Statutes
Insider trading is a federal criminal offense. While there are no federal statutes that specifically address insider trading, insider trading falls under Section 10b of the Securities and Exchange Act of 1934 (15 U.S.C. Section 78j), as a type of prohibited “manipulative and deceptive device.”
Thus, Section 10b is commonly referred to as the insider trading statute. When facing criminal allegations under Section 10b, corporate executives and other “insiders” must defend themselves by all means available. Insider trading charges can lead to substantial fines and federal incarceration; and, even if insiders are able to avoid prison time, the consequences of facing prosecution in the public eye can have devastating effects for their corporate careers.
The Federal Insider Trading Statute (15 U.S.C. Section 78j): An Overview
The federal government’s authority to prosecute insider trading cases comes from 15 U.S.C. Section 78j. As discussed in greater detail below, this statutory provision underpins SEC Rule 10b-5, which prohibits the use of any “device, scheme, or artifice to defraud” in relation to the purchase or sale of corporate securities. SEC Rule 10b-5 is commonly used in federal insider trading cases, and its central role means that understanding 15 U.S.C. Section 78j is critical for understanding (and defending against) federal insider trading allegations as well.
So, what does Section 10b of the Securities and Exchange Act of 1934 (15 U.S.C. Section 78j) prohibit? Under Section 78j, it is unlawful for any person, “directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange” to do any of the following:
- “To effect a short sale, or to use or employ any stop-loss order in connection with the purchase or sale, of any security other than a government security, in contravention of [applicable regulations];”
- “To 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, or any securities-based swap agreement any manipulative or deceptive device or contrivance in contravention of [applicable regulations];” or,
- “To effect, accept, or facilitate a transaction involving the loan or borrowing of securities in contravention of [applicable regulations].”
Insider trading cases can implement any one (or more) of these statutory provisions. SEC Rule 10b-5 further defines the acts that constitute insider trading under Section 78j, and 18 U.S.C. Section 1348 allows for criminal prosecution in federal insider trading cases.
The SEC’s Insider Trading Rule and the Federal Criminal Securities Fraud Statute (18 U.S.C. Section 1348)
A key aspect of the Securities and Exchange Act of 1934 is that it authorizes the U.S. Securities and Exchange Commission (SEC) to adopt regulations that prohibit specific types of fraudulent practices. One of the most significant steps the SEC has taken pursuant to this authority is its adoption of SEC Rule 10b-5. As the Legal Information Institute (LII) summarizes:
“The SEC promulgated Rule 10b-5 under Section 10(b) of the Exchange Act, which authorizes the SEC to regulate securities fraud. The text of the regulation, formally 17 CFR § 240.10b-5, states that ‘it shall be unlawful for any person . . . (a) [t]o employ any device, scheme, or artifice to defraud, (b) [t]o make any untrue statement of a material fact or to omit to state a material fact . . . or (c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.'”
As you may have noticed, similar to 15 U.S.C. Section 78j, SEC Rule 10b-5 does not explicitly mention insider trading. Yet, Rule 10b-5 has become known as the insider trading rule, and federal courts have interpreted Rule 10b-5 to allow for enforcement action when the following four elements are satisfied:
- Breach of a fiduciary duty or violation of a relationship of “trust and confidence” in connection with the purchase or sale of a corporate security;
- Use or possession of material nonpublic information in connection with the purchase or sale of a corporate security;
- Knowing or reckless use of the material nonpublic information when purchasing or selling the corporate security at issue; and,
- Reaping a personal benefit as a result of the purchase or sale.
There are several nuances to federal insider trading law that allow for prosecution in a wide range of circ*mstances. For example, while Rule 10b-5 applies to corporate “insiders,” the definition of insiders is not limited to company owners and executives. Advisors, accountants, and even family members who receive material nonpublic information about a corporate security can qualify as insiders (or “tippees”) under federal law. Additionally, a corporate insider doesn’t necessarily need to trade in the company’s own stock in order to face criminal insider trading charges. For example, in 2023, the U.S. Department of Justice (DOJ) filed a first-of-its-kind case against a CEO who was accused of using inside information to sell shares of one of his company’s competitors.
While 15 U.S.C. Section 78j and SEC Rule 10b-5 serve as the main sources of authority for federal insider trading charges, 18 U.S.C. Section 1348 allows for criminal prosecution of corporate insiders who engage in unlawful trades. Under Section 1348:
“Whoever knowingly executes, or attempts to execute, a scheme or artifice—(1) to defraud any person in connection with any . . . security . . . or (2) to obtain, by means of false or fraudulent pretenses, representations, or promises, any money or property in connection with the purchase or sale of any . . . security . . . shall be fined under this title, or imprisoned not more than 25 years, or both.”
This is the main federal criminal securities fraud statute. Like many other federal criminal fraud statutes, its breadth allows for prosecution in a wide range of scenarios. This includes prosecution of corporate insiders in cases involving allegations of insider trading.
Responding to Federal Insider Trading Allegations: First Steps and Defense Strategies
When facing insider trading allegations under SEC Rule 10b-5 or 18 U.S.C. Section 138, corporate insiders must act quickly to protect themselves. Federal insider trading investigations can proceed quickly, and the SEC and DOJ often work in concert to pursue parallel civil and criminal enforcement cases. With this in mind, some key first steps when facing allegations under SEC Rule 10b-5 or the federal insider trading statute include:
1. Engage Defense Counsel Promptly
The first step for any individual facing federal insider trading allegations (or any federal white-collar allegations) should be to engage experienced defense counsel promptly. As noted above, federal insider trading cases can progress quickly, and you will need defense counsel capable of dealing with both the SEC and the DOJ on our behalf. While federal insider trading allegations can lead to criminal prosecution under 18 U.S.C. Section 1348, it is also possible to resolve these cases without charges in many circ*mstances.
2. Review the Trade(s) and All Pertinent Documentation
When facing possible charges under the federal insider trading statute, it is critical to have a comprehensive and accurate understanding of the facts at hand. This involves reviewing the trade(s) in question as well as all other pertinent documentation (i.e., any corporate insider trading policies or Rule 10b5-1 pre-arranged trading plans). Once you know what the SEC and DOJ are going to find, then you can make informed decisions about how to move forward.
3. Evaluate Potential Defenses
Reviewing the relevant trade(s) and all pertinent documentation will also allow your counsel to evaluate all potential defenses. Depending on the facts at hand, there are several ways to defend against federal insider trading allegations. Some examples of potential defenses under SEC Rule 10b-5 and the federal insider trading statute include:
- No access to inside information
- No reliance on inside information
- “Piecing together” separate pieces of information that do not qualify as material and nonpublic
- Previously nonpublic information has been made public
- Reliance on legal counsel
- Trading pursuant to a pre-arranged plan
4. Evaluate Potential Defense Strategies
After determining what defenses you have available, your counsel can then evaluate potential defense strategies and advise you regarding how to deal with the SEC and DOJ. For example, while a cooperative approach can prove beneficial in some cases, corporate insiders must be careful to avoid sharing information that these agencies can use against them. If a more staunch defense is warranted, it will likely still be in an insider’s best interests to keep the lines of communication open in case it makes sense to target a pre-indictment or pre-trial settlement.
5. Focus on Avoiding SEC Enforcement Action and DOJ Prosecution
In the vast majority of federal insider trading cases, the best-case scenario is to avoid formal legal action. If your defense counsel can help you avoid SEC enforcement action and DOJ prosecution, you can also avoid the risks (and negative publicity) that come with facing federal charges.
Speak with a Federal Insider Trading Defense Lawyer at Oberheiden P.C.
If you need to know more about defending against federal insider trading allegations, we encourage you to contact us promptly. Call 888-680-1745 or request a complimentary consultation online to speak with a federal insider trading defense lawyer at Oberheiden P.C.
