Securities

What's Insider Trading?

 
  • In 2008, the Securities and Exchange Commission (SEC) filed charges against Mark Cuban for violating insider trading laws
  • In May 2010, the case is far from over
  • Illegal insider trading is when an investor buys or sells a company's securities, usually shares of stock, based on non-public information he has about the company
  • Not all insider trading is illegal
  • If you’re in the stock market, know which "hot tips" to avoid

 

A lot of us have money in the stock markets. The goal, of course, is to make money through the investments we make. Sometimes, the urge to make a profit gets an investor in legal trouble.

Mark Cuban

You may or may not know who Mark Cuban is. He's the billionaire owner of the NBA's Dallas Mavericks. He's a successful and experienced businessman and investor, as shown by his 2009 ranking of 138th on the Forbes 400 Richest Americans list.

In 2008, the Securities and Exchange Commission (SEC) filed insider trading charges against him. The charges stemmed from Cuban's 2004 sale of 600,000 shares of the stock of Momma.com. It was every share Cuban owned in the company.

According to the SEC, Cuban sold the stock because had "material, non-public information" about the company. It also claimed Cuban was able to avoid losing over $750,000 by using that information to sell the stock before the price of the stock dropped.

Cuban defended the lawsuit, and eventually it was dismissed because the SEC's complaint didn't claim that Cuban agreed not to use the "inside" information. The SEC is appealing the decision.

Cuban is playing hardball, too. He filed a lawsuit over the SEC's refusal to comply with his Freedom of Information Act (FOIA) request for documents related to the case. He claims the SEC went after him simply because it had grudge against him and without any real evidence of wrongdoing.

Insider Trading

Illegal insider trading is when an investor buys or sells a company's securities, usually shares of stock, based on material non-public information he has about the company. "Material" means the information is important and plays a big part in the investor's decision to buy or sell. "Insider" goes with "non-public." It's information that comes from someone with intimate knowledge of the company - someone on the inside.

Illegal insider trading can take many shapes, such as when:

  • An officer or employee of a corporation buys or sells shares of the corporation after learning about important and confidential business dealings, such as a plan to buy another company
  • Friends and family members who get a "tip" from the officer or employee about the business dealings and then buy or sell shares
  • Third parties - like lawyers, accountants, or printing companies - who get the information in ordinary business dealings and use the information to buy or sell stock in the company

The SEC's charge against Cuban is another classic example. It claimed an officer of Momma.com invited Cuban to buy more stock through a "stock offering" and he got the invitation before the offer was made available to the general public. Because he knew the offering would lower the value of his stock, the SEC claimed, Cuban immediately sold his shares.

The problem with the SEC's case, however, was that Cuban didn't make any promises to keep the stock offering a secret or to not sell his shares based on the information. At least that's what the trial court found and what the SEC is appealing right now.

Legal Insider Trading

Not all insider trading is illegal. Officers and employees of a corporation can buy and sell stock in company. All they need to do is file certain forms with the SEC. The forms usually need to be filed within two days of the purchase or sale. The SEC makes the transaction public.

Here's the difference. Say the president ABC, Corp. knows that the company is about to win a big contract for its goods. If he buys 10,000 shares of ABC stock:

  • Before the general public is told about the contract, he may be charged with violating insider trading laws if he doesn't file the necessary forms with the SEC
  • After the company gives a press release explaining the deal to the public, he needs to file SEC forms within 2 days of the purchase and no laws have been broken

The penalties for illegal insider trading can be severe. Investors usually have to pay a fine, give up or "disgorge" any money they made on the deal (or money they saved on the deal, like Cuban), and face jail time, too.

Avoid Temptation

Everyone who invests money wants to make money, right? At the very least, no one wants to lose money. If you get a "hot stock tip," think twice about it, and ask a few questions:

  • Did the tip come from someone who works at the company? If so, you may want to pass on the deal
  • Did it come from a "friend of a friend?" Ask your friend who his friend is, where he works and how he got the information or tip

If you think someone's violating the insider trading laws, contact the SEC immediately.

You may not be a billionaire and can't afford to go to war with the SEC like Cuban can. If you're careful and honest, you'll never have to worry about the SEC. If your hunger for profit gets the best of you, however, instead of heading to the bank, you may find yourself heading to court, and maybe jail.

Questions for Your Attorney

  • If I overhear two executives talking about a deal while waiting in line at a coffee shop, can I use the information to buy or sell stock in their company?
  • I found a letter on the bus explaining how a local company plans to buy another company. Can I buy stock based on that information without breaking the law?
  • Is it illegal if I buy stock based information I get from a friend who used to work for the company I want to invest in?

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