Insider trading is the purchase or sale of a security while in possession of material, non-public information (MNPI) in breach of a duty of trust or confidence.
Two theories of liability:
1. Classical theory: A corporate insider (officer, director, employee) who trades in the issuer's securities while possessing MNPI violates a duty to shareholders. 2. Misappropriation theory: An outsider who misappropriates MNPI from a source (employer, client) in breach of a duty of trust also violates insider trading rules — even without a duty to the company whose stock is traded.
Tipper-tippee liability: - Tipper: An insider who discloses MNPI for a personal benefit (pecuniary or reputational) is liable. - Tippee: The person who receives the tip is liable only if they knew (or should have known) the tipper breached a duty.
Key SEC rules: - Rule 10b-5: The primary anti-fraud rule; prohibits fraud, misrepresentation, and material omissions in connection with securities transactions. - Rule 10b5-1 plans: Allow insiders to pre-schedule trades under a written plan established when not in possession of MNPI. - Rule 14e-3: Prohibits trading on information about tender offers before announcement.
Penalties: Civil: up to 3× the profit gained/loss avoided + disgorgement. Criminal: up to $5M fines and 20 years imprisonment per violation.
> Exam tip: "Material" = information a reasonable investor would consider significant; "non-public" = not yet available to the general public. Pre-scheduled Rule 10b5-1 plans are an affirmative defense.