5 Ways Founders & Companies Can Safeguard Their Information Against Insider Trading & Misuse by Their Network
In June 2023, the Securities and Exchange Commissioner initiated legal proceedings concerning insider trading allegations against a stockbroker and his associate.
* For my female founders, or people who are not used to this terminology, insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security. Some might also argue that insider trading could also be tipping, or acting upon a tip provided by someone who does have the responsibility to safeguard the information.
The SEC contends that the associate illicitly gained access to the laptop of his girlfriend, an employee at an investment bank. Allegedly, he exploited this access to procure confidential information regarding impending mergers and acquisitions involving publicly traded companies. Subsequently, he purportedly collaborated with the stockbroker to execute trades based on this sensitive, nonpublic material.
There exists a common misconception that illegal insider trading only applies to public companies ( this is false — private companies have also investigated), and if you’re not an executive within a publicly traded company, you have the ability to act freely with any information you obtain.
This assumption, however, is not accurate.
The SEC has brought insider-trading cases against hundreds of parties, including:
- Corporate insiders who traded the company’s securities after learning of significant, confidential developments
- Insiders’ friends and family, as well as other recipients of tips who traded securities after receiving such information
- Employees of service firms such as law, banking, brokerage, and printing companies who came across material nonpublic information on companies and traded on it
- Government employees who obtained inside information because of their jobs
Even if a person, fund manager, potential investor, learns of significant news about a company, such as Apple’s imminent announcement of disappointing earnings from a friend who works there, they cannot exploit this information for personal financial gain, or social capital by diverting investment, influencing peers or colleagues not to invest or to invest in another company, or hastily sell their shares through a broker.
Conversely, for insiders holding positions within a company, the scenario differs. Should an insider gain knowledge of substantial delays in a highly anticipated product launch, they are not bound to retain their shares indefinitely. Unlike external individuals, insiders have the option to engage in trading activities based on this information at a later point, once the details become public knowledge. This distinction underscores the importance of ethical and legal considerations surrounding the use of privileged information in financial dealings.
In reality, insider trading is a commonplace occurrence, but it is crucial to emphasize that it is conducted within legal boundaries.
Defining “nonpublic” information is straightforward, but the term “material” introduces a certain level of ambiguity. While the concept may lack precision, there are some broad categories that warrant caution.
These include information pertaining to earnings, mergers and acquisitions, alterations in assets or asset quality, novel patents and discoveries, regulatory approvals, and noteworthy developments involving customers or suppliers.
So, if you’re a founder or CEO of a company, where does all of this information leave you? And how do you safeguard yourself against potential illegal insider trading? Or protect yourself against someone gaining access to your information and using it for personal gain? I’ve rounded up the best practices I could find, and I’m sharing them below.
- Implement Blackout Periods
Publicly traded companies implement blackout periods to safeguard their insiders from potential legal complications, publicly traded companies implement blackout periods. These are predefined intervals during which company insiders are generally barred from engaging in the trading of their company shares. A common practice is to invoke blackout periods before and after the release of company earnings, serving as a preventative measure.
2. Know Who Has Access to Your Financials & Milestones Before You Submit them for an Accelerator or other Program Where Investment is Given
Sharing sensitive regulatory milestones or financial information with accelerator programs or investors who lack a fiduciary duty to your company poses a considerable risk, potentially leading to insider trading and adverse repercussions for your business. In such scenarios, where confidentiality and trust are paramount, divulging nonpublic information in accelerator applications or other online forms to entities who have no fiduciary obligation can create opportunities for misuse. Information asymmetry may enable those with access to act on such privileged insights, engaging in market activities that can be detrimental to the fairness and integrity of trading. This not only compromises the competitive advantage and strategic positioning of your business but also undermines investor confidence. It underscores the importance of exercising discretion and implementing robust safeguards when sharing sensitive details, ensuring that information is disclosed selectively to parties bound by ethical and legal responsibilities to protect your company’s best interests.
If you have concerns about the use of your information, share your concerns up front, and you cannot reach an agreement or obtain information about who has access to the information, you can also walk away from the opportunity.
3. Don’t Assume People Won’t Share Your Private Milestones ( good or bad) with Other People or Tip Them Off About Your Success or Failure
Being a founder or executive can come with a lot of pressure, and you might be inclined to share information, good or bad, with people whom you feel you have a close relationship with. This could be especially true at social or networking events, conferences or in after hours events where people are more relaxed. But it can be a pitfall if you are not careful. Be sure to remove yourself immediately from any conversations that stray into sensitive topics or conversations that are off-limits around the water cooler.
4. Who Has a Fiduciary Duty to Your Company? Who Is Expected to Have Trust and Confidence within Your Company?
Knowing who has a responsibility to safeguard your information can help you catch potential illegal trades down the line. What’s clear about the definition of insider trading is that there does have to be some kind of breach of assumed trust between the parties. So if the person has some kind of relationship to you — i.e. friend, family member, organization you send regular updates to for example, — and they act on information that was entrusted to them, they are likelier to pose a problem. Here are a few things to keep in mind.
- Case law unequivocally establishes that if the tipper derives information from non-confidential sources such as discarded materials or unsolicited emails, no criminal activity is implicated.
- For legal scrutiny to occur, the tippee, the recipient of the information, must actively act upon the received tip, or information not publically available. The absence of any subsequent trade indicates the absence of criminal liability.
- Profit generation by the tippee is a pivotal factor in determining the severity of any enforcement action. The swiftness of the holding period and the magnitude of profit made directly influence the level of attention and legal repercussions a trade might attract. Clear delineation of these parameters is imperative for comprehensive understanding and compliance with insider trading regulations.
5. Don’t Recommend or Induce Based on Inside Information
It is an offence under MAR to deal or attempt to deal in financial instruments or recommend or induce another person to transact based on inside information.
MAR penalizes activities such as insider trading, market manipulation, and the unauthorized disclosure of information. National regulatory authorities are entrusted with the responsibility of detecting and preventing market abuse, equipped with the authority to impose sanctions on non-compliant entities. MAR not only sets forth stringent prohibitions but also delineates mechanisms for detection and compliance within the framework of securities markets.
A Bonus Resource
If you’re truly interested in staying in the loop about how and when investors ( friends, employees, and family included), you can check the SEC’s Edgar database. It allows free public access to all filings related to insider buying and selling of stock shares.