The New York Daily News just published an article of hedge fund manager who was facing insider-trading charges and who apparently committed suicide.

A hedge fund manager facing insider-trading charges was found dead in his Brooklyn apartment – the victim of an apparent suicide, officials said.

On June 15, Valvani was hit with federal insider-trading charges after he was accused of getting advance word about U.S. Food and Drug Administration approvals of generic drugs and using the information to make profitable trades.

He earned about $25 million on the secret information – and passed on the info to another portfolio manager who made his own illegal trades, authorities said.

Insider trading can result in a maximum fine of $5 million a maximum prison sentence of 20 years. But just what constitutes Insider Trading and when is insider trading legal or illegal?

Insider Trading Definition

Investopedia provides an insider trading definition and help with understanding when is insider trading legal or illegal.

Insider trading can be illegal or legal depending on when the insider makes the trade: it is illegal when the material information is still nonpublic–trading while having special knowledge is unfair to other investors who don’t have access to such knowledge. Illegal insider trading therefore includes tipping others when you have any sort of nonpublic information. Directors are not the only ones who have the potential to be convicted of insider trading. People such as brokers and even family members can be guilty.

A crucial term here is material information. Corporate insiders who are privy to plan of a merger that has not yet gone public hold material information and if they trade on that info they are probably guilty of insider trading. However, an employee of the company working on the loading dock who sees a huge inflow of new equipment and a huge outflow of products may very well assume that the value of the company’s stock will go up. Making the inference that more business means more profits and buying or selling stock is very unlikely to be construed as insider trading.

Timing Is Everything

When an insider has material information he or she cannot use it to trade until that info is public. However, once the information enters the public domain they can legally trade on it. To the extent that the market moves greatly and the person does not act rapidly there may be no advantage. However, there are times when the value of insider info is not immediately clear to the market in general in which case an insider can still place trades between the time when info becomes public and when analysts have had time to digest it. Here is where average traders are wise to pay attention to what insiders are buying and selling in own accounts.

When Is Insider Trading Not Insider Trading?

There is always the risk that a corporate officer may wish to sell some of his stock for perfectly legitimate reasons. He does so and then his company’s stock crashes. He will be suspected to have known this was going to happen and may be prosecuted. How can he avoid this? The Securities and Exchange Commission has a rule that applies. The New York Times Deal Book discusses the fine line between legal and illegal insider trading.

To address the issue of how insiders can trade in their company’s shares, the S.E.C. in 2000 adopted Rule 10b5-1 to give corporate employees a means to buy and sell without fearing potential securities fraud charges.
Under the rule, an insider can put in place a plan to trade company shares when the person does not have inside information. That allows a corporate employee to “carry out those pre-planned transactions at a later time, even if they later become aware of material nonpublic information.”

In other words, it is a type of legal insider trading because the plan must prevent the insider from changing the transaction by having in place a mechanism for the timing of the trades and the amounts involved.
The risk, of course, is that the insider could be shooting himself in the foot by setting up losing trades but at least they won’t be illegal.