Lesson 1 of 6
Material, and non-public
Two words decide whether information is dangerous to trade on. Both have been defined by courts and rules, and neither means what intuition suggests.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
Who writes thisEditorial processLinkedIn (opens in a new tab)X (opens in a new tab)
In one minute
- The Supreme Court's materiality standard asks whether a reasonable investor would consider the information significant, not whether it would move the price by a set amount.
- Non-public means not yet disseminated to investors generally, which is a fact about distribution rather than about how many people know.
- Neither word has a bright line, and the absence of one is the point: tests that draw them have been rejected.
Almost every question about insider trading turns on these two words. They are defined in decisions and rules that anybody can read, and reading them is more useful than any rule of thumb.
The two questions, and where each is answered
Is it material
- The standard comes from TSC Industries and was adopted for Rule 10b-5 in Basic.
- The question is whether a reasonable investor would consider it significant.
- Bright-line tests for when a negotiation becomes material have been rejected.
Is it non-public
- The question is whether it has been disseminated to investors generally.
- Information known to a few analysts and not released is not public.
- Publication in a filing, a press release or a widely available report changes the answer.
Both must be true before the rest of the law is engaged at all.
The materiality standard, in the courts' words
TSC Industries against Northway, decided in 1976, sets the general standard: an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. The Court rejected the broader formulation, all facts a reasonable shareholder might consider important, that the court below had used.
Basic against Levinson, in 1988, expressly adopted that standard for the section 10(b) and Rule 10b-5 context, phrasing it as a substantial likelihood that disclosure would have been considered significant by a reasonable investor.
Why there is no percentage
In Basic, the Court also rejected the agreement-in-principle test, under which preliminary merger discussions would not become material until the parties had agreed price and structure. It declined to adopt that bright line, holding that its policy rationales did not justify excluding otherwise significant information from the definition of materiality.
Non-public, and what changes it
Information is non-public until it has been disseminated in a manner that makes it available to investors generally. The mechanism a company uses to do that is the subject of the Regulation FD lesson later in this course, which sets out what the rule requires of an issuer when it has selectively disclosed something.
The practical consequence for a researcher is that the number of people who know something is not the test. A fact known to a supplier, a former employee and two analysts is not public, however widely it feels shared inside an industry.
What this lesson is for
It is for the moment in research when somebody starts telling you something specific and you have to decide, quickly, what you are hearing. The two questions above are the ones to ask, in that order, and the next lesson explains why the answers matter: the theories under which trading on such information has been held unlawful depend on duties owed by the person who told you as much as on what you were told.
Check yourself
What is the materiality standard the Supreme Court adopted for Rule 10b-5?
- Any fact a reasonable shareholder might consider important
- A substantial likelihood that a reasonable investor would consider the information significant
- Any fact that moves the price by more than five percent
Show the answer
Answer: B.
TSC Industries set the standard and Basic expressly adopted it for the Rule 10b-5 context. The broader "might consider" formulation was rejected.What did Basic decide about preliminary merger discussions?
- They are immaterial until price and structure are agreed
- It rejected that bright-line test, so such discussions can be material earlier
- They are always material
Show the answer
Answer: B.
The Court declined to adopt the agreement-in-principle test, holding that its rationales did not justify excluding otherwise significant information.When does information stop being non-public?
- When several analysts know it
- When it has been disseminated in a way that makes it available to investors generally
- When a company employee mentions it in a meeting
Show the answer
Answer: B.
The test concerns dissemination to investors generally, not how many individuals happen to know.Sources
- TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976): the materiality standard, and the rejection of the broader formulation used by the court below.
- Basic Inc. v. Levinson, 485 U.S. 224 (1988): adoption of the TSC standard for the section 10(b) and Rule 10b-5 context, and rejection of the agreement-in-principle bright-line test.
What this leaves out
- This is education about what published decisions say, not legal advice, and it does not tell any reader what they may do in their own situation.
- These are United States authorities. Other jurisdictions define both words differently, and rules change.
- Materiality is decided on facts and circumstances by courts. No summary can settle a particular case.
- Nothing here is advice about any security.