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10b-5: What Is Insider Trading?

Prior to 1934, only common law fraud dealt with insider trading. However, in 1934, the federal Securities and Exchange Commission unveiled a comprehensive scheme to combat the issue. This was followed up with the SEC Act of 1943. This Act’s section 10(b) has created the most comprehensive scheme used to deal with insider trading. Today, corporations must live up to the requirements of section 10(b) in order to avoid being implicated for insider trading.

Section 10(b) of the 1943 Act enunciated that “it shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange…to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” While that is a mouthful, directors have come to know that this stands for the proposition that they cannot use manipulative or deceptive measures to gain an unfair advantage in trading.

Rule 10b-5 is also critical in understanding insider trading. This section makes it unlawful to defraud, mislead, make false statements, or to engage in any acts that would operate as fraud upon any person in connection with the purchase or sale of any security.

Although these rules were not originally used to deal with insider trading, through a series of Supreme Court decisions, Section 10(b) and Rule 10b-5 gave rise to the jurisprudence governing insider trading. Private causes are now allowed to allege that directors are responsible for harming the corporation due to insider trading. In order to have standing, the litigant must have bought or sold shares due to the information to have standing. Further, scienter, or knowledge, is needed on the part of the director being alleged of wrongdoing. However, where there is an applicable state remedy, 10b-5 will not be used.

Through future cases, the definition of what violates insider trading took shape. Today, insiders cannot participate in the market when they have information that might affect the value of the stock unless they disclose it to the investing public first. Insiders are liable to other shareholders, and must disclose any information that they receive, whether or not the director acts upon it.

Insider trading is a long-standing doctrine of corporate law. Pursuant to both state and federal statutes, directors cannot take advantage of information they gained not available to the public. If you suspect a director of your corporation is guilty of insider trading, consulting with the right legal team can help you take a step in the right direction to resolving the issue. Call the Trembly Law Firm at (305) 431-5678 today to schedule a consultation.

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