Would this qualify as illegal insider trading?

Factual Questions
1

Let’s say my friend works for Microsoft and knows that it’s about to come out with a product that will eat into Apple’s main market in a way that will likely lower Apple’s stock. He tells me about it.

My friend and I go and short Apple’s stock just before the public reveal of Microsoft’s product. Apple’s stock loses value and my friend and I make a profit.

Have either one of us broken insider trading laws? My friend and I are most definitely trading on non-public info but that non-public info is gained from someone who is an insider of Microsoft and we are trading Apple’s stock, not Microsoft’s. What legal duty do my friend and I have toward the shareholders and creditors of Apple?

I am not looking for legal advice, this doesn’t concern me or any of my clients and is simply a question of legal curiosity.

2

IANAL but I had to research case law on this issue once, and based on what I found back then, you’d be okay.

The specific case was a young man whose father worked for the company. He profited. His father did not profit.

Sorry, I don’t remember the case. Sometime in the '90s I think. Things could have changed, other courts could interpret it differently, my research could have been insufficient, etc.

3

IANAL but I bet it’s illegal.

The company I work for makes it very clear what we are and aren’t allowed to do, and this is on the “not allowed” list. It doesn’t matter what stock is being purchased, but whether it’s based on insider information. Of course, my company’s policy might be staying well clear of a fuzzy line.

4

Another example I thought of was the following:

A parts supplier has a car maker as its main client. I get non-public information that the car maker will go bust and cut off the supplier, which will be very bad for the supplier. Can I short the supplier?

It’s the same sort of question, I suppose. Do companies which go into simple procurement contract (“I sell you this many widgets”) have a fiduciary duty toward each other and a relationship of trust and confidence, legally?

5

I’m not very familiar with insider-trading laws, but I think you’re approaching it from the wrong angle. Insider-trading laws aren’t based on a fiduciary duty to the company you work with. They are public policy laws to keep the stock market honest, with everyone operating from the same knowledge base. So my gut reaction is that your examples would both be caught by insider trading laws.

However, that’s not meant as legal advice; purely speculative. Perhaps a Doper with more knowledge on the issue will come along.

6

Giving privileged information to someone outside of the company is called “tipping” and is illegal in many jurisdictions.

From the Criminal Code of Canada:

Note that you just need to know there’s a risk that the other person will use the inside information; even if there’s no actual trading, it’s still a crime.

7

The definition of insider trading is trading on material, non-public information. In your example, you’re clearly doing that. I don’t believe the fact that you’re trading a different stock makes any difference.

8

Hogarth, thanks for the text.

382.1 (1) A person is guilty of an indictable offence and liable to imprisonment for a term not exceeding ten years who, directly or indirectly, buys or sells a security, knowingly using inside information that they

(a) possess by virtue of being a shareholder of the issuer of that security;
(b) possess by virtue of, or obtained in the course of, their business or professional relationship with that issuer;
(c) possess by virtue of, or obtained in the course of, a proposed takeover or reorganization of, or amalgamation, merger or similar business combination with, that issuer;
(d) possess by virtue of, or obtained in the course of, their employment, office, duties or occupation with that issuer or with a person referred to in paragraphs (a) to (c); or
(e) obtained from a person who possesses or obtained the information in a manner referred to in paragraphs (a) to (d).

Marginal note:Tipping

(2) Except when necessary in the course of business, a person who knowingly conveys inside information that they possess or obtained in a manner referred to in subsection (1) to another person, knowing that there is a risk that the person will use the information to buy or sell, directly or indirectly, a security to which the information relates, or that they may convey the information to another person who may buy or sell such a security, is guilty of

(a) an indictable offence and liable to imprisonment for a term not exceeding five years; or
(b) an offence punishable on summary conviction.

Note 382.1 (1):
“buys or sells a security, knowingly using inside information that they”
“possess by virtue of being a shareholder of the issuer of that security” OR
“possess by virtue of, or obtained in the course of, their business or professional relationship with that issuer” OR
“obtained in the course of, a proposed takeover or reorganization of, or amalgamation, merger or similar business combination with, that issuer” OR
“obtained in the course of, their employment, office, duties or occupation with that issuer” OR
“obtained from a person who possesses or obtained the information in a manner referred to in paragraphs (a) to (d).”

Note that it specifies trading a security based on info obtained through dealing with the issuer of that security. It doesn’t prohibit trading the security of another issuer you haven’t dealt with or cases where you didn’t get the info from someone who dealt with the issuer whose security is traded on based on insider info.
382.1 (2) comports an ambiguity. It says: “use the information to buy or sell, directly or indirectly, a security to which the information relates”
What does “relates” mean? How broadly is it interpreted? If narrowly construed, then only stock and other financial instruments of the issuer the insider is inside of are covered by the prohibition.

If we interpret 382.1(2) by looking at 382.1(1), then the narrow interpretation should prevail. Otherwise, it would mean that an insider in company A who got insider info which will affect company B (without being a company B insider) can trade on company B but may not tip someone to trade on company B.
Although I see that 382.1(1) b) would make my supplier scenario illegal since it’s info gained in the course of their business with the issuer.

Piper,
I do see your point. There is some ambiguity concerning insider trading laws. Are they there to protect people who are owed a fiduciary duty and/or have a relationship of trust and confidence with the insider or are they to serve the interest of society as a whole (to the extent they aim to, anyway)?

9

You could be guilty of insider trading under the misappropriation theory, although to my knowledge, this line of reasoning has not been applied to a product launch (someone who specializes in securities law could obviously provide a more thorough and up to date analysis of this).

I hope this isn’t a hijack, but another interesting question the OP presents, although I’m not sure if it would be a valid legal defense, is whether knowledge of the upcoming product launch would even give you at an actual advantage over an ordinary investor to the extent that any type of regulation would be necessary, or even effective. Think about some of Mr. Softee’s recent creations. Your friend calls you up and gives you a tip about this great new product called the Zune, Windows Vista, etc., that will wipe Apple off the map - probably best taken with a grain of salt. Determining whether this information is of any value would involve a lot of speculation, and would require expertise of both the product and question and the market for said product to know whether the tip is even worth acting on.

10

It’s clearly a case of tipping (IMO), but I’m less sure about insider trading. Again, from the Criminal Code of Canada (just before the tipping section, in fact):

Note that it says “that issuer” and “that security” (i.e. the issuer and/or security you have the insider relationship with).

EDIT: ninja’ed by MichaelEmouse

11

Yes, IIRC there was a case recently where a fellow working for some bank or stockbroker that did IPOs and stock issues, tipped an old college chum - regularly - about upcoming stock activity. The tipper apparently did not profit, but his friend stll was convicted, and so was he for participating, IIRC.

In the Canadian case, I guess it depends on what you mean by “a security to which the information relates”.

I guess the trick for the prosecutor would be to poke holes in the defence argument - “I knew I could not trade Apple, so I would have to invest my tech portion of my dollars is an unaffected stock.” The prosecutor would have to demonstrate it was obvious the news would significantly affect Apple, making it a ‘related stock’, which would require industry analysis of the fact; yet the details were so secret that nobody saw it coming, then who would independently have confirmed that effect except in hindsight? Hindsight is a bad basis for a case.

After all, one could point to the fact that Windows 8, MS Tables, Phones, etc have not had a significant impact, so where`s the proof of cause and effect between the gossip news guaranteeing a windfall from shorted Apple?

12

Certainly in your case, if you tell your friend “Microsoft is coming out with a great new product”, then there’s the risk that your friend might go out and buy Microsoft stock (which is clearly related to the information you gave him). Whether he does so or not, it’s still tipping.

13

You’re right.

14

But the way I read it, the guy who receives the information is not guilty if he buys Apple, not Microsoft - unless you can prove the related thing. Theres no crime in receiving a tip unless you act on it.

The onus would be on the prosecutor to prove relatedness. I suspect being in the same business is not close enough. They would have to prove the cause-and-effect of news on stock could be reasonably anticipated.

Of course, it would be easier if Joe Schmoe had never bought a stock or option before in his life. it would be easier if he did the trade 5 minutes after the phone call with the tip. If he was trading tech stocks all the time, I suspect the charge would be hard to prove.

The devil is in the details.

15

You’re right that there’s no crime in receiving a tip that you don’t act on. But there is a crime in giving a tip, as long as there’s a risk that the recipient might act on it or pass it on to someone else who might.

16

I’ve always wondered if it was illegal to short several stocks without knowing what specific event would happen. For example, I work for a large company that was recently acquired by another even larger company, which is a public company. The employees knew for some time before the acquisition that our company was for sale but wasn’t sure who the buyer was. What we did know (courtesy of our receptionist) was that the Vice President had come on two separate occasions to our facility with senior management from company A and B, who we presume were in a bidding war for our company. Since the acquiring company typically has their stock drop, would it have still been illegal to short the stocks of BOTH A and B?

At one point, company A started coming for repeated visits, making us all about 90% sure they would be the acquirer, which turned out to be correct. Had I shorted the stock for just company A, would that have been insider trading?

If it matters, the point where A and B were both coming around was about 3 months before the public announcement and the point where just A was coming repeatedly was about one month before… This happened in Maryland if it matters, but our facility is in San Diego, CA

17

I think it’s actionable as misappropriation, under US v. O’Hagan. There, the tippee (one of the lawyers for the acquiring company) learned of an upcoming acquisition and bought shares in the target. The court ruled that “A fiduciary who [pretends] loyalty to the principal while secretly converting the principal’s information for personal gain … dupes or defrauds the principal.” It found that converting the company’s confidential information to one’s personal use is akin to embezzlement. In the OP’s hypothetical, only one party is an insider, but I’m pretty sure there is older precedent holding that a tippee can be liable by imputation if he knows that he is receiving misappropriated information.

It was pointed out earlier as to Canadian law:

US law, by contrast, does not have that restriction. The O’Hagan court ruled that it was no defense that the defendant traded a different company’s stock:

The OP’s hypothetical postulates short selling of a different company as to opposed to taking a long position, as in O’Hagan, but I don’t see why that would be a material difference.

18

This reminds me of the scene in the movie Wall Street where Charlie Sheen’s character follows Gordon Gecko’s nemesis around for a few days, tracking his movements and taking note of people he meets with. From this information Gecko is able to speculate that he is planning on buying a steel company, and he trades accordingly to profit from this information. My impression has always been that since all of Sheen’s snooping was done in public it was legal. In addition, Gecko didn’t know he was planning on buying the steel company, just that his competitor visited their facilities and met with some of the company big-wigs. The purpose of this was anybodies guess: maybe he was just interested in buying a small chunk of stock. Maybe he didn’t like what he saw at the plant, or couldn’t seal a deal with the board and was unable to buy the company.

19

Actually, all Sheen’s character (Bud Fox) was able to confirm for Gekko was that Wildman met with people in the finance industry, and then left for Erie, PA, where the steel company in question was located, the rest was pure conjecture on their (Fox/Gekko’s) part. I remember reading an article several years ago contrasting insider trading, as presented in the film, versus the actual laws in place at the time, which I can’t seem to find. As I recall, the steel company incident was likely not illegal because all Fox did was observe Wildman’s activities in various public places and draw an inference from them. I believe the article gave an analogy where, if you were near an airport and noticed one of XYZ Airline’s planes involved in a crash, and called your broker to short XYZ before the media was able to confirm the incident and the specific airline to the general public, no laws would be broken. In other words, even though information isn’t common knowledge, this does not, in and of itself, make it privileged. Actually, the issue was discussed in a prior thread as well.

In addition, it’s probably best to take the movie with a grain of salt. In the sequel, Gekko mentions that he and Josh Brolin’s character would sometimes collaborate on transactions until an incident that occurred before he (Gekko) “got hot in the eighties,” and yet the original movie takes place in 1985, roughly coinciding with Brolin’s portrayal of a teenager in “The Goonies.” Also, the sequel contained several scenes where Shia LaBeouf was in a subway station or walking down the street, and yet nobody attempted to push him in front of a train, car, etc.

20

So… (based on the quoted Canadian law)
if the secretary told you, that’s an insider tip.

If the limo driver or hotel concierege recongnized the people, or checked them in and found the details, that’s also an insider tip. OTOH, if the hotel hired the limo driver, rather than the taking-over company, is that enough of a business connection? What if the hotel hired a caterer to feed the executives during the meetings? Are they now possessing insider info?

But if you happened to recognized the guys becaue you were on the plane or checking into the hotel the same time they were, then it’s not information discovered in the course of business.