Insider trading is a type of financial misconduct which involves a person or a corporation buying or selling equities or stocks based on confidential information they have been privileged to have access to. It is a commonly used term that hints at the illegal activity that takes place when insiders capitalize on information not available to the general public and make a profit by trading in stocks, bonds, or other securities.
Understanding Insider Trading
Insider trading is an often illegal action where insiders of a company, such as executives or employees, take advantage of their access to confidential information related to the company to profit by trading in the company’s stocks, bonds, or other securities. This is considered an illegal activity because the privileged information is not available to the general public, giving the insider an unfair advantage in their trading activities.
The US Securities and Exchange Commission (SEC) has a few rules and regulations in place to prevent insider trading. These rules are set in place to protect investors from the potential for unfair financial gain by the select few individuals with access to confidential information.
Types Of Insider Trading
Insider trading can be classified into two main types; legal insider trading and illegal insider trading.
Legal Insider Trading
Legal insider trading is the trading of stocks and other securities by insiders with the permission of the SEC, under certain guidelines. Legal insider trading allows corporate officers like CEOs and CFOs, board members, and other institutional investors to buy or sell specific stocks and securities after the proper disclosures have been made. This typically happens during company mergers, acquisitions, and other deals.
Illegal Insider Trading
Illegal insider trading is any activity related to the buying or selling of securities by a company’s executives or other employees based on information not available to the public. It is illegal as the privileged information provides an unfair advantage to the insider taking advantage of it by trading or passing on the information to others. When illegal insider trading occurs, it is typically done with the intention of making a profit, which is the primary feature of the crime.
Examples Of Insider Trading
Illegal insider trading can take place in varying degrees of complexity. Below are some examples of illegal activities associated with insider trading:
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Tipping: Tipping is when an insider provides information to a family member or friend about a potential investment. This provides them with an “inside edge” that the general public does not have.
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Edge Profiting: Edge Profiting is when an insider uses non-public information to buy or sell stocks for their own benefit, without the intention of passing on the information to others.
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Prohibited Shares: Prohibited Shares is when an insider buys or sells shares of their own company, while the company is prohibited from taking that type of action due to SEC regulations.
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Trading On Materially False Information: Trading on materially false information is when an insider knowingly trades shares based on false information. This can be done in order to artificially inflate the stock prices.
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Manipulating Analyst Reports: Manipulating analyst reports is when an insider uses false information to manipulate the stock market. This can be done in order to influence analyst reports and causes the stock to be overvalued.
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Corporate Insiders: Corporate insiders are individuals who are in a company’s highest legal echelons, such as directors, officers, or majority shareholders, and therefore have access to privileged information and trade in that information.
Insider trading is a term used to describe any activity related to the buying or selling of stocks or securities based on information not available to the public. The US Securities and Exchange Commission (SEC) has several rules and regulations in place to prevent illegal insider trading activities such as tipping, edge profiting, prohibited shares, trading on materially false information, manipulating analyst reports, and corporate insiders. Though some forms of insider trading are legal, it is important for insiders to know when and how to trade properly to avoid possible criminal sanctions.
