Insider Trading Enforcement Daniel A. Nathan

• Pages: 39-56

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CHAPTER 4

Insider Trading Enforcement

Daniel A. Nathan

The Securities and Exchange Commission (SEC) is the principal agency that

enforces the law against insider trading, given its historic role in policing

the financial markets and its sweeping jurisdiction over any conduct that

occurs “in connection with” transactions in securities. The Department of

Justice (DOJ) also actively prosecutes insider trading, either upon referral

from the SEC or Financial Industry Regulatory Authority (FINRA), on a

parallel track with the SEC, or based on potential violations that it identi-

fies and develops through investigations by federal agents, informants,

or cooperating witnesses. Other regulators, in particular, self-regulatory

organizations such as FINRA, are much less active in prosecuting insider

trading for the practical reasons discussed later in the chapter, but they

have long played an important role in identifying possible incidents of

insider trading through the use of their extensive surveillance capabilities,

and they refer these leads to the SEC or federal prosecutors. Finally, the

law provides for private rights of action by shareholders who were on the

losing end of trades in which an insider obtained an unfair advantage based

on his or her possession of material non-public information.

1. The SEC

The SEC is charged with “protect[ing] investors and the markets by inves-

tigating potential violations of the federal securities laws and litigating the

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40 CHAPTER  Insider Trading Enforcement

SEC’s enforcement actions.”1 Central to that mission is creating and main-

taining the appearance that the markets present a “level playing field,” and

trading based on an unfair advantage interferes with that appearance.2 As

previously discussed, the legal analysis of what is “unfair” is often a complex

and fact-intensive endeavor, and the law of insider trading continues to

evolve. The highly fact-oriented process of proving insider trading often

makes the SEC’s—and other agencies’—investigations lengthy and resource

intensive. This chapter provides a general overview of the steps taken by

the SEC in developing an insider trading case, although the investigations

can follow many different paths.

SEC staff attorneys in the Division of Enforcement generally play

a lead role in the investigation’s fact gathering,3 in contrast to criminal

prosecutions, where the prosecutors often rely on federal law enforce-

ment agents—usually from the Federal Bureau of Investigation (FBI) or

the Postal Inspection Service—to gather facts.4 The SEC attorneys might

be supported by staff investigators who are experienced in understanding

trading records and scheduling out trading, but such assistance is often

unnecessary to a staff lawyer, who is likely well versed in such documents.

A. Initiating an Investigation

An insider trading investigation typically begins with an announcement of a

material event involving a public company, such as a merger or an earnings

announcement that is significantly above or below the market’s expecta-

tions. Such announcements typically will cause a significant movement in

the price of all securities issued by the company. Increasingly, regulators’

default reaction to such public announcements is a presumption that

insider trading might have occurred. Regulators review trading prior to the

1 SEC Enforcement Manual, §1.4.1 at 1.

2

SEC, Insider Trading—Fast Answers, https://www.sec.gov/answers/insider.htm (“Because

insider trading undermines investor confidence in the fairness and integrity of the securities

markets, the SEC has treated the detection and prosecution of insider trading violations as

one of its enforcement priorities.”).

3 SEC Enforcement Manual, § 3.1.1 at 28.

4 The involvement of the attorneys in gathering facts could make them potential witnesses

in any ultimate trial of an insider trading case that they worked on and potentially dis-

qualifies them from trying the case. That is at least one reason why criminal prosecutors

rely on agents. Although that dual role does not yet appear to have caused issues for the

SEC in trying these cases, the SEC has at least partially addressed that problem by using a

separate Trial Unit within the Division of Enforcement to play a lead role in any such trials.

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