Guarding Against Allegations of Illegal Insider Trading

January 15, 2013

Guarding against allegations of illegal insider trading

Insider trading has become a hot topic in the news recently as federal prosecutors continue to crack down on white-collar crime. Unfortunately for some of those who are charged with insider trading offenses, the line between legal and illegal securities transactions is not always as clear as it seems.

Insider trading is the trading of stocks, bonds or stock options by a corporation's "insiders," such as officers, executives and major shareholders. Contrary to popular misconception, insider trading is not illegal in all cases; in fact, because many corporate employees receive company stock as part of their compensation package, in many cases insider trading is not only acceptable, it is practically unavoidable.

However, insider trading becomes illegal when an individual buys or sells stock on the basis of confidential information that he or she has obtained about the company, in violation of a fiduciary duty or other relationship of trust or confidence. For example, illegal insider trading occurs when company employees or their friends and family members trade in company stock after receiving non-public information about major corporate developments such as a merger, acquisition or other significant event that is likely to affect the value of the stock. This type of insider trading is a form of securities fraud.

People charged with securities fraud can face steep fines and long prison sentences if convicted, and authorities are prosecuting these offenses with renewed vigor after several major financial scandals have come to light in recent years. Given the rate at which new allegations of investment fraud are surfacing, many corporate insiders are understandably wary of the risk that any trade of company stock may be viewed as illegal if the transaction turns out to have been particularly beneficial to them.

Rule 10b5-1 plans offer some defense

To enable corporate employees to trade in their company's shares without fear of criminal charges, the Securities and Exchange Commission adopted Rule 10b5-1. The rule allows company executives and other insiders to establish a plan for trading company shares at a time when they do not have insider information. The trades are then carried out at a later date according to the plan, regardless of whether an individual has since obtained confidential information relevant to the transaction.

Critics of Rule 10b5-1 question its effectiveness at preventing illegal trades, however, noting that the planned transactions can be adopted any time and may be modified or canceled after they are put in place. Thus, trades under Rule 10b5-1 plans may still be vulnerable to manipulation by insiders with material non-public information.

On the other hand, however, trades made according to Rule 10b5-1 are by no means immune from giving rise to allegations of securities fraud. Instead, the rule merely serves as a potential defense in the event that a criminal investigation takes place, requiring a company insider to prove that he or she adhered to the plan and did not have inside information at the time the plan was put in place.

To strengthen Rule 10b5-1 and reduce its potential for manipulation, some experts suggest changes such as establishing a minimum interval between the implementation of a plan and a subsequent transaction, as well as limiting each employee to a single plan or allowing modifications only during a specified period each year.

People under investigation or facing criminal charges for suspected securities fraud should contact an experienced criminal defense lawyer with a history of success defending clients against allegations of financial crimes.

Article provided by Ann Fitz, Attorney at Law, PC
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