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4 ways to prevent insider trading

On Behalf of | Aug 13, 2021 | Securities Litigation

An insider can put a company in trouble if they trade its securities after learning important information about the company. The law considers an insider to be anyone who owns more than 10% of a public company’s shares. This means that not only board members can partake in insider trading, but also some employees. However, board members can prevent this illegal practice by implementing some policies and educational programs.

Know what constitutes material information

Keeping information confidential until it can be released to the public may be the obvious way to go. But what exactly does the law consider material information that can influence an investor’s decision? Most companies’ insider trading policies regard the following as material information:

  • A material change in earnings
  • Pending or proposed mergers, acquisitions, joint ventures or other contracts that may lead to significant revenue
  • New product announcements
  • The occurrence of major claims, disputes and litigation
  • Pending bankruptcy or financial liquidity problems
  • Changes in management
  • The gain or loss of a significant customer, supplier or business partner
  • Changes in the status of governmental investigations

Officers must also be cautious of not “tipping” or revealing anything important to family and friends, as they also count as outsiders.

Implement an educational program

Once board members are aware of what information can lead to unlawful trading, they must ensure that their employees know it, too. Implementing educational programs about insider trading is the best way to ensure that employees know about this practice. If insiders don´t know about this practice, they may end up partaking in it without even knowing that it is illegal.

Establish a blackout period

Most companies prevent insider trading by imposing a blackout period before a quarter ends or through a quarter’s earnings announcement. A blackout period is a company policy that prevents insiders from buying or selling a company’s securities during a specific period. If any employee or executive trades during this time, they can be removed from the company and face serious consequences like fines or jail time.

Impose pre-clearance procedures

Another way to prevent insider trading is by imposing a rule that all insiders must inform the Chief Accounting Officer before trading in the company’s shares. This means that any securities’ purchase or sale must go through the officer first. With a pre-clearance procedure, an employee cannot trade unless they have permission to do so.

Protecting a company

The Securities and Exchange Commission will bring civil action against anyone who does insider trading. Additionally, when the case involves criminal prosecution, an individual may have to pay up to $5 million in fines. A company may have to pay up to $25 million. Insider trading is costly and illegal. Besides, it can also damage a company’s reputation, which is why board members should avoid it at all costs.