KZNerd: re "juicy stuff" WARNING-really long post
Given the recent spate of comments about quiet periods and analysts being told "juicy stuff," I thought I'd recycle a private message to Chuck R that I sent a couple of weeks ago about trading on inside information:
Rule 10b-5 of the Securities Act of 1934 is an extremely broad rule:
Rule 10b-5 -- Employment of Manipulative and Deceptive Devices
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,
a. To employ any device, scheme, or artifice to defraud,
b. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
c. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
[The Insider Trading Act of 1988 led to a further refinement. Below is a discussion of the relevant penalties (my bolding):]
TITLE 15 - COMMERCE AND TRADE
CHAPTER 2B - SECURITIES EXCHANGES
-HEAD-
Sec. 78u-1. Civil penalties for insider trading
-STATUTE-
(a) Authority to impose civil penalties
(1) Judicial actions by Commission authorized
Whenever it shall appear to the Commission that any person has
violated any provision of this chapter or the rules or
regulations thereunder by purchasing or selling a security while
in possession of material, nonpublic information in, or has
violated any such provision by communicating such information in
connection with, a transaction on or through the facilities of a
national securities exchange or from or through a broker or
dealer, and which is not part of a public offering by an issuer
of securities other than standardized options, the Commission -
(A) may bring an action in a United States district court to
seek, and the court shall have jurisdiction to impose, a civil
penalty to be paid by the person who committed such violation;
and
(B) may, subject to subsection (b)(1) of this section, bring
an action in a United States district court to seek, and the
court shall have jurisdiction to impose, a civil penalty to be
paid by a person who, at the time of the violation, directly or
indirectly controlled the person who committed such violation.
(2) Amount of penalty for person who committed violation
The amount of the penalty which may be imposed on the person
who committed such violation shall be determined by the court in
light of the facts and circumstances, but shall not exceed three
times the profit gained or loss avoided as a result of such
unlawful purchase, sale, or communication.
(3) Amount of penalty for controlling person
The amount of the penalty which may be imposed on any person
who, at the time of the violation, directly or indirectly
controlled the person who committed such violation, shall be
determined by the court in light of the facts and circumstances,
but shall not exceed the greater of $1,000,000, or three times
the amount of the profit gained or loss avoided as a result of
such controlled person's violation. If such controlled person's
violation was a violation by communication, the profit gained or
loss avoided as a result of the violation shall, for purposes of
this paragraph only, be deemed to be limited to the profit gained
or loss avoided by the person or persons to whom the controlled
person directed such communication.
(b) Limitations on liability
(1) Liability of controlling persons
No controlling person shall be subject to a penalty under
subsection (a)(1)(B) of this section unless the Commission
establishes that -
(A) such controlling person knew or recklessly disregarded
the fact that such controlled person was likely to engage in
the act or acts constituting the violation and failed to take
appropriate steps to prevent such act or acts before they
occurred; or
(B) such controlling person knowingly or recklessly failed to
establish, maintain, or enforce any policy or procedure
required under section 78o(f) of this title or section 80b-4a
of this title and such failure substantially contributed to or
permitted the occurrence of the act or acts constituting the
violation.
(2) Additional restrictions on liability
No person shall be subject to a penalty under subsection (a) of
this section solely by reason of employing another person who is
subject to a penalty under such subsection, unless such employing
person is liable as a controlling person under paragraph (1) of
this subsection. Section 78t(a) of this title shall not apply to
actions under subsection (a) of this section.
(c) Authority of Commission
The Commission, by such rules, regulations, and orders as it
considers necessary or appropriate in the public interest or for
the protection of investors, may exempt, in whole or in part,
either unconditionally or upon specific terms and conditions, any
person or transaction or class of persons or transactions from this
section.
(d) Procedures for collection
(1) Payment of penalty to Treasury
A penalty imposed under this section shall (subject to
subsection (e) of this section) be payable into the Treasury of
the United States.
(2) Collection of penalties
If a person upon whom such a penalty is imposed shall fail to
pay such penalty within the time prescribed in the court's order,
the Commission may refer the matter to the Attorney General who
shall recover such penalty by action in the appropriate United
States district court.
-----
As you can see, the key word is material. To a certain extent, this is self-defining, since the use of information (and understand that it's the use of inside information, not the mere possession of it, that creates the potential legal exposure) to make or lose money is only as material as it turns out to be. That is to say, to come into awareness of information and act on it in the belief that it is important is only relevant if in fact its eventual dissemination does what the holder/trader believed it would do.
A non-lawyer's example (for what it's worth): assume that you corroborate your belief that the K-7 has in fact been successfully fabricated on a 0.18-micron process and that you go out and buy 1,000 out of the money call contracts based on this knowledge.
Could it be Door #
1) Two days later, AMD announces that very fact and the stock goes up 10 points.
a) You're now really wealthy.
b) You're now also in big trouble, because you could be on the hook for up to 3X your profits.
c) The SEC calls. It's about your recent unusual option trading in AMD. Uh-oh.
d) I've never heard of you. Or SI, for that matter. What's this whole Internet thing about, anyway?
or maybe it's Door #
2) Two days later, the EPA declares all of Intel's fabs to be Super Fund sites and shuts them down. AMD is now the only MPU supplier and, faced by capacity constaints, can immediately triple the price of all of its MPUs. The incremental revenue is all profit and the stock goes up 10 points.
a) You're now really wealthy.
b) Your K-7 knowledge had nothing to do with the increase in the stock price.
c) You fondly remember those people who communicated with you on SI and send them a relatively small fraction of your new wealth.
d) SEC? Never heard of them.
Also, under the 1988 Act, the insider who passes on the information is as liable as the person who trades on it. And you're probably right in assuming that very few high-tech employees understand this. - Tad LaFountain
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