Understanding Tipper-Tippee Liability, Misappropriation, and the Rules for Family Members
When it comes to insider trading, family members can face prosecution for illegally trading securities based on material nonpublic information. While prosecutors must prove that a family member engaged in illegal insider trading, federal law does not automatically shield spouses and family members from prosecution. Insider trading is considered a “white-collar” crime, and, as such, it is subject to prosecution by the U.S. Department of Justice (DOJ).
Insider Trading Laws and Family Members
Insider trading is prohibited by Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 of the U.S. Securities and Exchange Commission (SEC). These authorities broadly prohibit the use of material nonpublic information to gain an unfair advantage in the securities markets. As a result, they can be used to prosecute a wide range of individuals for engaging in illegal insider trading, including (but not limited to):
- Public company employees and executives;
- Employees and executives of closely held companies;
- Consultants and contractors who serve as “temporary insiders;” and,
- Family members who trade on material nonpublic information received from companies’ employees, executives, or temporary insiders.
This last scenario, often referred to as “tipper-tippee” insider trading, often involves family members who share information among themselves. Whether a company’s employee or executive “tipped” a family member by sharing nonpublic information disclosed in confidence (i.e., to their spouse or another immediate family member) or to a family member with whom they are not particularly close, improperly trading on material nonpublic information can lead to criminal prosecution at the federal level.
Family members can also face criminal prosecution for illegal insider trading based on the misappropriation theory. This theory applies when an individual “misappropriates” material nonpublic information from a third party. For example, if one spouse appropriates material nonpublic information from the other without their knowledge or consent, then the individual who engaged in the misappropriation (i.e., by accessing their spouse’s computer or mobile device without authorization) can face criminal prosecution under this theory as well.
The Elements of Illegal Insider Trading
To secure an insider trading conviction, federal prosecutors must prove certain elements. These elements can vary depending on the specific charges prosecutors decide to pursue. While most insider trading cases involve prosecution under Section 10(b) of the Securities Exchange Act of 1934, federal prosecutors can also pursue charges under other statutes, such as the mail fraud statute and the wire fraud statute.
In a typical insider trading case under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, prosecutors must prove all three of these elements beyond a reasonable doubt:
1. The Accused Traded Securities Involving a Publicly Held Company
First, prosecutors must prove that the accused engaged in a “security transaction” involving a publicly held company. This is a broad element, as “security transactions” can range from buying and selling stocks and bonds to trading options and other securities. The accused’s trading activity must involve a publicly held company, which means the company must have registered securities with the SEC. The accused may seek to defeat the government’s case by challenging whether this element has been established in pre-trial litigation or during trial.
2. The Accused Possessed Material Nonpublic Information About the Company or Its Securities
Second, prosecutors must prove that the accused possessed material nonpublic information about the company or its securities. This information might pertain to a planned corporate merger or acquisition, a major contract that has not yet been publicly announced, a company’s earnings, or any other nonpublic information that could affect a company’s share price once it becomes public knowledge. This element provides another potential defense strategy, as it may allow the defendant to argue that they did not possess the information in question.
3. The Accused Knew (or Reasonably Should Have Known) that the Information was Nonpublic
Third, prosecutors must prove that the accused knew (or reasonably should have known) that the information in question was nonpublic (i.e., that they engaged in insider trading activity knowingly).
Sentencing for Insider Trading Involving Family Members
Despite the fact that family member (or tippee) insider trading can involve multiple parties, all parties can face the same penalties if they are convicted. Under Section 32(a) of the Securities Exchange Act of 1934, each family member charged with illegal insider trading can face up to a $5 million fine and 20 years of federal imprisonment.
The actual penalties imposed in a criminal insider trading case depend on various factors, including the amount of profit or loss avoidance involved and the role of each defendant. For example, a family member who serves as a tippee (i.e., by trading on material nonpublic information they received from a spouse or other immediate family member) could face a more severe penalty if their trades also resulted in a larger profit or greater loss avoidance. Likewise, if prosecutors allege that a spouse or other immediate family member served as a tipper and shared material nonpublic information in violation of a fiduciary duty, they could face a more severe penalty as well.
Defending Against Allegations of Illegal Insider Trading Involving Family Members
Given the substantial penalties for federal insider trading involving family members, those facing these allegations must defend themselves by all means available. Depending on the circumstances involved, potential defense strategies in these cases can include (but are not limited to):
1. No Tipper-Tippee Relationship
Demonstrating that a tipper-tippee relationship did not exist between family members can serve as a complete defense to a charge of illegal insider trading. For example, the accused may be able to assert that they were not aware the information they received was nonpublic, or that they did not know that they’d been entrusted with information in confidence. In these types of scenarios, the accused would not be liable as a tippee.
2. No Misappropriation
Demonstrating that the accused did not engage in the misappropriation of material nonpublic information can serve as a complete defense to a charge of illegal insider trading as well. This might involve proving that the accused had the family member’s consent to use the information in question.
3. No Material Nonpublic Information
If the information allegedly used to engage in insider trading does not qualify as “material nonpublic information,” then this can serve as a complete defense to the government’s case as well. Once the information becomes public, it no longer qualifies as “material nonpublic information,” and it can be used for securities trading without violating federal law.
4. No Security Transaction
Defendants may also be able to defend against the government’s case by arguing that no qualifying “security transaction” occurred. If they did not engage in a security transaction involving a publicly traded company, then their conduct should not be considered illegal insider trading.
5. Violation of Rights
If federal prosecutors or agents with the DOJ, Federal Bureau of Investigation (FBI), or another agency violated the accused’s rights during an investigation, then any improperly obtained evidence may be inadmissible in court. If the government’s evidence is inadmissible, prosecutors may have no choice but to drop their case.
6. Other Defenses
The specific defenses available in any particular case will depend on the facts and circumstances involved. If you or a member of your family is facing an insider trading investigation, our legal team can evaluate the circumstances of your case and help you choose a strategy focused on achieving the desired outcome.
What To Do if You or a Family Member Has Been Accused of Illegal Insider Trading
If you or a member of your family has been accused of illegal insider trading or if you have been implicated in an investigation, defending yourself effectively requires experienced legal representation. At Spodek Law Group, our attorneys have extensive experience representing clients in high-stakes white-collar cases. Our experience includes handling federal insider trading cases under Section 10(b) of the Securities Exchange Act of 1934 and other pertinent federal laws. We are available to intervene in federal investigations quickly, and we can help you make informed decisions about how best to protect yourself. To discuss your insider trading defense strategy in confidence, contact us today.
Contact the Insider Trading Defense Lawyers at Spodek Law Group Today
If you need to talk to an insider trading defense lawyer at Spodek Law Group, we encourage you to contact us promptly for a confidential initial consultation. Call 908-643-7005 or get in touch online to speak with an attorney today.
Written By
Todd Spodek
Todd Spodek is the Managing Partner of Spodek Law Group P.C. He is a second-generation trial attorney who has been recognized as one of the Top 100 Trial Lawyers in the country. He has represented clients in some of the highest-profile federal criminal cases in the Eastern District of Pennsylvania and beyond.
