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Old 12-20-2005, 05:55 PM
Posts: n/a
Default Re: Insider Trading Question

Under Rule 10b5-1 of the 1934 Exchange Act, insider trading occurs when a person makes use of material, non-public information in his/her decision to buy or sell a secuirty in breach of a duty of trust or confidence owed to the issuer of that security, its shareholders or the source of the information.

Material = information that would affect a reasonable investor's decisions to buy and sell.

Some examples of people who are presumptively "insiders" unable to trade on the basis of material, non-public information (not exhaustive):

--when a person agrees to keep information secret
--when the person who gives the info. and the person who receives it have a relationship where the giver would reasonably expect the recipient to keep the information secret (e.g. the lawyer for a corporation).
--when one receives the information from your insider spouse, parent, child or sibling, subject to the defense that the recipient didn't know (and shouldn't have know) the information was confidential.

Basically, when the above categories of people trade on the secret info. they are given in the course of their employment, they are thought to steal -- or misappropriate -- money from the corporation by exploiting their information advantage. They didn't give value to the company for their stock windfall, but they are reaping it. The same rules obviously prohibit CEOs, control-persons and directors -- classic insiders -- from making trades based on their inside info. However, these groups must report all trades, and that heightened scrutiny makes any blatantly illegal insider trade more obvious to the SEC and shareholders than the more indirect, "misappropriation" cases referred to above.

Figuring out whether you have a duty to the corporation, its shareholders or its agents is only one step in the analysis, however. The SEC also prosecutes people under the tipper/tippee theory, as well as under the misappropriation theory. In tipper/tippee cases, all that matters is that the recipient knowingly received material, non-public information from an insider and traded based on that knowledge. The tipper/insider is also liable for his breach of duty in divulging corporate secrets. Even if you overhear a conversation between insiders about, e.g., a forthcoming merger, you break the law when you trade on the basis of that information (although the insiders aren't liable). However, if you found some note in the trash or in some other way came upon information that was not directly given to you by an insider and you couldn't reasonably know it was prepared by an insider, it is unclear whether it would be illegal to trade based on its contents.

In your examples above, 1 is almost certainly insider trading, and 2 is probably insider trading. I would be surprised if the gas company you referenced didn't include its new technology in a public statement to investors or in a 10K or 10Q. However, both sources were insiders (employees with confidential information are presumptively insiders), you knew that, and they gave you information that was not available to the general public and could affect share price. If you traded based on that information you would be liable for insider trading and so would your sources.

Hopefully this answers your question and gives you a slightly better idea of what constitutes insider trading. I'm a recent law school grad with only a bit of securities experience, so if anything I wrote is unclear or contradictory to what you know, please tell me and I'll try to be more clear.
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