Material non-public information

Material non-public information is confidential data about a company or security that has not been made available to the general public. This information must also be significant enough that a reasonable investor would consider it important when deciding whether to buy, sell, or hold an investment.

For someone to be found guilty of insider trading, prosecutors must prove three essential elements:

• Material information: The information must pass the "substantial likelihood test." This means a reasonable investor would consider the information important enough to influence their investment decisions. The information should potentially change how investors view the company or security.

• Non-public information: The information has not yet been shared broadly with investors through proper channels. These channels include SEC filings, official press releases, news reports, or other legitimate forms of public disclosure that reach the general investing public.

• Obtained in violation of a duty: The person must have acquired the information by breaking a legal obligation. This could involve violating a fiduciary dutyLegal obligation to act in the best interests of another party, requiring utmost good faith and loyalty., betraying a relationship of trust and confidence, or breaking another type of relationship that legally required keeping the information confidential.

Material information typically falls into two main categories: company-specific information and market-related information.

Company-specific material information often includes financial and operational details such as quarterly earnings results, significant merger or acquisition proposals, changes to previously announced earnings forecasts, and serious cash flow or liquidity problems. It also covers major changes to dividend payments, significant lawsuits or legal settlements, and important developments involving senior management, such as CEO changes or key executive departures.

Market-related material information focuses on trading activity and investor behavior. This includes knowledge of large pending orders to buy or sell securities, information about major institutional investors' portfolio holdings, and details about significant changes in fund positions that could affect stock prices.

Information becomes "public" only when it has been distributed widely enough that ordinary investors can reasonably access it. The disclosure must reach the general investing public through established channels and allow sufficient time for the information to spread.

Acceptable forms of public disclosure include official filings with the Securities and Exchange Commission (SEC) or other government agencies, coverage by established news reporting services, and publication in widely circulated financial publications. However, simply posting information on a company website or mentioning it in a small investor meeting does not automatically make it public. The disclosure must be broad enough and given enough time to reach the general investment community.

Federal law requires investment advisers to take proactive steps to prevent insider trading. Specifically, Section 204AProvision of the Investment Advisers Act requiring investment advisers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material non-public information. of the Investment Advisers Act Investment Advisers Act of 1940 The Investment Advisers Act of 1940 is the primary U.S. legislation regulating investment advisers, including hedge fund managers, establishing registration requirements, fiduciary duties, disclosure obligations, and compliance standards for advisers meeting certain thresholds. mandates that both registered investment advisers Registered investment adviser (RIA) A registered investment adviser (RIA) is a hedge fund manager or other investment adviser that has registered with the SEC or state securities regulators. These advisers must follow comprehensive rules including fiduciary duties, compliance requirements, and regular examinations. and exempt reporting advisers Exempt reporting adviser An exempt reporting adviser is an investment adviser that doesn't have to complete full SEC registration, but still must meet some basic reporting requirements. This status typically applies to advisers who only manage private funds with less than $150 million in U.S. assets, or advisers who exclusively manage venture capital funds. must create and maintain comprehensive insider trading policies.

These policies must be designed to effectively detect and prevent the misuse of material non-public information. The regulations recognize that different investment firms face different risks, so policies should be customized to address the specific insider trading risks each business encounters.

For hedge funds, this often means addressing risks that arise from fund managers serving on corporate boards, receiving information from "value-added" investors who may share confidential details, and using alternative data sources that might contain non-public information. The policies must be actively maintained and updated as business practices and risks evolve.