Insider Trading, refers to the act of trading in a company’s stock by individuals with access to non-public information that pertains to the entity. The insider breaching policy and offering non-public information to external parties is known as a tipper. The outsider benefiting from privileged information is called the tippee. However, not all inside trading activity is illegal. Insider trading activity that is documented with the Securities and Exchange Commission (SEC) in advance is permissible.
The SEC is an entity charged with regulation of stock exchange in the US— by ensuring transparency among all stakeholders. In 2000, the SEC enacted Rule 105b-1 which explained illegal insider trading activity. The rationale behind the criminalization of insider trading was that it breached the transparency of the US Stock markets— a tenet the markets were built upon. Despite being expounded by the SEC, insider trading has never formally been defined in any Statute in the US. Owing to this, a cloud of uncertainty has always engulfed stakeholders in US Stock markets.
Over the years, judicial decisions from the U.S Supreme Court and Circuit Courts have only thrown the public into further disarray, regarding what constitutes illegal insider trading. An example is the grey area cast in the 1984 landmark case of Dirks v. SEC. In its ruling, the Supreme Court interpreted a breach of Stock markets’ transparency as when “a tipper stands to benefit from disclosing non-public information to unwarranted parties personally.” Unfortunately, the Court did not clarify the scope of the term ‘personal benefit.’ For years, stakeholders in US Stock markets were bound by the decision in Dirks v. SEC where insider trading was concerned.
The public was thrown into disarray in 2014 when the Second Circuit Court issued a different interpretation of the term ‘personal benefit’ in United States v. Newman. The Court interpreted that the personal benefit doctrine was also applicable where the tipper and tippee have a close relationship and that such benefit does not necessarily have to be financial. In Salman v U.S, the Supreme Court upheld this decision.
Tumult grew in August 2017 when the personal benefit doctrine was applied to include a tippee who had invested after receiving confidential information from a doctor, in U.S v. Martoma. The doctor was neither related to the defendant, nor had he received any ‘benefit’ from sharing the information.