Suppose someone has non-public information about a company that is not derived from him or anyone else having inside knowledge about that company. Is it legal to trade on it?
I can think of a couple of examples offhand:
This guy is a connected insider at Company A and on that basis knows that Company A is about to issue a disastrous earning report which will tank the stock. Obviously, selling or shorting stock in Company A would be insider trading. But instead, the guy shorts stock in Company B, another firm in the same industry and to which he has zero connection, The rationale is that with Company A reporting disastrous earnings, it’s virtually certain that other firms in the industry will also be hit to an extent.
The guy knows that someone - possibly himself - is about to file a massive class action lawsuit against some company which, as Michael Avenatti might say, would “take $10 billion off the company’s market cap”. But he has zero insider connection to this company. Can he short the stock?
I’ve never heard of anyone doing these things which you would think should be pretty common, but possibly they just don’t get reported on because they’re completely legal.
To be an insider, you need to have material non-public information about the security, something that is present in both your examples; but to commit insider trading, the act of trading also needs to be in breach of a fiduciary duty or some other relationship of trust. I don’t see this present in your second case, since a plaintiff who sues a company does not owe a duty to that company. In your first case I wouldn’t be so sure about that; but I think it’s arguable that if companies A and B are so intertwined in their business that company A’s disastrous earnings make company B suffer too, then a duty of trust or confidence is also owed by that person to company B.
Example 1 seems like clear insider trading to me. You have inside information about a company and you acted on it to profit from it.
Example 2, if you’re the one suing, doesn’t seem like insider trading. If you know someone suing, it still doesn’t seem like it, since no one in the company knows about it yet.
To be clear, I’m not talking about where Company B has any relationship with Company A, or at least that this is the reason they will also decline.
It’s extremely common for major news about one company in a field to impact others in that same field, entirely on the basis that it changes sentiment about the field. So if one tech/energy/entertainment/travel/etc. stock reports disastrous earnings, then the other tech/energy/entertainment/travel/etc. stocks also get hit based on the notion that the tech/energy/entertainment/travel/etc. field is not doing well and the other companies are probably about to underperform expectation as well. (The reverse if earning do well, of course.)
So the guy at Company A doesn’t have any actual insider knowledge of the actual stock he’s trading at Company B, or any connection at all to Company B. He’s just capitalizing on an expection of market sentiment.
But he only knows about that market expectation because of his insider knowledge.
ETA, to flesh this out more. Let’s say company B was a supplier to A. In fact, A was its main customer – surely trading in Company B would be bad, right? OK, let’s say your insider info was that Company A will have a disastrous earnings report because of prior unknown problems with the industry, so you expect all the names in that industry to fall (such as B) – you can’t trade on that. OK, assume that the disastrous earnings was because of something specific to A, which may leave less competition for B, but has nothing to do with the industry. You could bet on B going up.
In any of those cases, you’re making profits based on insider info and you can’t do that.
There was a case about 10 years ago where someone was charged with insider trading because his friend who worked with the companies channeled to him inside information. he had no connection to the companies. It’s just the trades were so obvious the SEC went looking.
That’s pretty clearly insider trading. He had insider knowledge about the company he was trading, even though he got it from someone else. (Martha Stewart was investigated for insider trading based on insider knowledge she allegedly got from someone else.) The cases in the OP are about someone who has no insider knowledge about the company he is trading.
For your first example, I’m thinking of the opposite situation. You know the company you’re working for is doing well and you believe it’s due to trends in that market sector. Therefore you choose to invest in other companies in that sector. I’m pretty certain that’s legal. Expertise in a market sector isn’t insider information, even if it’s backed up by non-public knowledge about a specific company. (Although there’s a good chance it might be prohibited by your employment contract if you’re in the financial reporting division.) Your example is that the company is doing badly. Presumably that’s again due to trends in that market sector. So the same logic should apply to shorting other companies’ stock because the market sector as a whole is doing badly. Speculating on a market reaction based on an announcement you have insider knowledge about is more problematic. But I don’t think it crosses the line into illegal trading since you have no actual knowledge about how the market will react to other companies in the sector.
I believe your second example is illegal trading, whether or not it’s properly termed insider trading. You have specific material knowledge of an act or action that will harm a company, and you make a trade based on that knowledge. That’s not legal. A comparable example is if you know that a drug company is about to have it’s latest prestige drug fail a drug trial, and you short the company prior to the announcement of the failed trial. Or you work for a company that is the biggest customer of some publicly traded supplier. You know your company is about to cancel its contract with the supplier and you decide to short the suppliers stock. I believe both of the above are examples of illegal trading, and your lawsuit example falls into the same category.
Looking at the definition of insider trading, I’m probably wrong about number 1 – every definition seems to define it as trading in that companies stock (or options or bonds, whatever).
Wouldn’t the manipulation of GameStop and AMC stock be the definition of outsider information? Aren’t companies that are bought by corporate raiders doing the same things?