Apparently it’s illegal to do any sort of trading with knowledge not known by the general public, hence the troubles that Martha Stewart is having.
My question is regarding what to do if you have insider knowledge and are a stockholder. Do you just wait and holdoff as long as it takes for it to become news, and then act, or can you put out a press release, or post on a message board, or in some way make an effort to alert the general population, before selling/buying…
Here’s the law. I haven’t had time to read it.
It is a very complicated law, but shareholders are expected to wait a specified amount of time when acting on inside information. And you can’t reverse your “insider” status.
When I sat through the remake of “Sabrina”, the title character’s father, the chauffeur for the rich businessman, remarks that he became wealthy from listening to his employers business dealings, I thought to myself, “Man, the SEC would bust his ass.”
I think anytime someone makes a gob of money very quickly on Wall St., the SEC gives them a good eyeballing. Especially if they take a very large position (long or short) on a stock within a couple days prior to a major announcement by the company (or any major newsworthy event that would effect THAT particular stock’s price).
I assume Martha is not a broker so she can’t specifically sell/buy shares, right? She tells someone else (her broker) to sell/buy. Since the law is complicated it would make sense that this is how things work - so the broker has to be fully knowledgable of the law. So, can’t it be argued that the broker is primarily at fault here?
The broker is a co-defendant in the case. Stewart is accused of conspiring with her broker to cover up the illegal insider trading (by agreeing to lie and say that they had a prior agreement to sell the stock at a certain price).
Does the knowledge have to come from the company in question? Obviously if I work for company X and hence get an email from the CEO showing he’s about to go insane, and short the stock, that’s insider trading.
What if I just hang around outside the office every morning and notice that the CEO has underpants on his headm and guess he’s insane and short? Anyone COULD have that information.
What if I happen to offer the CEO a lift, and hence notice the underpants on his head? What if I’m a taxi-driver? A chauffer?
What if I discover unrelatedly that people called Greg are likely to go insane, and look up the company and that’s the CEO’s name? It’s private knowledge, but not due to that company.
The prohibition against insider trading is against trading while in the possession of material, non-public information. So there are two things you can do. You can wait for it to become not material, or you can wait for it (or cause it) to become public.
How does something become not material? When superceding events intervene. Let’s suppose you have come into possession of a company’s non-public business projections for the first quarter of 2004. Furter suppose that these projections are different from the analyst guidance projections. After the company reports the first quarter, whether they met the projections you have or not, your information is stale and you may trade freely. If you learn that Amalgamated Widget is going to make a bid for the company, the information becomes stale if they change their mind. (NOTE: Don’t do either of these things without talking to a lawyer – the examples are stupefyingly simplified!)
What about public? Well, you can’t just put out a press release and be done with it. The information must be public and widely disseminated. What the heck does that mean? There’s no objective standard, but generally speaking it means disseminated in a way that a reasonably diligent potential trader in a company’s securities would have access to it. The most bulletproof place is in SEC filings, especially since they’re now available online. If you’re a company’s CEO, you can cause the company to file an 8-K announcing to the world whatever the information is, and following that you can trade.
You can also make it public via press release, but you can’t write your own, fax it to the Wall St. Journal and be done with it. Someone has to actually publish the release. So say the Journal picks it up on its wire service – you’re good. There are also large, professional press release services such as Businesswire and PRNewswire. Most observers believe that sufficiently many investors follow those companies’ press releases that using them is sufficient to acheive “dissemination” even if no independent source picks up the story. But not all observers.
Also, keep in mind that you may be prohibited from making information public by other restrictions – confidentiality agreements, fiduciary duties, privacy laws, etc. So this avenue is not available to everyone or in all cases.
Here’s the basic smell test: If the information you have would make a reasonable person make a different judgement about a security’s value and that person doesn’t have access to the information, you’re restricted.
It’s important to realize is that insider trading is very, very rarely litigated. Most cases are settled. So there is little case law as to what, specifically, insider trading is.
Insider trading is trading on the basis of material, non-public information.
If you have such information, you either have to disclose it publicly or refrain from trading.
The SEC alleges that Waskal had such information about the FDA status of his company’s drug. He or his family traded on it. Bacanovic/Fanueilli then tipped Martha according to the SEC. She knew it was a disclosure of material nonpublic informaiton and she still traded on it. If the SEC proves all of this, they have proved insider trading.
Technically, the information must be divulged in breach of some duty. If you overhear the info on an elevator you are generally considered to be OK, although this is not always true (Barry Switzer was charged under somewhat similar facts).
An employee of a financial printer that was printing takeover documents traded, was charged, and got off. Court said he owed no duty to the company, althought the law has since been changed.
A wrinkle in the Martha Stewart case is she is not charged with criminal insider trading. The govt basically has only a circumstantial case of that, so they did not charge her, presumably out of fairness because they generally would not charge others in such situation. I think they did bring a civil case against her to recover 3X the losss she avoided by selling. The criminal prosecution focusses on her cover up of the insider trading, which apparently the SEC thinks it has strong evidence, and her statements with respect to her own public company.
Martha’ Stewart’s excuse - that she had a standing order to sell at $40 - to me is implausible because a broker can easily enter that into a computer and Merill Lynch never did. I simply don’t believe her.
I think the jurors may get confused becuase the govt did not charge her with criminal insider trading. I have not heard them explain why. The reason I give above is my surmise.
BTW, the link above is not the insider trading rule. The insider trading rule is Rule 10b-5 as it has been interpreted by countless court cases. Its not something you can link to. The poster above linked to Reg FD which mostly applies to companies when they are making disclosures, as oppsoed to investors when they are trading. Reg FD is related but its not the same thing.
More specifically, you don’t have that information – you have an educated guess based on behavior you have observed in a public place. So you’d probably be OK. If you were the CEO’s shrink, even if you didn’t work for the company, you’d be in possession of inside information in addition to your other duties under your profession’s canon of ethics.
This is called the “mosaic” theory – it is legal to piece together small pieces of information and draw a correct conclusion from it, so long as no one piece is not material inside information. However, one must be careful – the mosaic theory is mostly used for professional analysts writing up their reports for brokerage customers; individuals who try to use it often get tripped up. Again, not a lot of case law. I think your example would have you clear – again, you don’t have any actual “information” about the company that isn’t public. But suppose you eat lunch at the same restaurant as a company’s CEO. Every day. And every day he comes in alone and sits at the lunch counter. Today he comes in with a half-dozen banker-types in thousand-dollar suits, requests a corner booth and they all go there and talk in hushed tones. You make the correct guess that the CEO is meeting with bankers to sell the company. Have you violated the insider trading laws? Dunno. I do know I’d want to be your lawyer, because I’d send my kids to college off you whether you’re guilty or not. And I do know I wouldn’t want to be you, because life would just suck for a while, again whether you’re guilty or not.
Firstly, thanks for trying to explain. It’s very interesting to read about. And don’t worry, I’m not planning on using any of the advice 
I’m not sure if you miss my point with my last example. I wasn’t imagining piecing together information, I was imagining that I have some new information, that only I know, but not due to my association with my company. Eg. I wake up tomorrow, and invent a solar power generator that’s cheaper than petrol engine. Can I short petrol companies?
To slightly tweak Shade’s example, and perhaps tweak it a bit too far:
Let’s say it’s 1984, and the Mac has just been released to the general public. I have been watching the publicly-available knowledge about Apple doing something about a GUI-based OS (like the Xerox PARC’s systems of some time before) on Motorola 68000 chips, so I begin intensive planning on a program that will tie up the market in graphical design on personal computers for as long as Apple is the only serious player in the home GUI market. When the Mac’s API is publicly released, all I need to do is incorporate it into a mostly-finished product, put it through the final testing process (assume I’d built 68000 computers of my own as testbeds), and sell Apple an exclusive, renewable license to my now-finished market-killer.
Would it be unwise of me to buy Apple stock before the deal is completed? How about afterwards? Let’s say I short Microsoft (or Digital Research, or IBM) based on the release date of my package; would I be liable then?
I would say in that case you are OK. It’s highly speculative that you will ever get the thing to market and be profitable.
Alternatively, lets say you are a scientist that has been working on a top-secret project of the type you mention. You know some company is going to announce the product next week and you invest accordingly, then you are probably in trouble.
And it doesn’t have to be “company” news. If you know for certain N. Korea is going to invade S. Korea tomorrow and you short-sell the US market, you are in trouble again.
That is, you “know for certain” because of information the public is not aware of.
And it’s all a mater of “how much” too. If you invest $100 in some company on “inside information”, you are probably going to be OK even if you go around bragging about it, because you aren’t going to make that much money on the deal anyway. But, if you buy $1,000,000 of stock in that same company, and trading $1,000,000 in stock is not what you commonly do, you better have some reasonable answer as to why you bought it, when the shares skyrocket in a couple days.
This is somewhat offtopic, but can anyone explain to me why insider trading should be illegal? Who was harmed by Martha’s actions?
If she had decided to follow the law and not sell her shares on the day that she did, the folks who bought ImClone that day would have paid at least the same price for their shares, if not more due to there being fewer sellers in the market with Martha’s absence. Their loss, after the ImClone crash, ends up being at least the same and probably more.
Can anyone explain who she hurt? 
Lets say you and I are the big shareholders in company X. I work in the President’s office, so I know all the inside poop before it hits the street. I know before the opening tomorrow the company will make a negative announcement. I sell my shares for $100 a piece before the market closes, the next morning the company makes the announcement and the stock opens at $15 a share. You wouldn’t mind?
Sure people buy and sell shares every day. But wouldn’t you be mighty pissed off if someone sold you shares for $100 knowing for CERTAIN they would be worth MUCH less in the morning?
Originally posted by ccwaterback:
I’d be upset at losing money certainly, but I still don’t see how I’m any worse off because of your actions. If you hadn’t been selling at the time, I might have had to pay $101 per share from someone else, and the crash would have happened anyway. In a civil suit, wouldn’t someone have to prove that your actions cost them money? Who would that be? And if there is no victim, should it be illegal?
No, the “inside poop” that he knows is not that the stock will crash. What he knows is that something in the company is changing that will in all likelihood cause people to sell stock. If this company change is announced to everyone at the same time (or as well as this can be done) then all shareholders have an equal chance to cut their losses. If only one person knows about the change then he can sell all his stock (based on the value of the company before the change) before anyone else knows about the company change.
An analogy could be: You find a beautiful house. You decide you want to sign for it tomorrow. Over night the house burns down. The next day, you go to the realtor’s office; the realtor knows the house burned down but he sells it to you anyway. Fortunately, in this case there are laws that protect you.
Originally posted by robo99:
I do understand the reasons why people object to insider trading. And I agree that it seems like common sense to oppose it. But I’m trying to think outside the box and question the harm that actually comes of it.
I don’t agree that the people who are buying the shares from the inside trader are getting the equivalent of a burned down house. A house is unique and only has one seller. Stocks are typically numbered in the millions, are identical, and have multiple simultaneous buyers and sellers. Buyers don’t ask for the insider’s shares by name. They ask for some shares, period, and will get them from someone even if the insider doesn’t sell.
In other words, even if the insider obeys the law, those people are going to take the same loss on their investment. The insider didn’t cause the stock to drop. He or she only profited from the knowledge.
Again I ask, who did the insider hurt? Who could claim damages in a civil suit?