Inside Insider Trading

The definition of potential insider trading in the credit-derivatives market is the same as it is for any type of security or security-based transaction. The foundation of the law lies in Rule 10b-5 of the Securities Exchange Act of 1934, which prohibits the purchase or sale of a security on the basis of material, nonpublic information about that security or its issuer. But the law has evolved with judicial interpretations of it.

The Joint Market Practices Forum developed by financial institutions to address concerns about such abuse in the credit-derivatives market draws on statutory, regulatory, and judicial definitions of insider trading. The following definitions and guidelines are drawn from the exposure draft of the forum's guidelines for best practices:

Information is material if:

• It is likely that a reasonable investor would consider the information important in making an investment decision.
• The investor would view the disclosure of the information as having significantly altered the overall information available.
• The disclosure of the information is reasonably certain to have a substantial effect on the security's price.

Information is nonpublic if:

• The information has not been disseminated generally to investors.
• Insiders have not waited a reasonable time after disclosure before trading, with the reasonable period dependent on the circumstances of the dissemination.

Individuals who are prohibited from trading on such information include:

• Insiders, including directors, officers, and controlling shareholders of a corporation.
• Those who provide professional services to a corporation such as accountants, consultants, and lawyers.
• Those who have engaged in a confidential arrangement with a source of information, such as a lender.
• Those who pass along tips to others likely to act on the information, and those who receive tips on inside information.

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