Insider trading is a term used to describe the buying or selling of a security by someone who has access to material, non-public information about the security. This practice is considered illegal and unethical because it gives an unfair advantage to those who have access to information that the general public does not.
What is Insider Trading?
Insider trading is the trading of a public company’s stock or other securities by individuals with access to non-public information about the company. This information could be anything that is not available to the public, such as financial results or upcoming mergers and acquisitions.
The Securities Exchange Commission (SEC) has a broad definition of insider trading that includes any buying or selling of securities based on material non-public information. This includes both legal and illegal insider trading.
How Does Insider Trading Work?
Insider trading is typically carried out by corporate insiders, such as executives, directors, and employees, who have access to sensitive information about the company. These individuals may buy or sell shares of the company’s stock based on this information, which can result in significant gains or losses.
In some cases, outsiders may also engage in insider trading if they have access to sensitive information about the company, such as lawyers or investment bankers working on a deal.
Why is Insider Trading Illegal?
Insider trading is considered illegal because it gives those with access to non-public information an unfair advantage in the market. By trading on this information, they can make profits that would not have been possible if the information was available to the public.
Additionally, insider trading undermines the integrity of the financial markets and erodes investor confidence. It can also harm the company’s reputation and lead to costly legal battles.
Examples of Insider Trading
Insider trading has been the subject of many high-profile cases over the years. One of the most famous cases is that of Martha Stewart, who was convicted of insider trading in 2004. She sold her shares of ImClone Systems after receiving non-public information about the company from her broker that the FDA had declined to review the company’s new cancer drug.
Another example is Raj Rajaratnam, founder of hedge fund Galleon Group, who was convicted in 2011 of insider trading. He had received insider information from corporate insiders and used the information to trade on the stock market.
Penalties for Insider Trading
Insider trading is a serious crime that can result in significant penalties. If convicted, individuals can face fines, imprisonment, and the loss of their professional licenses. Companies can also face fines and reputational damage if their employees engage in insider trading.
In addition to legal consequences, insider trading can also result in significant financial losses. Investors who engage in insider trading can be subject to civil lawsuits and may be required to pay back any profits made from the illegal trades.
Preventing Insider Trading
To prevent insider trading, companies can implement strict policies and procedures for handling material non-public information. This includes limiting access to sensitive information, monitoring employee trading activity, and educating employees about the risks of insider trading.
Investors can also protect themselves by avoiding stocks that are subject to insider trading allegations or by conducting thorough research before investing in a company.
Insider trading is a serious crime that undermines the integrity of the financial markets and erodes investor confidence. It is important for companies to implement strong policies and procedures to prevent insider trading, and for investors to conduct thorough research before investing in a company.