What is MNPI?
Material Non-Public Information “MNPI” may = Insider Trading
When alternative data “alt data” includes includes transaction/point-of-sale data, email receipt data, health care claims data, social media, satellite imagery analytics, for example – there is a wide range of legal implications like MNPI/insider trading, data privacy, contract and IP/property issues. All of these need to be considered prior to redistribution/resell to an investor. We examine the risk of MNPI first as this is the most heavy hitting and consequential for all parties involved.
Background on Securities Laws
Under the federal securities laws (Securities Exchange Act of 1934) information becomes “public” either when it is disclosed “‘to achieve a broad dissemination to the investing public generally and without favoring any special person or group,’” or when, “although known only by a few persons, their trading on it ‘has caused the information to be fully impounded into the price of the particular stock.’” SEC v. Mayhew, 121 F.3d 44, 50 (2d Cir. 1997) (quoting respectively Dirks v. SEC, 463 U.S. 646, 653 n. 12 and United States v. Libera, 989 F.2d 596, 601 (2d Cir. 1993)).
Under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, information is “material” if there is “a substantial likelihood that a reasonable investor would view it as significantly altering the ‘total mix’ of information available.” United States v. Cusimano, 123 F.3d 83, 88 (2d Cir. 1997) (citing Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988) and TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)). Now, although trading on “material” information from insiders is prohibited, investment analysts may obtain information from insiders for the purpose of “filling in the interstices in the analysis” – so basically, adding in color to their mosaic. This rule established in Dirks v. SEC, 463 U.S. 646, 659 n. 17 (1983) is opaque as “neither corporate insiders nor analysts can be sure when the line is crossed” from an unlawful MNPI perspective. Id.
Now, assuming the data is indeed MNPI, the SEC would still need to prove that the transmitted data from a vendor to investor was in violation of a duty or through deception in order to constitute insider trading. There are two theories that the SEC relies on – classic theory and misappropriation. High-level summary: 1) classic theory applies when the corporate insider or his tippee (the person who has been tipped off with insider information) trades in the securities of the tipper’s public corporation based on MNPI in breach of the insider’s duty to the company’s shareholders and 2) the misappropriation theory applies when a person misappropriates confidential or sensitive information for securities trading purposes, in breach of a duty of confidentiality owed to the source of information, like an employer or a client. For example, a vendor may breach a duty of confidentiality under the terms of their contract by selling data that incorporates confidential information of a company.
This misappropriation theory also applies where deception is used to obtain confidential information – like hacking – where there is no real breach of a duty of trust or confidentiality to any particular person or employer. Trading on data or information obtained through computer hacking or accessing proprietary records/accounts could be insider trading if the information is hacked by deceptive means or unauthorized access.
An insider trading claim also requires showing that the defendant acted with “scienter” in trading on or tipping MNPI in breach of a duty or in deceptively obtaining information. A tipper does not need to have specific knowledge but must understand that tipping the information would violate confidence. This is not very difficult to prove.
Examples of “Material” Information
- earnings and dividend estimates
- significant product developments
- major changes in management
- public offerings
- significant litigation or government investigations; and
- significant transactions such as corporate takeovers, mergers, tender offers, joint ventures, or purchases or sales of substantial assets
Current Regulatory Landscape for Alt Data + Best Practices
To date, there is no precedent insider trading case(s) in connection with big data/alt data. There is also very little in general case law and settled guidance. Rest assured though, this is coming in the very near future and internal legal and compliance teams at hedge funds are conducting extremely thorough diligence prior to onboarding vendors.
In the absence of established legal and regulatory framework, investors are implementing best practices to mitigate risk of insider trading in connection with the alt data sets they are ingesting.
Here’s what they are thinking about (use this list as guidance during your data monetization process):
- Who is the data vendor? Private or publicly traded company (does the hedge fund have a position in the name?) What is the main business purpose? What other lines of service or business is the vendor offering? Who leads the company, is their background check clean?
- What is the data that is being purchased? How time sensitive is it? What is the delivery/lag in delivery? How many other investors are purchasing this dataset? Are there any geographic limitations of the resell of the data?
- Who owns the data that the firm is purchasing? Does the vendor have the appropriate rights to the data and the right to sell the data to a third party for that third party’s intended use? (for example, not to make the end-user’s experience on the platform easier but for analytics and research or any undefined/unlimited purpose)
- How is the data collected? What is the underlying methodology? Is there a clear data collection path?
- Is the data vendor able to rep and warranty in an agreement that the data does not contain any MNPI (or PII)?
- Is the data vendor able to indemnify the investment firm against any claim that the data from the vendor was obtained or sold in breach of the vendor’s legal duties to the sources of the data?
- How has the data vendor thought about insider trading/MNPI concerns? Is there internal or external legal counsel or compliance involved in the collection, review, redistribution analysis? Is there a written policy and/or training for internal employees? Has an information barrier been implemented if the vendor is offering multiple lines of business (for example, advisory or consulting services to public entities, government entities, etc.)