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What Is Insider Trading and Why Is It Illegal?

Recently, Eastman Kodak's shares saw a substantial gain. According to the Wall Street Journal, on July 28, 2020, the company announced that it had received a $765 million government loan, which would allow it to start producing generic drug ingredients. Shortly after the announcement, shares rose as high as 2,190%. But even just a couple days before the statement was made, its shares saw a spike of 26%.

The steep increase in shares prompted Senator Elizabeth Warren to write a letter to the U.S. Securities and Exchange Commission, calling for the agency to begin an investigation into how the loan announcement was handled. The question: Was the jump in Kodak's stock a result of insider trading?

Because of the allegations of insider trading, the government loan was put on hold, according to CNN Business. Subsequently, Kodak's shares dropped by 30%.

What Is Insider Trading?

Insider trading occurs when an insider with a fiduciary duty to an organization divulges non-public, material information about that company for some type of advantage. When a person has a fiduciary duty, it means they are generally tasked with protecting a company's assets and have a responsibility to act in the best interest of the organization.

Non-public information is anything about the organization that is not yet made available to the public. Material information is anything that can affect the organization's financial condition.

If a person with confidential information buys or sells a company’s stock, that person is engaged in illegal insider trading. This offense is not limited to insiders such as company officers, directors, lawyers, or contractors. An insider who sells or gives confidential company information to a person who then buys or sells publicly-traded stock based upon the insider’s tip can be prosecuted along with the insider.

Additionally, insider trading doesn't only occur when someone makes a profit from the material information they received. Avoiding losses is also considered an offense.

For instance, one of the most well-known cases of insider trading involved Martha Stewart. She had received a tip from a broker about ImClone Systems, which affected her buying/selling decisions about the biopharmaceutical company. Based on this information, she sold nearly 4,000 shares. After the FDA said it would not approve one of the company's drugs, its shares fell 16%, allowing Stewart to avoid a loss of over $45,000.

A more recent criminal case of insider trading involves the former Apple corporate law director who was charged with insider trading because of his use of Apple’s, nonpublic financial information to avoid almost $377,000 in losses while trading Apple Stock. Defense attorneys in the case asked the U.S. District Judge to dismiss the charges contending that there is no such crime as insider trading. The judge denied the motion and the prosecution will continue.

There is no specific crime entitled "Insider Trading." In prosecuting insider trading cases, the Department of Justice and the SEC rely upon the statutes and regulations which prohibit fraud in relation to publicly traded securities. When insider trading is discovered it is common for the SEC to file a civil case and for the Department of Justice to bring criminal charges. The SEC will sue to recover any profits resulting from insider trading and also seek to prohibit the defendant from engaging in the securities business. The Department of Justice, through the criminal case, will seek to put the defendant in prison, forfeit any profit resulting from insider trading, and pay a criminal fine.

The SEC as well as the Department of Justice conduct extensive and thorough investigations which include obtaining records of the purchase and sale of securities. In addition, federal investigators will interview company employees, stockbrokers, and other witnesses to develop evidence that the defendant had knowledge of confidential information that allowed the trading of stock for profit or the reduction of loss. In addition, federal investigators often conduct an unscheduled meeting with the person suspected of insider trading. These unscheduled and impromptu meetings involve a visit by federal investigators to the person's home after working hours. Federal investigators have learned that such meetings often result in their target speaking without the benefit of a lawyer. This type of interview by federal investigators often results in a confession of insider trading or a charge of making false statements to a federal investigator. These meetings occur so often that federal agents call them Knock and Talk meetings.

Sentences, fines, and forfeitures in criminal insider trading cases can be quite harsh. During an insider trading criminal case that we defended, the Department of Justice attorneys asked the court to sentence the defendant to a year in prison and impose a fine of over $300,000. The court placed the defendant on probation for one year and imposed a $10,000 fine.

Insider trading cases can be complex and the earlier a person is represented by an experienced white-collar criminal defense attorney, the better their chances for a more favorable outcome.

If you are being investigated for or have been charged with insider trading or any other securities fraud offense, contact the Law Offices of Horwitz & Citro, P.A. at (407) 901-5852. We have extensive experience in this area of the law and can provide the legal representation you need in Orlando.