What Is the Insider Trading Sanctions Act Of 1984?

The Insider Trading Sanctions Act of 1984 is a piece of federal legislation that allows the Securities and Exchange Commission (SEC) to seek a civil penalty, of up to three times the amount of profit or loss, from those found guilty of using insider information in trades, as well those who provided information not generally available to the public. The Insider Trading Sanctions Act of 1984 also provides for criminal fines to be levied.

Key Takeaways

  • The Insider Trading Sanctions Act of 1984 allows the SEC to impose civil penalties on insider trading.
  • Insiders are those close to a company that have knowledge about it that is not public information.
  • Insider trading is trading based on non-public information (given or received) for financial gain, whether personal or through another entity.

Understanding the Insider Trading Sanctions Act Of 1984

The U.S. Congress passed the Insider Trading Sanctions Act of 1984 in order to help the SEC prosecute those accused of insider trading, which was a top priority in the 1980s. Before the Act was passed the amount a trader could make through insider trading far outweighed the potential financial penalties.

Signed into law by President Reagan on August 10th, the Act severely ratcheted up civil penalties and other legal remedies available to federal regulators for violations related to the publishing of "inside" market information. By shifting the emphasis from compensation of victims to punishment for offenders, the move was largely received as a sign the government was getting tough on those abusing inside information.

From a market theory perspective, the Act served as a "risk-reward" mechanism that created an equation by making the penalties for insider trading more aligned with the size of the temptation for profit. Lawmakers reasoned potential violators would be restrained by the threat of material monetary penalties.

One element of the Act remains an uncertainty today: fiduciary duty. The existence of fiduciary responsibility is the first requirement for establishing liability. Meaning, a defendant must first be an insider. While the Act presented some vagaries surrounding who exactly is an insider, it did add some needed safeguards useful in promoting the confidence of investors in capital markets. By better leveling the playing field for all investors, the Act likely contributed to making U.S. financial markets more trusted.

Insider Information and Insider Trading

Insider information is information that is not publicly known. The information is only known by insiders of a company, such as directors, officers, or employees of a company. These people are called insiders because they have knowledge about the company that the public does not have. They are not allowed to act on that knowledge in the public financial markets for financial gain.

Therefore, insider trading is acting upon non-public information for financial gain, even if it is not personal gain. For example, if an employee of a public traded company finds out via a memo in the trash can that their company is going to be bought out at a premium to the current share price, it is insider trading to buy stock in anticipation of the announcement, or to tell someone else to do the same.

Insider trading is subject to the insider trading laws discussed above. Those who do it, or participate, are subject to civil and criminal penalties.

Insider trading is not just acting on non-public information to make money, it could also be avoiding losses. Selling a stock knowing that negative news (which is currently non-public) is going to be released to the public in a couple of days is insider trading.

Once information is public, it is no longer inside information and can be acted on in any way a particular investor sees fit.

Example of Insider Trading and Martha Stewart

On December 28, 2001, ImClone's stock price plummeted when it was publicly announced that one of its drugs failed to get Food and Drug Administration (FDA) approval. Prior to this date, the SEC undercovered that multiple people within the company, their family members, and prominent investors were tipped off to dump their shares prior to the official announcement. This selectively allowed certain individuals to sell their shares at a higher price knowing full well that after the announcement the share price would be much lower, and those buying the shares from these insiders would not be doing so if they had the same information the insiders had.

Martha Stewart was also tipped off by her broker, and she sold $230,000 worth of stock prior to the announcement. Ultimately, she was sentenced to five months in jail, five months of house arrest, and two years probation. Martha Stewert maintains her innocence stating her broker had an order to sell the stock if it fell below a certain price. The SEC didn't believe her.