3.2 Insider Trading, Information Barriers, and Personal Trading Supervision
Key Takeaways
Exchange Act Section 15(g) (cited as Section 15(f) in FINRA's outline, its former designation) requires every broker-dealer to establish, maintain and enforce written policies reasonably designed to prevent misuse of material nonpublic information.
The SEC may seek a civil penalty of up to three times the profit gained or loss avoided from an insider trader, and controlling persons who recklessly fail to prevent violations face penalties up to the greater of an inflation-adjusted $1 million (about $2.6 million after the 2025 adjustment) or three times the profit or loss.
Criminal penalties for willful violations reach $5 million and 20 years in prison for individuals and $25 million for entities.
Under Rule 10b5-2, a duty of trust or confidence exists when a person agrees to keep information confidential, when the parties have a history of sharing confidences, or when the information comes from a spouse, parent, child or sibling.
Rule 3210 requires prior written consent for associated persons' outside brokerage accounts, but accounts limited to mutual funds, UITs, variable contracts and 529 plans are exempt.
Task 2.6 asks principals to address "insider trading and related internal control policies and procedures" and "civil and criminal penalties." Packaged-product firms face these risks too. Employees may learn about a fund's portfolio holdings, a pending fund merger, an issuer's undisclosed results through a family member, or an institutional client's large order.
What Makes Information "Material" and "Nonpublic"
- Material: there is a substantial likelihood that a reasonable investor would consider the information important, or that it would significantly alter the "total mix" of available information. Examples include unannounced earnings, mergers, regulatory decisions, executive departures, and for funds, non-public portfolio holdings or an impending manager change.
- Nonpublic: the information has not been broadly disseminated, for example through a widely circulated press release or an SEC filing, and the market has not had time to absorb it. Information shared at a private dinner or in a chat group is still nonpublic.
Insider trading violates Section 10(b) and Rule 10b-5 when a person trades, or tips others who trade, on material nonpublic information (MNPI) in breach of a duty:
- the classical theory covers corporate insiders who owe duties to their company's shareholders; and
- the misappropriation theory covers outsiders who trade on information taken in breach of a duty to its source, such as a broker who trades on an institutional client's confidential plans.
Rule 10b5-2 says a duty of trust or confidence exists when a person agreed to keep information confidential, when the parties have a history, pattern or practice of sharing confidences, or when the information came from a spouse, parent, child or sibling, unless the recipient shows no reasonable expectation of confidentiality.
Rule 10b5-1 treats a trade as made "on the basis of" MNPI if the trader was aware of it, but provides an affirmative defense for trades under a written plan adopted in good faith before the trader became aware of MNPI. The plan must specify amounts, prices and dates, or a formula, and the trader may not later influence its execution. The 2022 amendments added cooling-off periods: for directors and officers, the later of 90 days after adoption or two business days after the next Form 10-Q or 10-K, up to 120 days; for most others, 30 days. They also restricted overlapping plans and single-trade plans.
Broker-Dealer Controls: Section 15(g)
The Insider Trading and Securities Fraud Enforcement Act of 1988 added the requirement now found in Exchange Act Section 15(g). FINRA's outline cites it as Section 15(f), its designation before the Dodd-Frank Act renumbered it. Every registered broker-dealer must establish, maintain and enforce written policies and procedures reasonably designed, considering its business, to prevent misuse of MNPI by the firm or its associated persons. Common tools:
| Control | Purpose | Who knows |
|---|---|---|
| Information barriers | Physically and electronically separate units that receive MNPI (such as banking or fund portfolio teams) from sales and trading | Policy is firm-wide; "wall-crossings" require compliance approval |
| Watch (grey) list | Lets compliance quietly monitor trading in securities about which the firm may have MNPI | Compliance only, so trading is not tipped |
| Restricted list | Restricts solicitation, recommendations or proprietary and employee trading in listed securities | Distributed to affected personnel |
| Personal trading surveillance | Reviews employee and covered-account trades against the watch and restricted lists | Compliance and supervisors |
Supervising Employees' Personal Accounts
Rule 3210 requires an associated person to obtain the employer's prior written consent before opening an account at another member or other financial institution in which securities transactions can be effected and in which the person has a beneficial interest. The person must notify the executing firm of the association in writing. On the employer's written request, the executing member must send duplicate confirmations and statements or the equivalent data. Accounts that existed before the person joined the firm require consent and notice within 30 calendar days of joining.
The person is presumed to have a beneficial interest in accounts of a spouse, of children who live in the household or are financially dependent, and of other related individuals or others the person controls and materially supports. Under Rule 3210.03, the rule does not apply to transactions in, or accounts limited to, unit investment trusts, municipal fund securities and 529 plans, variable contracts, or redeemable investment company securities (mutual funds), or to monthly investment plan accounts and accounts under Internal Revenue Code Section 530A. Rule 3110(d) separately requires review of trades in accounts disclosed under Rule 3210 and in covered accounts for possible insider trading (Section 3.1).
Penalties and Enforcement
| Source | Sanction |
|---|---|
| Insider Trading Sanctions Act of 1984 (ITSA); Exchange Act Section 21A | Civil penalty up to three times the profit gained or loss avoided, plus disgorgement |
| ITSFEA (1988); Section 21A(a)(3) | Controlling persons, including a firm and its supervisors, who knew or recklessly disregarded the likelihood of a violation and failed to prevent it, or who knowingly or recklessly failed to maintain Section 15(g) policies, face a penalty up to the greater of $1,000,000 or three times the profit or loss. The $1,000,000 figure is adjusted for inflation; after the 2025 adjustment it is $2,626,135. The SEC made no adjustment for 2026. |
| Section 20A | Investors who traded contemporaneously with the insider may sue, with damages limited to the profit gained or loss avoided |
| Section 21(d) | The SEC may seek injunctions and refer willful violations to the Department of Justice |
| Criminal penalties (Section 32(a)) | Up to $5 million and 20 years for individuals and $25 million for entities |
| Whistleblower program (Section 21F) | Awards of 10% to 30% of sanctions collected in actions resulting in more than $1 million in sanctions |
FINRA can also discipline the firm and individuals under Rules 2010, 2020 and 3110 for insider trading or for supervisory failures that allowed it.
A broker-dealer's investment banking group is advising an issuer on a confidential acquisition. Compliance adds the issuer to a list visible only to compliance staff, so it can monitor firm and employee trading without signaling the deal to sales and trading. Which list is this?
A watch list
A restricted list
A Rule 3210 consent list
A taping list under Rule 3170
A representative has an account at another broker-dealer that holds only mutual fund shares and a 529 plan. Does Rule 3210 require the employer's prior written consent for the account?
No, because Rule 3210 does not apply to accounts limited to redeemable investment company securities and 529 plans
Yes, because every outside account in which the person has a beneficial interest requires consent
No, because Rule 3210 applies only to accounts at banks
Yes, unless the account was opened before the representative's association
A branch manager's poor supervision allowed a representative to trade on a client's merger information, and the representative avoided a $200,000 loss. If the SEC shows the manager recklessly disregarded the likelihood of the violation, what is the maximum civil penalty against the manager as a controlling person under Section 21A?
Three times the representative's annual compensation
$25 million, the criminal fine for entities
The greater of the inflation-adjusted $1,000,000 amount ($2,626,135 after the 2025 adjustment) or $600,000, which is three times the loss avoided
$200,000, the amount of the loss avoided
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