These FAQs are part of a series of frequently asked questions that address four primary areas of interest to investment advisers:
- Compliance Program Components;
- Daily Operations;
- Client Protection; and
- Registration and Disclosure
Q1: What is insider trading?
A1: Insider trading is defined as the buying or selling of 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.
Q2: What is inside information?
A2: Inside information means material information about securities that has not been disseminated to, or is not generally available to, the general public (also referred to in conversation as “material non-public information”).
Q3: Who is an insider?
A3: The rule against insider trading prohibits trading while in possession of information which is received, directly or indirectly, from an “insider” who discloses that information through a breach of duty. The concept of an “insider” is broad. It includes officers, directors, members, and employees of a company.
Q4: Can a person be a temporary insider?
A4: Yes. A person can be a “temporary insider” if he or she enters into a special confidential relationship in the course of performing services for a company and, as a result, is given access to information solely for the company’s purposes. A temporary insider can include, among others, a company’s attorneys, accountants, consultants, bank lending officers, and the employees of such organizations.
Q5: When is information material?
A5: Information is “material” if its disclosure would be likely to have an impact on the price of a security or if reasonable investors would want to know the information. Either positive or negative information may be material.
Q6: What are some examples of material information?
A6: While it is not possible to define all categories of material information, there are various categories of information that are particularly sensitive and, as a general rule, should always be considered material. Examples of such information include:
- Financial results;
- Projections of future earnings or losses;
- News of a pending or proposed merger;
- Impending bankruptcy or financial liquidity problems;
- Gain or loss of a substantial customer or supplier;
- Changes in dividend policy;
- New product announcements of a significant nature;
- Significant pricing changes;
- Stock splits;
- New equity or debt offerings;
- Significant litigation exposure due to actual or threatened litigation; or
- Major changes in senior management.
Q7: When is information public?
A7: Information is “public” when it has been disseminated broadly to investors in the marketplace. Tangible evidence of such dissemination is the best indication that the information is public.
Q8: What are some examples of when information has become public?
A8: Information is public after it has become available to the general public through a public filing with the SEC, publication on the Dow Jones Newswires, The Wall Street Journal or some other publication of general circulation and after sufficient time has passed so that the information has been disseminated widely. Information furnished by an issuer in a web cast or conference call which is publicly announced in advance and made available to analysts, investment managers and the general investing public also would be deemed public.
Q9: What is the difference between a non-insider and a quasi-insider?
A9: Non-insiders may be persons who have, or are employed with companies who have, arms-length dealings with the issuer, such as vendors and suppliers. A quasi-insider is someone who possesses a relationship with the issuer which gives him or her access to confidential information about the issuer and has a duty to keep such information confidential. An attorney, accountant or consultant to the issuer are typical examples of quasi-insiders.
Q10: What is tipping?
A10: Tipping refers to the practice of communicating material, nonpublic information about a security to another person who then purchases the security. By communicating such information, the tipper seeks to do indirectly (e.g., through tipping) that which he or she cannot do directly (e.g., engage in insider trading).
Q11: When is a “tippee” liable for insider trading?
A11: Tippee liability requires proof that the insider/tipper breached a fiduciary or other duty by disclosing confidential information to the tippee for an improper purpose and that the tippee knew or should have known that the tipper’s communication constituted such a breach.
Q12: How much “knowledge” does a tippee need to have before they are liable?
A12: It is enough that that tippee was aware that the information confidential and was given to him or her without apparent corporate justification.
Q13: Are investment advisers registered with the SEC required to adopt specific policies and procedures that address insider trading?
A13: Yes. Section 204A of the Advisers Act requires SEC-registered investment advisers to establish, maintain and enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information by the investment adviser or any person associated with the investment adviser.
Q14: What are the consequences of insider trading?
A14: The wrongdoers and their “controlling persons” (including employers) are exposed to
- SEC enforcement investigations, administrative proceedings, and lawsuits.
- Lawsuits brought by private plaintiffs, under both express and implied private rights of action, seeking damages.
- Civil fines of up to three times the profit gained or loss avoided by the wrongdoers (or, in the case of “controlling persons,” the greater of $1 million or three times the profit gained or loss avoided by the wrongdoers).
- Criminal investigations, convictions, and sanctions, including substantial criminal fines and (in the case of individuals) prison sentences.
Q15: With respect to insider trading, what are some questions that investment advisers should ask while establishing or reviewing their compliance programs?
A15: Investment advisers should ask:
- Whether they have effective processes to identify, contain, and prevent the unauthorized and/or inappropriate use of nonpublic information that comes into their possession?
- If their employees come into possession of nonpublic information, is this information effectively identified, documented, and contained so that it is used appropriately?
- If their employees come into possession of nonpublic information about an issuer as a result of a client’s position in that issuer (e.g., a participation in a bank loan), is this information controlled effectively so that it is not used to unlawfully trade in other instruments of the issuer (e.g., shorting the issuer’s equity if the issuer’s financial condition deteriorates)?