X walk out of the office of company Y with a broad smile on his face. You suspect that X has just made some profitable deal with Y, and so you buy stock in X. That's completely legal. But if you stopped the president and talked to him, and he told you that he had just made a profitable deal with Y, and you buy stock in X, that would be illegal insider trading.

Or if a tech company announces that it is investing in some new invention, and you are a brilliant physicist and know that it is scientifically impossible for this invention to ever work so you quickly sell your stock in the company, that's legal. But if you work for the company, and you see that development on the invention is running into problems, and so you dump your stock, probably illegal.

Etc.

In your example, insider trading laws generally involve a scienter requirement, that is, you must know that the information is non-public. If you overhear two people in a bar discussing a rumor they heard, and you buy or sell stock based on that, that's probably legal because you have no way to know if their information is public or not. So -- usual disclaimer, I am not a lawyer -- the farther from the source you are, the more likely you don't know that information is non-public, and the tougher it would be to prosecute you. And of course if somebody told his brother who told his wife who told all her girlfriends one of whom posted it on her Facebook page, etc, at some point so many people have heard this that you could argue it is now "public".

Jay
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  • "you must know that the information is non-public" are you certain of this? Seems like it would be a pretty simple affirmative defense if this were true. – D Stanley Jan 23 '18 at 21:58
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    @DStanley: The legal standard is probably of the "should have known" variety, which does away with the need for mind reading. I am not a lawyer but I think there are two general approaches to meeting that: (A) The reasonable person standard, applied to the same circumstances of the trader, or (B) showing that the trader had a duty to know (for instance, if he was required to protect non-public information of said company, he'd have to make a habit of researching the disclosure status of everything he heard) – Ben Voigt Jan 24 '18 at 00:42
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    In your last paragraph it's not about public vs non-public, it's about material vs non-material. Two people discussing a rumor is non-material as you can't reasonably know whether it's true or not – 0xFEE1DEAD Jan 24 '18 at 12:29
  • In your bar example, I could not be sure that the barflies were not just bullshitting. Does that enter into the equation? – emory Jan 24 '18 at 17:41
  • @DStanley As BenVoight says, scienter rules often say "know or should have known". But even the laws that simply say, for example, "knowingly receive stolen property", sorry, you can't just say, "Oh, I didn't know" and expect the judge to say, "Well, as we can't read your mind, we'll have to just take your word for it." Courts look at the evidence in the individual case, from explicit evident that you knew, like someone testifies that they told you or you sent an email in which you discuss the matter, to indirect evidence. See, e.g. https://legal-dictionary.thefreedictionary.com/scienter – Jay Jan 24 '18 at 20:21
  • Even if you work for the company - as long as you are not listed as an actual insider, it is not illegal per se. The example with the scientist, as long as he does not know the actual risk management profile, whether or not this was expected and communicated by management. The real know how on whether a situation is SNAFU or just FU should be with the registered insiders. – Stian Jan 25 '18 at 13:32