Insider Trading Compliance

by Erika Johansen

"Insider trading" refers to an illegal use of information while trading securities. When the trader makes a trade based on information that he knows is confidential, both federal and state law may hold him liable for that act. The law has also created requirements, known as compliance programs, for companies in an attempt to prevent insider trading. Specific insider trading compliance questions, or questions about a specific state's law, should go to an attorney.

Understanding Insider Trading

Under the Securities and Exchange Act Rule 10(b)-5, there are several ways to run afoul of insider trading laws. If a person receives confidential information via his relationship with a company, he's an insider and may not trade on that information. In certain situations, if an outside party trades based on confidential information obtained from an insider, that outside party may also be held liable, particularly if the outsider knows that the insider has breached his duty to a company in disclosing the information. Some courts also find liability when an outside party trades based on inside information obtained from someone to whom the outsider owes a duty of confidentiality (for instance, if an attorney should trade based on confidential information obtained from one of his clients.) Courts have typically ruled that parties may not trade on inside information unless they first disclose the information to the public.

IAA Section 204

The Investment Advisors Act of 1940, Section 204 demands that investment advisors registered with the Securities and Exchange Commission keep detailed records and implement certain procedures to prevent insider trading. The law also demands that such investment advisors properly supervise their employees' actions in order to make sure that the employees are in compliance with those procedures.

SEA Section 15(f)

The Securities Exchange Act, Section 15(f) requires each broker or dealer of securities to create written rules and compliance procedures designed to prevent commission of insider trading, by either the brokers and dealers themselves or anyone they associate with in a business context. This Section also empowers the Securities and Exchange Commission to create such rules, which brokers and dealers must follow.

SEA Section 21A

In addition to the criminal penalties for insider trading, Securities Exchange Act Section 21A creates several forms of civil liability for the same actions. While the insider trader may be held liable, the law also creates liability for those who "controlled" the insider trader, if those controlling persons failed to take action to prevent such behavior. Under the law, this failure to take action can come in the form of a failure to implement insider trading compliance procedures. In some situations, the controlling person's liability can reach as high as $1,000,000.

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