Scientific Research and Insider Trading

Yale faculty and researchers (particularly in biomedical fields) are often privy to sensitive research information that is not known by the general public. Whether or not such information is subject to express confidentiality restrictions, it is important to be aware that buying or selling any security on the basis of such information or “tipping” another person who trades on such information may result in personal liability under the federal securities laws.

Insider trading involving biomedical research has been discussed in the press:

• http://seattletimes.nwsource.com/html/businesstechnology/drugsecrets1.html
• http://seattletimes.nwsource.com/html/health/2002426761_hedge08m.html

These articles describe situations where a researcher is a willing participant in the leak of medical secrets in exchange for payment or other consideration or an unwitting victim of scheming financial analysts seeking nonpublic information. Faculty should be vigilant in guarding against the latter situation. The former situation, as well as the trading of stock while in the possession of material nonpublic information, may result in a violation of federal securities laws and should therefore be avoided at all costs.

The legal background is as follows: In general, Section 10 and Rule 10b-5 of the Securities Exchange Act of 1934 (the “1934 Act”) prohibit any person from using any “manipulative or deceptive device” in connection with the purchase or sale of any security. According to Rule 10b5-1, included among “manipulative and deceptive devices” is the purchase or sale of a security “on the basis of material nonpublic information about that security or issuer in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information.”

“Material nonpublic information” generally means information that is available to only a select group of persons (i.e., not disclosed to the public) that would likely affect the market price of the company's securities or be important to a reasonable investor in determining whether to buy, hold or sell the securities in question. Major new discoveries or advances in research, or a finding that research underway is not coming to fruition, might well be deemed material nonpublic information.

For the purchase or sale to be “on the basis of” the material nonpublic information, the person making such purchase or sale need only have been aware of such information when the purchase or sale was made. Thus, the person with inside information engaging in the trade need not have intent to defraud the issuer or the counterparty to be found liable under this rule. There are certain affirmative defenses that may be raised, such as the fact that the purchase or sale of a security was carried out pursuant to a pre-existing contract; however, such defenses are narrowly defined and may be overcome if there is any indication of bad faith.

Rule 10b5-2 addresses situations where a breach of a family or other non-business relationship may give rise to liability under the misappropriation theory of insider trading. More specifically, the Rule specifies that a “duty of trust or confidence” is present in the following circumstances, among others:

1. whenever a person agrees to maintain information in confidence;
2. whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or
3. whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling; provided, however, that the person receiving or obtaining the information may demonstrate that no duty of trust or confidence existed with respect to the information, by establishing that he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties' history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information.

Thus, a person may be in violation of the 1934 Act if he or she trades on the basis of material nonpublic information that was obtained in a context where confidential treatment of such information was expected, even if such person is not subject to a written confidentiality agreement with respect to that information or does not owe a direct duty of loyalty to the issuer. Subject to certain exceptions, information obtained from family members is presumed to be obtained in confidence.

In addition, case law establishes other situations that give rise to violations of federal insider trading law. For example, in the instance where a researcher does not trade on the basis of the material nonpublic information but merely “tips” another person who does trade, the researcher may nevertheless be found liable for insider trading liability if he or she personally benefited, directly or indirectly, from providing the tip, including pecuniary gain, reputational benefit that will translate into future earnings or a gift of confidential information to a trading relative or friend. In many of the cases illustrated in the web links above, medical researchers have been found to tip investment analysts regarding sensitive medical information in exchange for payment or other consideration, subjecting themselves to liability.

In addition to federal securities law, liability may be incurred on the basis of breach of contract (if there was an agreement of confidentiality), state securities laws and/or foreign securities laws. Any member of the faculty or staff who has questions about the matters discussed here, should contact the Office of the Vice President and General Counsel.