Insider trading is the purchase or sale of a security while in possession of material, non-public information (MNPI) about that security, in breach of a duty of trust or confidence owed to the source of the information.
Two theories of liability: 1. Classical (traditional) theory: A corporate insider — officer, director, or employee — who trades in the company's securities while possessing MNPI violates a duty to the company's shareholders. 2. Misappropriation theory: A person who steals MNPI from a source (their employer, a client, a family member) and trades on it breaches a duty to the source — even if they owe no duty to the company whose stock they trade.
Tipper-tippee liability: - An insider who tips (gives MNPI to) another person is liable if they received a personal benefit (money, reputation, or a friendship-based favor). - The tippee (recipient) is liable if they knew (or should have known) the tipper breached a duty.
Penalties: - Civil: Disgorgement of profits + civil penalty up to 3× the profit (or loss avoided) under SEC enforcement. Private plaintiffs can also sue. - Criminal: Up to $5 million fine and 20 years imprisonment per violation.
Insider Trading Sanctions Act (1984) and ITSA (1988): Dramatically increased criminal and civil penalties; created "bounty" payments for insider trading informants.
Rule 10b5-1 trading plans: Allow insiders to pre-schedule trades when they are NOT in possession of MNPI; provides an affirmative defense against insider trading claims.
> Exam tip: Insider trading = MNPI + breach of duty. It is a crime, not just a regulatory violation. Tippers AND tippees can both be liable. Rule 10b5-1 plans are the primary safe harbor. Tested heavily on SIE, Series 7, and Series 65.