Federal Insider Trading Charges: Defenses and Penalties

federal insider trading

In recent years, there has been a significant increase in federal insider trading cases, with federal prosecutors cracking down on individuals who trade securities based on nonpublic information. These criminal charges can have serious consequences, including years in federal prison.


At Kolsrud Law Offices, we specialize in defending individuals accused of insider trading and other white-collar crimes. Our experienced team is dedicated to protecting the rights of our clients and helping them achieve the best possible outcome in their cases. If you are facing federal insider trading charges, don’t wait to seek legal representation - contact us today for a consultation.

Statistically, insider trading penalties have intensified over the past decades, with recent cases resulting in some of the largest fines in history. For example, in 2020, the SEC reported over $4 billion in disgorged profits and penalties from enforcement actions related to violations of securities laws including insider trading.

What is Considered Inside Trading?

Insider trading refers to the buying or selling of a publicly-traded company's stock by someone who has non-public, material information about that stock.


Under federal law, insider trading becomes illegal when it involves deceit or a breach of duty to other shareholders. Specifically, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 issued by the Securities and Exchange Commission (SEC) are crucial in the enforcement of insider trading laws.


These provisions prohibit fraudulent activities in connection with the purchase or sale of securities, including acts of insider trading.


Key Elements of Illegal Insider Trading


    ➤Material Information: Information is considered material if a reasonable investor would find it important in making a decision to buy, sell, or hold a security. Examples include non-public earnings reports, news of a pending merger, or acquisition.


   ➤Non-public: Information that has not been released to the general public and is thus not legally available to the market at large.


   ➤Breach of Duty: The trader must be violating an explicit trust or duty while trading on this material, non-public information. This often includes insiders like executives and employees, but can also extend to any individuals (e.g., family, friends, business associates) who receive such information from an insider (often referred to as "tippees").

inside trading examples

Examples of Insider Trading

 Here are specific scenarios that illustrate practices deemed as insider trading under federal laws:


  1. Executive Action Prior to Earnings Announcements:
    • Scenario: The CFO of a company learns that upcoming quarterly earnings will far exceed public expectations. Before the earnings announcement, he buys shares of his company to sell them post-announcement at a higher price.
    • Legal Breach: This is insider trading because the CFO used material, non-public information to influence his stock purchase, breaching his duty to the shareholders not privy to this information.
  2. Tipping Insider Information:
    • Scenario: An employee in the R&D department of a tech company knows that the company is about to patent a groundbreaking technology. She informs her brother, who uses this tip to buy stock in the company.
    • Legal Breach: Both the employee and her brother could be prosecuted for insider trading—the employee for leaking non-public, material information, and her brother for using this tip to make a profit.
  3. Mergers and Acquisitions:
    • Scenario: A lawyer working on a merger between two major pharmaceutical companies buys stocks in the target company before the merger's public announcement.
    • Legal Breach: The lawyer's purchase of stock, based on confidential information about the merger, constitutes insider trading as he has a fiduciary duty to both his client and the shareholders of the companies involved.
  4. Government Leak:
    • Scenario: A government official learns of an imminent regulatory approval for a new drug from a pharmaceutical company and buys stocks based on this information.
    • Legal Breach: This is insider trading because the official acted on material, non-public information that was expected to affect the pharmaceutical company's stock price once made public.
  5. Hedge Fund Strategies:
    • Scenario: A hedge fund manager receives a tip from an insider at a biotechnology firm that a major project failed its clinical trials, information not yet public. The manager shorts the firm’s stock based on this tip.
    • Legal Breach: Trading on this negative tip not only implicates the hedge fund manager in insider trading but also the insider who disclosed the information, as they both sought to benefit from material, non-public information.

How Do Investigations for Inside Trading Work?

Insider trading investigations involve multiple regulatory bodies and sophisticated techniques to uncover illicit activities. 


Understanding the process behind these investigations can provide valuable insights for anyone involved in the financial sector, as well as for those who might find themselves under scrutiny.


Initiating Bodies and Key Regulations

  • Securities and Exchange Commission (SEC): The primary agency for enforcing federal securities laws, including those related to insider trading. The SEC uses comprehensive surveillance and analytical techniques to monitor trading patterns and investigate suspicious activities.
  • Financial Industry Regulatory Authority (FINRA): This private corporation acts under the supervision of the SEC to oversee U.S. brokerage firms and exchange markets. FINRA aids in the initial detection of irregular trading patterns that may suggest insider trading.
  • Federal Bureau of Investigation (FBI) and Department of Justice (DOJ): For criminal investigations, the FBI steps in, often in coordination with the SEC and the DOJ prosecutes the cases in court.


Steps in an Insider Trading Investigation

  1. Detection: The investigation typically begins with the detection of unusual trading activity. This can arise from:
    • Market Surveillance Algorithms: These sophisticated systems analyze trading patterns and flag transactions that deviate from normative behavior, such as large trades made in close proximity to major, market-moving announcements.
    • Tips and Complaints: Whistleblowers, disgruntled employees, or observant individuals often provide crucial information that can trigger an investigation.
  2. Preliminary Analysis: Once suspicious activity is identified, regulators conduct a preliminary analysis to determine the likelihood that insider trading has occurred. This involves:
    • Review of Trading Records: Regulators examine who traded and what was traded before significant public announcements.
    • Audit Trails: Detailed scrutiny of electronic communications, financial statements, and personal connections between traders and insiders within the company.
  3. Formal Investigation: If preliminary findings suggest wrongdoing, a formal investigation is launched:
    • Subpoenas and Testimonies: The SEC issues subpoenas for brokerage records, emails, phone records, and other documents. Testimonies from suspected insiders and traders are also collected.
    • Forensic Analysis: Financial experts analyze trading data to uncover patterns that might indicate a coordinated strategy of exploitation of non-public information.
  4. Enforcement Actions: Based on the evidence gathered, the SEC decides whether to pursue enforcement actions, which can include:
    • Civil Actions: These may involve fines, disgorgement of profits, or bans from trading and serving as a company's officer or director.
    • Referral to the DOJ: For criminal prosecution, the case is referred to the DOJ, where charges are filed, and the accused are tried in federal court.
inside trading penalties

Penalties For Federal Insider Trading

Both criminal and civil penalties can be applied to inside trading charges, depending on the specifics of the case and the agencies involved in prosecution and regulation. 


Criminal Penalties:

  • Imprisonment: Convicted individuals can face substantial prison time. The maximum sentence can be as severe as 20 years, particularly in cases involving egregious breaches of trust and significant impacts on market integrity.
  • Fines: Criminal fines for individuals can be as high as $5 million. For entities such as corporations or partnerships, the fines can reach up to $25 million, or more depending on the circumstances and the scale of the illicit activities.
  • Probation: In some cases, individuals may also be sentenced to probation, which involves compliance with various prescribed conditions rather than imprisonment.


Civil Penalties:

  • Disgorgement: This penalty requires the offender to pay back any illicit profits gained from the insider trading activity. This is often combined with other penalties to eliminate any financial benefit derived from the crime.
  • Fines: The Securities and Exchange Commission (SEC) can impose civil fines up to three times the amount of the profit gained or the loss avoided from the illegal trading activity.
  • Injunctions: Individuals may be subject to injunctions, which are legal orders that prohibit them from engaging in certain activities, including trading in particular markets or serving as an executive in public companies.
  • Bans: The SEC can also impose bans preventing individuals from serving as officers or directors of public companies, which can be a career-ending sanction for corporate executives.


Other Consequences:

  • Reputational Damage: The stigma of being involved in insider trading can severely damage an individual’s professional reputation and personal relationships.
  • Legal Expenses: The cost of legal defense can be substantial and can impact an individual's financial stability regardless of the trial's outcome.
  • Career Impact: Convictions can lead to job loss, and the associated public record can permanently hamper future employment opportunities in financial services and other sectors.


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Defense Strategies Against Insider Trading Charges

Facing insider trading charges can be a daunting experience given the complex nature of securities law and the severe penalties involved. However, there are several defense strategies that can be employed by legal teams to challenge the allegations.


These defenses can mitigate the severity of the consequences or potentially result in a dismissal of the charges.

  • Lack of Material Non-Public Information

    • Definition: This defense argues that the defendant did not have access to material non-public information at the time of the alleged insider trading. Information is "material" if a reasonable investor would consider it important in making investment decisions.
    • Application: Demonstrating through records and communications that the accused had no knowledge of the sensitive information can invalidate the prosecution's claim that insider trading occurred.

  • No Intent to Commit Fraud

    • Definition: Insider trading laws hinge on the intent to commit fraud. Without the intent to use undisclosed material information for personal gain, no crime can be established.
    • Application: Legal defenses can show that the transactions were coincidental or part of a pre-established trading plan, which can include automatic trading instructions that execute without the trader’s direct input once certain market conditions are met.

  • Pre-arranged Trading Plans

    • Definition: A pre-arranged trading plan (known as a 10b5-1 plan in the U.S.), set up when the insider legitimately has no material non-public information, provides a strong defense against insider trading accusations. These plans schedule future trades at a time when the insider does not possess any material inside information and are executed irrespective of subsequent information the insider receives.
    • Application: Showing that trades were scheduled in advance through a 10b5-1 plan can effectively counter allegations that the trades were made based on material, non-public information.

  • Mistake of Fact

    • Definition: This defense asserts that the defendant was mistaken about the facts surrounding the situation and that any breach of securities law was not intentional.
    • Application: If the defendant believed the information was already public or did not understand it to be material, this misunderstanding can be presented as a lack of fraudulent intent.

  • Advice of Counsel

    • Definition: If a defendant can prove that they made trades based on the advice of a legal professional, whom they believed was providing lawful guidance, they can use this as a defense against charges of insider trading.
    • Application: Documentation and testimony that the defendant consulted with a lawyer or compliance officer and disclosed all relevant information before making a trade can support this defense.

The strategies outlined above provide pathways for defense against insider trading charges but require meticulous preparation and expert legal interpretation to be effectively employed. Each case is unique, and thus, a defense that is highly effective in one situation may not be applicable in another.

Contact a Federal Defense Attorney

Josh Kolsrud, the founder of Kolsrud Law Offices, offers unparalleled expertise, derived from a distinguished career in both prosecution and defense.


Initially working at the Maricopa County Attorney’s Office, Josh handled thousands of felony cases and received numerous "Attorney of the Month" awards. His experience expanded in the Major Crimes and Repetitive Offender Bureau, further honing his skills in prosecuting serious offenses.


Josh has managed over 3,500 cases and conducted more than 100 jury trials. His role as an Assistant United States Attorney involved collaborating with federal agencies on complex criminal cases, including drug trafficking, illegal reentry, human trafficking, and white-collar crimes. This extensive background gives him a unique insider's perspective on federal prosecution tactics, which he effectively applies to his defense strategies.


We ensure detailed attention from the initial consultation through all phases of the legal process. For immediate assistance or to schedule a consultation, reach out to us via phone at (602) 638-3790, visit our website to learn more, or submit an inquiry through our contact form at Kolsrud Law Offices Contact Page.



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