You Might Be an Inside Trader If…You Trade on Your Unconfirmed Suspicions of a Cybersecurity Event Prior to Its Public Revelation or Disclosure
Earlier this year, the SEC released cybersecurity guidance addressing, among other things, the risk of insider trading in the event of a data breach. This risk comes in multiple forms, including the intruders trading on stolen information and insiders trading on the knowledge of the breach itself. The SEC demonstrated its willingness to address the latter situation in the recent insider trading case against Jun Ying, the former chief information officer of Equifax’s United States Information Systems business unit.
This past March, the DOJ indicted Ying with securities fraud and insider trading, while the SEC brought parallel civil charges. Upon discovering that it had suffered a major cybersecurity breach, Equifax immediately formed various response teams to address the breach. Only one of the teams was informed that Equifax was the victim of the breach. The other teams were told they were working on a “business” or “breach” opportunity for an unnamed client. Initially, Equifax instituted a trading blackout, but only for its employees who were told of the breach. Both the criminal indictment and the SEC complaint allege that Ying, who was not on the team that was informed of the breach, nonetheless concluded that the “unnamed client” was actually Equifax. The complaint and indictment both cite a text Ying sent to another employee stating that the breach “sounds bad” and “We may be the one breached . . . I’m starting to put 2 and 2 together.” Ying subsequently exercised all of his vested Equifax options and immediately sold those shares for approximately $950,000, thereby avoiding more than $117,000 in losses. The day after exercising his Equifax options, Ying was notified of the breach by Equifax’s counsel, and instructed not to trade on that information. An internal investigation conducted several months later revealed Ying’s trading and he was asked to resign.
Ying’s case stands out for two reasons. First, the CIO is facing civil and criminal liability not for trading on information he obtained, but for independently concluding his employer was the victim of a breach. Here, the SEC and DOJ are applying a broad interpretation of the insider trading knowledge requirement. Under Rule 10b5-1, a trade is “made ‘on the basis of’ material non-public information . . . if the person making the purchase or sale was aware of the material nonpublic information when the person made the purchase or sale.” As the CIO argued in his June 11, 2018 motion to dismiss, the indictment “describes little more than an employee who exercised options after being lied to by Equifax about the ‘material nonpublic information’ at issue.”
Second, the case illustrates the need for public companies to closely consider their procedures for responding to a breach, including their processes for issuing trading blackouts during investigation of the breach, and how and when to communicate with employees who are not part of the core incident response team. Equifax demonstrates that even careful planning cannot prevent inadvertent discovery of material non-public information. Public companies should also consider revising their incident response plans to include provisions for issuing trading blackouts — when to issue, to whom, by what process, and for how long. Companies should also consider revising their insider trading policies or offering additional employee training to address instances in which employees may obtain (whether directly or indirectly) non-public information regarding a potential data breach impacting the company or its customers.