In the fast-paced world of securities regulations, the line between legal and illegal trading practices can sometimes seem blurred. As some experts lament, a lot of conduct can fall under the broad umbrella of securities fraud. Moreover, federal law does not actually have a crime called “insider trading.” Instead, the Securities and Exchange Act prohibits trading securities based on non-public information.
Novel Theory
Now in a first ever case of its kind, the U.S. Securities and Exchange Commission (SEC) is pursuing enforcement based on a novel theory of “shadow insider trading.” Unlike the traditional insider trading cases where an insider trades securities of the insider’s company, the SEC sued a biotech executive for allegedly using insider information to trade in the securities of another, rival company. The case is the first time the SEC has pursued this broad enforcement theory and it has alarming implications for the financial industry.
“I can’t say I’m surprised. Hearing directly from top SEC officials in 2023, we learned how the federal government is keenly focused on corporate fraud”
Ron Herman, Founding Partner
However, recent developments in insider trading law, particularly the emergence of “shadow trading,” have heightened the risks for private hedge managers. “I can’t say I’m surprised. Hearing directly from top SEC officials in 2023, we learned how the federal government is keenly focused on corporate fraud,” said Ron Herman, referring to rare insights gained at the 2023 ABA White Collar Crime Institute.
Traditionally, the SEC has pursued insider trading as civil enforcement actions by regulatory bodies like the Securities and Exchange Commission (SEC). However, the shifting landscape shows prosecutors increasingly targeting insider trading as a criminal offense.
Potential Risks for Hedge Managers
Private hedge managers are particularly vulnerable to criminal liability for insider trading. As fiduciaries entrusted with managing investors’ funds, hedge managers have a duty to act in their clients’ best interests and avoid engaging in illegal trading practices. The use of confidential information obtained through improper means to inform trading decisions can constitute a breach of this fiduciary duty, exposing hedge managers to criminal charges. Moreover, the interconnected nature of the financial markets means that even indirect involvement in trading schemes can attract scrutiny from law enforcement agencies.
Protecting Against Criminal Liability
Given the serious consequences of criminal liability, hedge managers must take proactive steps to mitigate the risks associated with insider trading. This includes implementing robust compliance programs and internal controls to prevent the misuse of confidential information, including trading in another, unrelated company.
Additionally, firms should ensure that their employees receive comprehensive training on insider trading laws and regulations, emphasizing the importance of ethical conduct and adherence to legal standards. Regular monitoring and oversight of trading activities can also help detect and address any potential violations before they escalate into legal liabilities.
Takeaways
The emergence of shadow insider trading poses significant risks for private hedge managers, including the looming question of future criminal enforcement. It’s not uncommon for the SEC to test out new legal theories by first bringing a civil action because the burden of proof is lower in such cases. If the SEC prevails in the Panuwat case, the government may not stop there and could bring in prosecutors from the Department of Justice to file criminal charges for shadow insider trading. Of course, intent is a key element in criminal cases, but the SEC will likely choose a strong case to test out its theory.
By understanding the complexities of insider trading laws and implementing effective compliance measures, hedge managers can safeguard themselves and their firms against legal exposure. Staying informed and proactive is essential in navigating the evolving regulatory landscape and maintaining the trust and confidence of investors.
About Us
Ron Herman is well-known in and out of the legal community as a skilled criminal litigator who is respected by judges, prosecutors, and community leaders. National and local reporters trust Ron to explain high profile cases to the public, by regularly interviewing him as a legal news expert. We are selective in the types of cases we represent, focusing on white collar offenses, such as financial crimes, Covid-19 loan (PPP) fraud, and healthcare fraud and conspiracy. Contact us to see how we can work together. Call (855) 457-7214 or text 561-529-9734.