1

SEC Rule 10B5-1 prohibits:

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.

but what if there is no "breach of a duty of trust"? Is there some other United States law, rule, or court ruling covering cases when one gains such information from the outside?

For example, consider some private Company A that is about to release a product that will likely lower the share price of some public Company B. Would an employee of Company A making trades (e.g. buying put options for Company B) based on this information be committing an illegal act?

A very similar question was asked here:

Insider Trading

but it only considers the question in a very general sense and does not address regulations in the United States specifically. Are there any recent examples of the application of laws, rules, or court cases related to this scenario in the United States?

Update:

Assume for the sake of this question that there is no breach of trust being committed against the source of the material nonpublic information (Company A). If it helps, imagine that Company A is a sole proprietorship where the employee committing the trades is the company's only employee (and consequently also the head of the company) and that there are no outside investors or stake holders involved with Company A whose trust could be breached.

5
  • 1
    Your example is very much insider trading and is a breach of a duty of trust or confidence... do you have a better example that fits your premise?
    – Ron Beyer
    Sep 22, 2021 at 2:03
  • The most important thing about "insider trading" is that someone trades based on information that is not available to the general public. The employee of company A trades on information that is not available to the general public. If the information about A's new product were public, and all the information why it will damage B's share price were public (even if most people don't know it, but everyone could know it), then likely no insider trading.
    – gnasher729
    Sep 22, 2021 at 12:38
  • I think it is pretty much written there - employee from company A is purchasing or selling shares on company B based on "material nonpublic information" in a breach of trust owed to the source of the material nonpublic information (Company A). Also note that many companies make it a conflict of interest to own, buy or sell shares from their competitors (regardless of the employer being a listed company) Sep 23, 2021 at 9:12
  • @RonBeyer I have updated the question with another example. There are likely other more plausible scenarios, but the main point of the question is this: Is insider trading possible with no breach of trust? In other words, consider a scenario in which everyone from private Company A is totally fine with what the employee trading Company B based on the not yet released information is doing.
    – nellapizza
    Sep 23, 2021 at 11:07
  • The breach of trust isn't just from company A or B, it also includes shareholders and the general public.
    – Ron Beyer
    Sep 23, 2021 at 13:37

1 Answer 1

2

Is it still insider trading if from the outside with no breach of trust?

No, because "insider trading is the abuse of a fiduciary position" Fry v. UAL Corp., 84F.3d 936, 938 (1996). Furthermore, Chiarella v. U.S., 445 U.S. 222, 232 (1980) refutes the notion that "[t]he use by anyone of material information not generally available is fraudulent". For it to be fraudulent, there would have to exist "with the sellers of the target company's securities" some prior dealings, or a relation of trust and confidence, a fiduciary position, Id. at 232.

In its rather unqualified formulation, the scenario you outline does not reflect an [employee's] abuse of fiduciary position. There is a duty the employee owes to company A, but the employee's informational advantage was neither a result of misappropriation nor used in a way that amounts to misappropriation, abuse, or leakage of A's trade secrets. A company's decision to release a product does not typically depend on the stock price of its competitor(s), and your description does not otherwise reflect that A's interests are directly or indirectly influenced by the value of B's options/securities. Most important, your update clarifies that the employee's trading has A's consent.

Although the proposition "for" in "buying put options for company B" suggests that the employee purchased put options on behalf of company B, it appears that you mean that "he [for his own personal profit] bought B put options". Again, your edit and comment reinforce the latter.

3
  • This is interesting, and a bit surprising. I've been employed in positions of trust so long that it never occurred to me. Sep 23, 2021 at 20:04
  • Ah very interesting, especially in Chiarella v. U.S., 445 U.S. 222, 232 (1980): "I write simply to emphasize the fact that we have not necessarily placed any stamp of approval on what this petitioner did, nor have we held that similar actions must be considered lawful in the future. Rather, we have merely held that petitioner's criminal conviction cannot rest on the theory that he breached a duty he did not owe." which seems to leave the door open for ruling such behavior fraudulent in other ways just not specifically insider trading that the defendant had been convicted of.
    – nellapizza
    Sep 24, 2021 at 0:56
  • 1
    @nellapizza "seems to leave the door open for ruling such behavior fraudulent in other ways". Yes, but actionability would be premised on manipulative practices (such as price rigging), misappropriation of nonpublic information (see Chiarella at 241), or other elements that are materially different from the scenario you have in mind. Sep 24, 2021 at 9:04

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.