Does shorting the competition count as insider trading?

October 30, 2009 5:15 PM

I work for Acme Widgets, a competitor of WorldWide Doodads. I know that tomorrow we will be releasing an amazing widget that is going to completely outshine WorldWide's product lineup. Obviously, I can't do anything with Acme's stock - that would be insider trading. But what about shorting WorldWide's stock? Is that allowed?
posted by anonymous to work & money (26 comments total)

I believe this is considered insider trading in the U.S., according to the misappropriation theory: http://www.investopedia.com/terms/m/misappropriation_theory.asp
posted by c, as in "kitchen" at 5:22 PM on October 30

The more pertinent question is: does your company's ethics policies allow its employees to do this?

This is not a question that can be answered by Metafilter because we don't know the particulars of your situation.
posted by dfriedman at 5:23 PM on October 30

No. It's the trading on the non-public information that makes it criminal, and you'd certainly be trading on non-public information in this case. You needn't be an employee of any company to engage in criminal insider trading.

The term "insider trading" is a bit misleading as it's not the being-an-insider part that constitutes an illegal trade, it's the trading-on-inside-information part.
posted by 0xFCAF at 5:23 PM on October 30 [5 favorites]

It is not clear from the way that the question is phrased that the information regarding Acme's product release is non-public information. Therefore, it's not clear that trading in Acme's stock would be insider trading.
posted by dfriedman at 5:25 PM on October 30

It's entirely clear from the question that the information is non-public, otherwise Worldwide Doodads' stock would have already dropped and the trader would be free to trade in his/her own company's stock.
posted by 0xFCAF at 5:29 PM on October 30 [2 favorites]

This is a legal question, and you know about asking legal questions online, right? Sorta like asking for a diagnosis of your skin condition via email.

Anyhow, as I recall the main insider trading statute is section 10b-5 of the 1934 Securities Exchange Act. It is extremely broad and general. It says (I got this from wikipedia -- you can do the same):

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

Note especially the "purchase of sale of any security" part. So yes, I'd say that your proposed short would fall within 10b-5.
posted by lex mercatoria at 5:36 PM on October 30

Your second example is just as much insider trading as your first.

It's "inside information trading", and illegal.

(Just because thousands of superwealthy folk do it every day doesn't mutter mutter rackenfrass...)
posted by rokusan at 6:16 PM on October 30

This page gives details of a case which might be relevant.

In July 1988, Grand Metropolitan PLC hired O'Hagan's Minneapolis law firm, Dorsey & Whitney, to represent it in a contemplated tender offer for Pillsbury. Although O'Hagan never personally worked on the deal, he started buying up Pillsbury stock and call options soon after Dorsey & Whitney began representing Grand Met. When Grand Met announced its tender offer for Pillsbury in early October, the value of O'Hagan's stock and options holdings skyrocketed. All told, O'Hagan pocketed more than $4 million in profits.

[...] On appeal to the Eighth Circuit, O'Hagan argued that he could not be liable for insider trading because, quite simply, he was not a Pillsbury insider and owed no fiduciary duty to the company or its shareholders. The Eighth Circuit agreed with O'Hagan and reversed his convictions, rejecting the SEC's theory that O'Hagan was nonetheless liable for "misappropriating" the information entrusted to his law firm.

[...] the Supreme Court resolved the circuit split by upholding the misappropriation theory and reinstating O'Hagan's insider trading convictions. In doing so, the Court endorsed an expansive definition of "insider" which goes beyond traditional corporate insiders. Justice Ginsburg's opinion stressed that while O'Hagan had no duty to Pillsbury or its shareholders, he did have a duty to the source of his information. "It was O'Hagan's failure to disclose his personal trading to Grand Met and Dorsey, in breach of his duty to do so, that made his conduct 'deceptive' under § 10(b) [of the Securities Exchange Act of 1934]." United States v. O'Hagan, 97 C.D.O.S. 4931 (decided June 25, 1997).

That said, the two cases aren't a perfect match; in United States v. O'Hagan, O'Hagan had knowledge of a planned purchase of a company, rather than planned competition with that company - (by buying increasing the value of the takeover target company, he acted against his responsibility to the company performing the takeover). Also, I'm not sure what would have happened if he had disclosed his personal trading to Grand Met and Dorsey - that is, if he was did not have a fiduciary duty to the company, and he also wasn't deceptive towards the source of his information.
posted by Mike1024 at 6:51 PM on October 30

IANAL and know nothing about this area, but what if you are wrong? What if you just *think* this product is fabulous? It seems to me that you are making a bet like anyone else-- you think this product is the bees knees and worth shorting the other guy, but is that really inside information? Can the inventor of something (who surely has inside information) not short his competitors stock and get it completely insanely wrong?

Let's say you are a Google employee and are completely sure that you have an iphone killer and short Apple... you could just as easily be *wrong* so does this really count as inside information that is illegal to trade on? It seems like you are just betting on yourself in a way that isn't defrauding anyone, but maybe I'm completely wrong...
posted by Maias at 7:21 PM on October 30

Mike1024, I don't think that's at all relevant -- neither the OP nor his firm owe any fiduciary duty to WorldWide, nor does he have any material non-public information regarding that stock. He may have non-public information regarding the market it is competing in, but that does not fall under the usual insider trading restrictions.

dfriedman is right. Talk with a company lawyer. I would be more worried about violating Acme's ethics policies than insider trading laws, though.
posted by FuManchu at 7:28 PM on October 30

No. What oxFCAF said. It is illegal to take advantage of non-public, "insider" knowledge regardless of what strategy you choose to do so.

As you're confident that the information would make illegal to purchase ACME's stock, then it is also wrong to short Worldwide's.
posted by lalex at 8:46 PM on October 30

Maias - the problem with your argument is that it suggests that trading on inside information would never be illegal. No matter how much information you have, you don't know for *sure* that the price of a given stock will go up or down. There's always some element of gambling. What's unfair and illegal is if in the context of everyone gambling, some of the gamblers have access to important inside information that others do not, which gives them an unfair advantage in assessing the odds, imperfect though that assessment may be.
posted by ManInSuit at 8:48 PM on October 30

FuManchu said: dfriedman is right. Talk with a company lawyer. I would be more worried about violating Acme's ethics policies than insider trading laws, though.

Suggesting that he talk with a company lawyer, and say, "Hey, I'm thinking about trading some WorldCo stock based on what I know about our product," is about as dumb a suggestion as I can imagine here.

Not to mention, not answering the question. The question has nothing to do with ethics.
posted by jayder at 10:52 PM on October 30 [1 favorite]

I would be more worried about violating Acme's ethics policies than insider trading laws, though.

I completely disagree. I would be far, far more concerned about SEC scrutiny for a possible violation of federal securities laws than I would be about an ethics-based reprimand or even termination from my employer.
posted by lalex at 12:49 AM on October 31

Maias: The law doesn't work that way. You can illegally trade on insider information and be wrong and lose a ton of money. Similarly, illegal gambling is against the law whether you win or lose the bet. If it worked any other way, the SEC would never be able to prosecute insider trading cases, because there's always a chance that the insider will be unsuccessful.

To use your Google employee example, say you're completely sure you have an iPhone killer so you buy a big stake in Google stock the night before the announcement. During the announcement, a horrific terrorist attack occurs on US soil and the market tanks, including GOOG. You did wind up being wrong, yet you still committed insider trading. The key factor here is trading based on material non-public information, not the particular nature of the trade.

Looking at this another way, suppose this actually turns out to be legal. Do you really want to get 90% of the way to an insider trading charge and be investigated for violations of your company's ethics policies? Would this be worth the financial gain? Would it still be worth it after paying your lawyers? After losing your job? Better hope you really made a killing on this trade, and again, this is all assuming that you didn't actually break the law, which in all likelihood, you did. Sure doesn't seem worthwhile to me.
posted by zachlipton at 1:23 AM on October 31 [1 favorite]

OP: I don't think many people commenting are involved in securities at all, let alone have any knowledge of securities trading law. So stop reading this thread and go talk to someone.


Suggesting that he talk with a company lawyer... is about as dumb a suggestion as I can imagine here.

I assure you it is most judicious thing one could do in the OP's situation.

I would be far, far more concerned about SEC scrutiny... than ... an ethics-based reprimand or even termination from my employer.

For severity of punishment, yes. For likelihood of punishment, no.


Despite the fear-mongering above, "insider trading" rarely applies to anyone below C-level management. The only time it usually applies to product development is in the case of bio-tech and pharmaceuticals. The violation hinges on trading based on *material* nonpublic information. You can legally trade on most nonpublic information. It is the material kind that you are prohibited from using.

So that is the key question: do you have material information? It is extremely unlikely. Insider trading (outside of bio and pharma) is usually limited to trading before an M&A announcement or before a surprising earnings result. Unless you are at the very top of the company, you do not have this material nonpublic information. Other examples would be the material information you gather when your employer (e.g., law firm, publication) has a duty to keep that information confidential. In bio and pharma, new discoveries and drug approvals are generally considered material. It is extrememely unlikely that you have material nonpublic information on WorldWide outside of the above examples, but you should consult the company lawyer anyhow.

The successful insider trading cases are far more egregious than what you've talked about above. Hell, look at Mark Cuban's latest case: he was given material nonpublic information by a CEO and traded on it. The SEC dropped their case on him because he had no fiduciary duty or confidentiality agreement.


For your own reading:
* Rule 10b5-1 -- Trading "on the Basis of" Material Nonpublic Information in Insider Trading Cases
* Rule 10b5-2 -- Duties of Trust or Confidence in Misappropriation Insider Trading Cases
* SEC Spotlight on Insider Trading
* SEC recent enforcement actions on insider trading


You likely have a confidentiality agreement with Acme. You are prevented from actively trading Acme securities. For WorldWide? You have zero inside information on them. You do not have any material nonpublic information about the company or its finances. What you do have is nonpublic information regarding its competitor, which is generally not material. I am no securities lawyer, but I have not heard of any SEC case about trading in a competitor's stock. None of the press releases at the SEC site have any example either. Third party trading violations are via an individual at an investment bank, law firm, or publication which owed some fiduciary or confidentiality duty to the security issuer.


Your biggest worry is whether Acme views trading on this confidential information is a violation of your agreement with them. This is possible. Hence you need to talk to a company lawyer.
posted by FuManchu at 1:44 AM on October 31

"I know that tomorrow we will be releasing an amazing widget that is going to completely outshine"

Would it be legal to make the trade shorting the competitor's stock IMMEDIATELY after the press release and newswire article announcing the product has gone out, and it becomes public knowledge? For example, being prepared to execute the trade but sitting on it until post-release.
posted by thewalrus at 2:40 AM on October 31

Mike1024, I don't think that's at all relevant -- neither the OP nor his firm owe any fiduciary duty to WorldWide, nor does he have any material non-public information regarding that stock.

I saw it as relevant because O'Hagan didn't owe any fiduciary duty to Pillsbury either; and he knew things known only to Pillsbury's competitors (Grand Met); but he was still sentenced to 41 months in prison for insider trading.
posted by Mike1024 at 5:58 AM on October 31

I completely disagree. I would be far, far more concerned about SEC scrutiny for a possible violation of federal securities laws than I would be about an ethics-based reprimand or even termination from my employer.

For me it would depend on the amount I was confident I could make on the trade; and what my job prospects would look like after being fired for an ethics violation. I mean, if the payout wouldn't exceed my losses due to being fired and becoming unemployable, what's the point?

That said, I would consult my own lawyer privately before discussing anything with my company's lawyers.
posted by Mike1024 at 6:07 AM on October 31

OP, a word of warning: I'm sure the links provided above are decent background, but 10b5-1 has been so thoroughly expanded upon through interpretations by the SEC and the courts that I would never, never make a decision based on just reading the rule and a couple of cases. That would be crazy. DIY securities law is not a good Saturday morning project.
posted by palliser at 8:15 AM on October 31

thewalrus, from what I understand, what you suggested is fine. As soon as the information becomes public, anyone can trade on it.

Mike, nothing prevents the company from turning you over to the SEC if they think what you did violated both their ethical rules and 10b-5. And I would go to the company's lawyers first, since they're the ones who will come after you if they don't agree with your lawyer's assessment of whether you should get fired for the trade. They won't fire you for asking about it.
posted by craven_morhead at 8:17 AM on October 31

Given that, corporate lawyers are about as conservative as you get. They will always choose the no-risk non-action if there is any fuzziness.
posted by smackfu at 10:52 AM on October 31

FuManchu, why are you giving legal advice when you are not a lawyer?

You realize that anonymous could lose his job, be criminally prosecuted, and be sentenced to prison. Isn't it a bit irresponsible for you to be advising him on this when you clearly do not have the credentials to do so?

Example: you have counseled him to talk to the company's lawyer. The company's lawyer has a clear ethical and fiduciary duty to the company, not to anonymous. Anonymous cannot expect the company lawyer to give him ANY advice, because the company's lawyer is not HIS lawyer. You are very possibly setting anonymous up to be fired. Your advice is absolutely nuts. And it's a great example of why you're supposed to be licensed to give advice about legal matters.
posted by jayder at 11:13 AM on October 31 [1 favorite]

To be clear, there is a difference between going to a company lawyer and asking "Is it insider trading if I short WorldWide's stock the day before we announce product X?" and going and asking "generally, what is the company policy on trading in our competitor's stock?" The former is a profoundly dumb idea as jayder says. The latter is not going to get you personalized legal advice appropriate for your situation (you need to engage your own lawyer for that), but it will likely give you general information about corporate policy that may be useful.

FuManchu: If you did this and it was, in fact, illegal, would you really and truly want to rely on the fact that the SEC might happen to be too busy to prosecute you? Or that they might eventually drop the charges? If you're going to come that close to committing a crime, at the very least, you need your own lawyer to help you untangle which side of the law you actually fall on here.

Supposing that you didn't actually break the law nor the letter of company policy, if caught and investigated, you will still be known as "that insider trading guy." How do you think that will help your chances for promotion?
posted by zachlipton at 12:15 PM on October 31

Suggesting that he talk with a company lawyer... is about as dumb a suggestion as I can imagine here.

I assure you it is most judicious thing one could do in the OP's situation.

Please be aware that your company's lawyer is not your lawyer. There is a world of difference.
posted by GPF at 6:12 PM on October 31 [1 favorite]

jayder, what the fuck? What legal advice did I give? Talk to someone? Why don't you chide the commenters giving legal advice claiming it is illegal insider trading? I just said he needed to talk to someone besides we ignorant AskMe commenters. Company restrictions on trading are usually braoder than legal restrictions, so asking there whether he can trade WorldWide stock is a good first step.

Mike1024, Pillsbury was an acquisition target, not just a competitor.
posted by FuManchu at 11:53 PM on October 31 [1 favorite]