Insider Trading Defense: What Corporate Insiders Need to Know When Facing CFTC, DOJ, or SEC Scrutiny

Corporate insiders can face criminal prosecution based on allegations of insider trading. Charges filed under the Securities Exchange Act and the federal securities fraud statute (18 USC Section 1348) can carry multi-million-dollar fines and decades of prison time. As a result, when facing a federal insider trading investigation, it is imperative to engage experienced defense counsel immediately.

With the rise of prediction markets, insider trading has received renewed attention in recent years. Federal authorities—including the Commodity Futures Trading Commission (CFTC), Department of Justice (DOJ), and Securities and Exchange Commission (SEC)—are once again pursuing insider trading cases with increasing frequency, and some of these cases are once again making national headlines.

But, while cases involving prediction markets may be of particular interest, traditional insider trading cases remain an enforcement focus for federal authorities as well. All insider trading allegations pose substantial risks, and corporate insiders accused of insider trading must be prepared to defend themselves by all means available.

What is the Definition of “Insider Trading”?

The federal prohibition against insider trading is based on the language of Section 10(b) of the Securities Exchange Act of 1934 and the SEC’s Rule 10b-5. While Section 10(b) (codified at 15 USC Section 78j) does not prohibit insider trading specifically, it states:

“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of . . . any national securities exchange . . . [t]o use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors.”

The prohibition in Section 10(b) against “any manipulative or deceptive device or contrivance” has been interpreted broadly to cover an extremely wide range of fraudulent practices—including insider trading. However, for the avoidance of doubt, the SEC has also adopted Rule 10b-5 which addresses insider trading specifically. While it does not use the term “insider trading,” Rule 10b5-1 states:

“The ‘manipulative or deceptive device[s] or contrivance[s]’ prohibited by Section 10(b) . . . include, among other things, the purchase or sale of a security of any issuer, on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information.”

There are three key aspects to Rule 10b5-1 that can play a key role in federal securities fraud cases involving insider trading allegations. These are: (i) the requirement for a “duty of trust or confidence;” (ii) the specific reference to “material nonpublic information,” or “MNPI;” and, (iii) the need for proof that a trade was made “on the basis of” MNPI.

1. “A Duty of Trust or Confidence” – The Definition of a Corporate Insider

The requirement for “a duty of trust or confidence” is the “insider” aspect of insider trading. If a person does not owe an applicable duty of trust or confidence, then they are not an insider (though they could potentially still be at risk of facing securities fraud allegations on other grounds).

As Rule 10b5-1 makes clear, the requisite duty of trust or confidence can be owed to multiple parties, including:

• The issuer of the security that was bought or sold; and,
• Any person who is the source of MNPI.

This means that multiple parties can qualify as “insiders” under federal law. Along with corporate executives and other corporate employees, this includes advisors (i.e., accountants, consultants, and lawyers) as well as family members. All insiders can face scrutiny on the same grounds—and all insider trading cases pose risks for the same penalties.

2. “Material Nonpublic Information” – The Standard for Insider Trading

For an insider to be held criminally liable under federal law, the insider must have access to “material nonpublic information,” or “MNPI.” Information qualifies as MNPI if, “there is a substantial likelihood that a reasonable shareholder would consider it important” in making an investment decision.

As a result, there is not a clear delineation of what information insiders can use and what information they cannot. Instead, before executing trades, insiders must make informed decisions on a case-by-case basis. While the DOJ and SEC expect insiders to err on the side of caution, insiders are entitled to execute trades when they do not have access to MNPI—and deciding whether information constitutes MNPI (or still constitutes MNPI after a period of time) necessarily involves making a judgment call in many scenarios.

3. “On the Basis Of” MNPI – The Government’s Burden of Proof

To pursue criminal charges for insider trading, the DOJ must be able to prove that an insider traded “on the basis of” MNPI. While this might sound like it poses a challenge for building the government’s case, Rule 10b5-1 provides that:

“[A] purchase or sale of a security . . . is on the basis of material nonpublic information . . . if the person making the purchase or sale was aware of the material nonpublic information when the person made the purchase or sale.”

This “awareness” standard sets a relatively low bar—and this requires careful consideration when building an insider’s defense. Notably, however, to pursue criminal charges under Section 10(b), the DOJ needs evidence of “willfulness;” and, under the federal securities fraud statute (18 USC Section 1348), federal prosecutors must be able to prove that an insider “knowingly” executed “a scheme or artifice  . . . to defraud.” As a result, even if disputing the DOJ’s evidence of “awareness” is not a viable defense strategy, it may still be possible to avoid prosecution (or a conviction in federal court) by raising questions about whether the government can prove a defendant’s mental state at the time a trade was made.

What Does it Take to Successfully Defend Against Insider Trading Allegations?

With all of this in mind, successfully defending against insider trading allegations during a CFTC, DOJ, or SEC investigation requires an informed and strategic approach that is custom-tailored to the circumstances at hand. Upon learning of an investigation, targeted insiders should take the following steps:

• Engage Experienced Securities Fraud Defense Counsel – In this scenario, it is critical to promptly engage an experienced securities fraud defense lawyer. Communicating with the government during a federal investigation requires in-depth knowledge of all pertinent laws, regulations, and procedures, as does formulating an effective defense strategy.
• Avoid Making Costly Mistakes – When facing federal scrutiny, it is also critical to avoid costly mistakes. Individuals who are facing scrutiny related to possible insider trading need to be extremely careful to avoid saying or doing anything that could limit their ability to execute a successful defense.
• Conduct an Attorney–Client Privileged Risk Assessment – Insiders (or alleged insiders) targeted in CFTC, DOJ, and SEC investigations should work with their defense counsel to conduct an attorney-client privileged risk assessment. Among other things, this will involve examining the alleged MNPI and the timing of the trade(s) at issue to determine whether the government is likely to be able to substantiate criminal charges.
• Formulate a Targeted and Cohesive Defense Strategy – Avoiding criminal charges in a federal insider trading case requires a targeted and cohesive defense strategy. Whether this involves disputing your status as an “insider,” challenging the government’s evidence of knowledge or willfulness, relying on a 10b5-1 trading plan, or some other means of defense will depend on the circumstances at hand.
• Target a Resolution that Avoids a Federal Indictment – Targets of CFTC, DOJ, and SEC securities fraud investigations should focus their efforts on securing a resolution that avoids a federal indictment. Not only can this help keep the case out of the public eye, but it also avoids the inherent uncertainty of defending against insider trading allegations in federal court.

What if I Am Guilty of Insider Trading?

What if you got caught insider trading? What if you broke the law, and federal agents and prosecutors will be able to gather the evidence they need to prove it?

Even in this scenario, you have options available. First and foremost, there is no guarantee that federal prosecutors will be able to build a case against you. Insider trading cases are complex, and there is a lot that federal prosecutors must prove to secure a conviction.

But, even if facing a conviction is a real possibility, your case is still far from over at the investigative stage. Experienced defense counsel will be able to help you take a strategic approach—and, while this might involve targeting a settlement, it might also mean working to avoid liability altogether.

Schedule a Free and Confidential Consultation with a Securities Fraud Defense Lawyer at Oberheiden PC

If you need defense counsel for a federal insider trading investigation, we encourage you to contact us immediately. Call 888-680-1745 or contact us online to speak with a senior securities fraud defense lawyer at Oberheiden PC as soon as possible.