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Insider Trading in Silicon Valley

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Insider trading may be a far bigger problem than many people both inside and outside of Silicon Valley realize.

Many involved in the Web 2.0 start-up tech world believe that insider trading laws do not apply to buying and selling shares of non-public companies. More specifically, they believe that because so many of those involved in such trading have inside information creates an exemption from the usual rules that bar trading while in possession of what the Securities and Exchange Commission calls "material non-public information."

Over the weekend I got several inquiries from people challenging my interpretation of securities laws to apply to these trades.

"Confused @carney, how can there be an insider trading issue in the Valley if everyone buying is basically an insider?" venture capitalist and serial online entrepreneur Jason Calacanis asked over Twitter. (His handle is @jason.)

Calacanis went on two make two more arguments that insiders in Silicon Valley should be exempt from insider trading rules.

"Only insiders r selling on private markets—person buying knows seller has more information by definition but r buying anyway right @carney?"

"if you're a millionaire buying private company stock the government doesn't need to regulate/protect you. you're professional"

Let me say that both of these are short-hand versions of some very persuasive arguments against insider trading rules, at least when employed against sophisticated investors trading with each other.

But this is not the state of the law. There is no exemption for this kind of trading.

Arguing that insider trading rules shouldn't apply because investors are sophisticated is like arguing that you drive better when drunk. The law doesn't care. You won't be able to defend yourself by throwing back a few shots, getting behind the wheel of your car, and showing the police or courts how good a drunk driver you are. The mere act of driving while under the influence is prohibited—even if you're good at it and nobody got hurt.

Likewise, the act of trading while in possession of material non-public information is illegal—except under certain very, very limited circumstances. (Such as stock sales made according to a pre-designated timeline.)

Don't take my word for it. Here's Stephen Diamond, a professor at Santa Clara University who teaches securities law, quoted in the New York Times.

“If the employee had material information which he did not share with the seller, he could be charged with violating the law,” Diamond said.

Could this be a big issue for Silicon Valley? You bet. Felix Salmon raises the point here.

On Friday, John Carney put up an intriguing post alleging that deals done on SecondMarket are subject to insider-trading laws. If he’s right, it seems to me that almost anybody buying or selling shares of a private company on SecondMarket would be breaking the law, at least if that company puts out little or no public information about itself.

This story is only going to get bigger.

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