What Is Tipping?
Tipping is the act of providing material non-public information about a publicly traded company or a security to a person who is not authorized to have the information with the intent to gain some sort of benefit. As long as the information is accurate, tipping can produce huge profits for an investor who acts on it when performing a securities transaction. In most cases, it also leads to unfair gains for the tipper because of pre-arranged agreements to share the trading profits. Tipping is closely related to insider trading.
- Tipping is telling someone secret or non-public information about a company or security that may motivate them to perform a transaction using insider information.
- Tipping is illegal in these instances: the person who receives the inside information either knows or suspects that the tipper is breaching a fiduciary duty; the tipper gets some benefit from the tipping; the tipper passes on the tip with the expectation that the recipient will try to profit from it.
- As long as the information is accurate, tipping can produce huge profits for an investor who illegally and unethically acts on it when performing a securities transaction.
- The United States Supreme Court may soon hear the case United States v. Martoma, which determines whether the tipper intended to benefit the person tipped can be inferred from circumstantial evidence.
How Tipping Works
Tipping can occur in person, by phone, through the mail, by email, or on the Internet. Tipping is illegal in these instances: the person who receives the inside information either knows or suspects that the tipper is breaching a fiduciary duty; the tipper gets some benefit from the tipping; the tipper passes on the tip with the expectation that the recipient will try to profit from it.
Although instances of tipping are rare, investment bankers and attorneys are often in possession of material non-public information that can be used for tipping. Mergers and acquisitions (M&A) announcements often result in significant price movements of the stocks of the companies involved.
Many of these potential M&A deals are worked on for weeks or months before they are announced to the public. A number of senior bankers, accountants, lawyers and their junior staff (even administrative staff) will have knowledge of these impending deals, but they are bound by strict rules of confidentiality. Divulging information to non-authorized individuals will cause a tipper to get fired, and possibly face much worse legal consequences.
Tipping can also occur prior to a company's earnings announcement.
Penalties for Tipping
If an individual is accused of tipping a relative or a friend—who then trades securities according to the inside information—that individual may be held accountable for up to three times the profit gained or loss avoided, plus disgorgement of the trading gains if your tippee cannot pay.
Suppose there is a financial analyst within a company who helps compile quarterly earnings reports. The analyst learns that an unexpected shortfall in earnings per share (EPS) will be announced on the day of the company's earnings announcement. He shares this information with a friend while they are having a beer together at a bar. The analyst's friend then buys a large number of put options on the company's stock through his mother's online account.
On the date of the company's earnings announcement, the stock plummets, producing huge profits for the tippee (the analyst's friend). The tippee shares a portion of the profits with his friend, the tipper. When the Attorney General's office learns of this instance of tipping, both of these individuals are fired by their employers and sued for insider trading, which eventually results in disgorgement of trading profits.