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By Julia Glum
September 22, 2020
Jade Schulz for Money

Insider trading seems like it should be black and white — if you don’t use secret stock tips to make a quick buck, you should be good to go.

But what about doing it unintentionally?

The pandemic has caused millions of people to work remotely, often within earshot of roommates, relatives and spouses. Gone are the days of conference rooms and exclusive meetings — you can listen in on someone else’s calls without even trying. You could find out information the public isn’t privy to. And if you’re an investor, that could land you in trouble.

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A brief history lesson: Concern around insider trading in the U.S. dates back to the stock market crash of 1929, when people with insider info got out of the market before everyone else did. The Securities and Exchange Commission was established in the aftermath.

Two federal securities laws passed in the ‘30s presented a simple fix to the insider trading problem. The law made it so any officer, director or significant shareholder of a public company was liable to that firm for profits they got from buying and selling their stock within six months.

Eventually, though, the SEC and prosecutors got “a little tired of other behaviors” not previously laid out in the law, according to Joan MacLeod Heminway, a professor at the University of Tennessee College of Law who has studied insider training for years. Basically, other people with nonpublic information were crossing the line — not just officers and directors.

The government began using general fraud protections to enforce against people they believed were acting unfairly. These are “mushy and broad,” Heminway explains, and prohibit deception in any purchase or sale of securities.

“Sounds good, right?” she adds. “The problem is getting courts to say what ‘deception’ means in this context.”

Since the ’70s, the U.S. Supreme Court has produced a handful of major decisions saying that deception means different things in different scenarios, but it always involves some sort of breach of duty. This makes sense for officers and directors — they’ve got a clear duty of trust and confidence to their firm. Breaching that by buying/selling securities themselves or tipping off someone else who’s not entitled to that info is clearly “deceptive.”

But it’s tricky when it comes to regular people.

“It’s not merely the unfairness of holding nonpublic information and trading on that that is actually punished,” Heminway says. “If the person doesn’t have a duty to someone that’s breached by doing that, then that person is not liable for insider trading violations.”

For example, say you overhear two people in an elevator gossiping about an upcoming product release. In your head, you connect it back to a particular company, and later you go make a trade relating to that information. Because you don’t owe that company a duty, and they weren’t technically disclosing the info, you’re not likely to be liable under U.S. law for insider trading violations.

However, Heminway says you probably don’t want to push it.

“If you have [information] and nobody else has it, you shouldn’t use it — at least without checking with a good lawyer,” she says. “You don’t want to take risks getting information from a friend that [they] may not be entitled to share with you, especially if you know they work for an investment bank or law firm or a particular company.”

In practice, this means you shouldn’t look at information on your roommate’s computer and avoid eavesdropping on her phone conversations because she could deem there to be a “duty of trust and confidence” between you. SEC charges for insider trading are at their lowest level since the ’80s, but it’s still not something you want to mess with. In just the last couple of years, the agency has gone after a corporate attorney and his wife, the roommate of a hedge fund analyst, an IT guy, a group of golfers, a financial adviser, a baseball player, a chemist and more.

One recent case involving a breach of trust took place in 2013. The SEC cracked down on a man named Tyrone Hawk, who overheard his wife on a work call talking about how her company was planning to acquire another. The wife also told Hawk not to trade any of his securities because there was a blackout window due to an upcoming deal.

Hawk did it anyway, buying shares just before the acquisition’s announcement and netting a cool $150,000 by selling once the stock price rose. (Hawk ended up paying more than $300,000 to settle the charges.)

The bottom line? To be safe, you should avoid doing pretty much any trading based on information you don’t think is public. It’s a complex subject area, and “even short of a[n insider trading] scheme, people can get themselves into trouble in this area,” Heminway says.

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The purpose of this disclosure is to explain how we make money without charging you for our content.

Our mission is to help people at any stage of life make smart financial decisions through research, reporting, reviews, recommendations, and tools.

Earning your trust is essential to our success, and we believe transparency is critical to creating that trust. To that end, you should know that many or all of the companies featured here are partners who advertise with us.

Our content is free because our partners pay us a referral fee if you click on links or call any of the phone numbers on our site. If you choose to interact with the content on our site, we will likely receive compensation. If you don't, we will not be compensated. Ultimately the choice is yours.

Opinions are our own and our editors and staff writers are instructed to maintain editorial integrity, but compensation along with in-depth research will determine where, how, and in what order they appear on the page.

To find out more about our editorial process and how we make money, click here.

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