Insider trading has been a high priority for the government since the 2008 financial crisis and continues to be one of the areas of focus by the Securities and Exchange Commission (SEC). While the insider trading laws remain murky, one thing is clear – contrary to what its name might suggest, the government has continuously sought to expand the scope of the insider trading laws well beyond corporate insiders.
Insider trading is generally defined as trading in a security on the basis of material, non-public information relating to the issuer that was secured in breach of a duty owed to the issuer, shareholders, or any other source of information. There are several theories of insider trading. For example, the “classical theory” of insider trading imposes liability on a corporate insider who trades in his own company’s security based on material, non-public information. The “misappropriation theory” expands the classical theory and imposes liability on corporate outsiders who trade in a security based on material, non-public information in breach of a duty owed to the source of the information.
Both recipients of material, non-public information (“tippees” of information) and those who provide the information (“tippers”) may face civil or criminal liability under either the classical or misappropriation theories. Under the classical theory, an outsider may be liable for trading on information passed to him or her by an insider tipper in breach of the tipper’s fiduciary duty to his company’s shareholders. Under the misappropriation theory, an outsider may be liable as the tippee of someone who has misappropriated inside information in breach of a duty to the source of the information. Generally, for a tippee to be liable for insider trading, he or she must know that the tipped information is material and non-public, and know or should know that the confidential information was initially obtained and transmitted in breach of a duty.
The SEC has not hesitated to bring actions against traders far removed from the initial tipper, allowing for the creation of a chain of persons with a duty to disclose. Courts have found liability may exist where the tipper’s conduct merely raised “red flags” that confidential information was being improperly transmitted. Similarly, in a criminal case, the Second Circuit found that the government need not prove that the defendant even knew the identity or nature of the source as long as he knew that the information was illegally obtained.
But how far is too far? The concern becomes how far down the chain the government may go and how far it will extend the definition of material, non-public information in pursuit of an insider trading claim. For example, in recent weeks the media widely reported that the SEC and FBI were investigating Phil Mickelson’s involvement in suspicious trades involving Clorox around the time that investor Carl Icahn was mounting an unsolicited bid for the company. Specifically, the media reported that authorities suspected that Icahn improperly passed information regarding his plans to famed Las Vegas gambler Billy Walters, who then passed the information to Mickelson. However, the New York Times has backed off, stating that its initial reports of Mickelson’s involvement were “overstated.” While it remains unclear whether the authorities are interested in Mickelson with respect to Clorox, it appears that he is not out of the woods entirely, as they are continuing to call into question certain trades he and Walters made in another company.
The SEC’s aggressive position with respect to Icahn, Walters, and perhaps Mickelson, may be a sign of things to come. The SEC, the Justice Department, and other regulators will continue to pay particular attention to insider trading, no matter who the trader might be.Back to news