Insider trading

Insider trading happens when someone buys or sells securities while they have access to three specific types of information: material information, non-public information, and information obtained through violating a duty of trust. Understanding each element is crucial for hedge fund professionals.

The SEC defines material information as any data that would significantly influence how an investor decides whether to buy, sell, or hold a security. Non-public information means the data hasn't been widely shared with other market participants yet. The duty violation typically comes from breaking a trust relationship, violating a contract, or misusing a position of authority.

Federal regulators and prosecutors pay close attention to insider trading violations within hedge funds. This is because hedge fund managers often have access to confidential information through their business activities. To avoid serious legal trouble, hedge fund managers must clearly understand the difference between legitimate research activities and prohibited trading practices.

Information becomes material when a reasonable investor would likely consider it important for making investment decisions. Generally, this includes any data that could substantially affect a company's stock price once it becomes public. The SEC evaluates each situation individually rather than using rigid tests, since the determination depends on the specific facts of each case.

Material information typically covers two main areas: corporate financial performance and business operations. Common examples include earnings announcements, major merger discussions or completed deals, changes to earnings forecasts, serious cash flow problems, dividend announcements, significant lawsuits, and important management changes. Information can also relate to securities market activities, such as large pending trade orders or hedge fund portfolio positions.

Information becomes public when it's broadly distributed to market participants. This happens through SEC filings, other government submissions, news services, or publications with wide circulation. Importantly, enough time must pass for the information to spread widely before it loses its non-public status.

Federal law generally requires a duty violation for insider trading charges to stick. Courts analyze where the information came from, how it was acquired, and what obligations applied to the people involved. Corporate officers automatically owe duties to their companies through their positions. Independent contractors can take on confidentiality duties through their contracts.

creates responsibility for people who receive from others. The person who receives the information (the "tippee") breaches duties when the person sharing it (the "tipper") disclosed it in exchange for personal benefit. The SEC must prove that the tipper gained some advantage—whether money, reputation, or other benefit—from sharing the confidential information.

Recent enforcement actions show that the SEC is expanding how it interprets insider trading concepts. In 2021, the SEC filed the first "shadow trading" complaint against Matthew Panuwat. involves using confidential information about one company to trade securities of a different but economically connected company, such as a competitor in the same industry.

In April 2024, after an eight-day trial, a federal jury found Panuwat liable for insider trading. The case is currently being appealed to the U.S. Court of Appeals for the Ninth Circuit. This appeal could have broad impact on how insider trading enforcement works in the future.

While shadow trading cases build on existing , they potentially expand insider trading liability to economically connected companies beyond traditional direct relationships. This development shows the SEC's continued efforts to adapt its enforcement strategies as market practices evolve.

The U.S. House of Representatives passed the Insider Trading Prohibition Act in May 2021. If this legislation becomes law, it would dramatically change current insider trading rules. However, the bill hasn't advanced through the Senate as of 2025. The proposed legislation would eliminate the "obtained in violation of a duty" requirement and remove the "personal benefit" requirement for tipper-tippee liability. These changes would make prosecutions significantly easier for the government.

In December 2022, the SEC adopted comprehensive changes to that became effective in February 2023. These changes significantly strengthen protections against opportunistic insider trading through pre-arranged trading plans. The amendments introduce mandatory cooling-off periods that require individuals to wait at least 90 days between adopting or modifying a plan and starting trades under that plan.

The enhanced framework requires directors and officers to provide written certifications when adopting trading plans. They must attest that they don't know of any material non-public information and are adopting the plan in good faith, not as part of a scheme to avoid insider trading prohibitions. The amendments also restrict the use of multiple overlapping trading plans and limit single-trade arrangements to one per twelve-month period.

New disclosure requirements mandate that public companies report quarterly about the adoption and termination of Rule 10b5-1 plans by directors and officers. This includes reporting material terms of such plans. Companies must also disclose whether they have adopted insider trading policies and procedures. If they have, they must file copies as exhibits to their annual reports.

Violating insider trading prohibitions creates severe consequences for both firms and individuals. Beyond reputational damage, both state and federal agencies can pursue civil and criminal actions. The SEC can impose sanctions including injunctions, of illegal profits, and civil monetary penalties.

The U.S. Department of Justice can criminally prosecute alleged violators. Willful violations can potentially result in imprisonment. Additionally, of the Exchange Act gives private investors the right to sue violators directly for damages.

of the requires registered investment advisers and to establish insider trading policies. These policies must be reasonably designed to detect and prevent misuse of . Fund managers must tailor these policies to address the specific insider trading risks their businesses face.

When hedge fund employees serve as directors or officers at portfolio companies, firms must implement policies addressing specific risks. These personnel might trade while possessing confidential information or inappropriately share data with colleagues. These situations create heightened risk because board members typically receive sensitive business information before it becomes public.

Hedge funds with value-added investors face additional compliance challenges. Value-added investors include corporate insiders, other investment firm affiliates, or members who may possess or provide . Firms should establish policies to identify these participants and prevent inappropriate information sharing with fund personnel.

Organizations using alternative data sources must maintain policies addressing risks that datasets might contain confidential information. The SEC has intensified oversight of alternative data usage in hedge fund trading decisions. Regulators recognize potential insider trading risks from seemingly harmless data sources.

In September 2021, the SEC reached a settlement exceeding $10 million with App Annie, Inc. and its former CEO for securities law violations. The company misrepresented how it derived alternative data and engaged in deceptive practices to attract trading firm clients. This case highlights regulatory scrutiny of this growing data category.

Based on how much firm personnel encounter confidential information about portfolio companies, organizations can implement various preventive measures. Some firms establish that prevent employees with confidential data access from communicating such information to other personnel. This can involve physically separating staff and restricting information access to designated employees.

When information barriers prove impractical or inappropriate, firms can limit information leakage consequences by implementing or watch lists of securities. Restricted lists identify companies whose securities are prohibited for personal trading by firm employees. Watch lists identify potential investment targets, with restrictions requiring firm approval before personal trading in such securities.