What is Insider Trading

What is Insider Trading ? (photo: blog.tipranks.com)

Insider trading refers to the act of trading a public company's stocks or securities by its employees who possess non-public, significant information about the company. Whether or not insider trading is considered illegal or legal depends on the timing of the trade made by the insider and the laws of the country in which the trade is conducted.

In the United States, insider trading is illegal if the information being used is still considered non-public, and individuals who engage in it are subject to severe penalties.

Understanding Insider Trading

To comprehend the concept of insider trading, the United States Securities and Exchange Commission (SEC) has established a definition for illegal insider trading, which is:

In the context of insider trading, material information refers to any information that could significantly influence an investor's decision to either buy or sell a security. Non-public information, on the other hand, refers to information that is not legally available to the general public.

The issue of legality arises from the United States Securities and Exchange Commission's (SEC) objective of ensuring an equitable marketplace. If an individual has access to insider information, they could gain an unfair advantage over other investors who lack the same access, and as a result, potentially generate disproportionate profits compared to their counterparts.

Illegal insider trading encompasses the act of sharing material nonpublic information with others. On the other hand, legal insider trading occurs when a company's directors purchase or sell shares, but they do so in compliance with legal disclosure requirements. The Securities and Exchange Commission (SEC) has established regulations to safeguard investments against the effects of insider trading. It is irrelevant how the material nonpublic information was obtained or whether the individual is employed by the company.

For instance, if someone gains knowledge of material nonpublic information from a family member and shares it with a friend, and if the friend proceeds to utilize this insider information to generate profits in the stock market, then all three individuals involved may face legal repercussions.

The most effective method to avoid legal difficulties is to refrain from sharing or using material nonpublic information, even if it was inadvertently overheard.

Read More: What is Forex Trading

Examples of Insider Trading

- Martha Stewart

It is not only directors of companies who can potentially face charges for insider trading. A notable example of this is the case of Martha Stewart, who in 2003 was accused by the SEC of securities fraud and obstruction of justice, which included insider trading, regarding her involvement in the ImClone case of 2001.

Stewart sold almost 4,000 shares of the biopharmaceutical company, ImClone Systems, based on information she received from her broker at Merrill Lynch, Peter Bacanovic. Bacanovic's tip was provided after ImClone Systems' CEO, Samuel Waksal, sold all of his shares in the company. This happened during a period in which ImClone was awaiting a decision from the Food and Drug Administration (FDA) on its cancer treatment, Erbitux.

In the aftermath of these transactions, the FDA rejected ImClone's drug, resulting in a 16% decrease in the company's shares in a single day. By selling her shares early, Stewart was able to avoid a loss of $45,673. However, the sale was executed based on a tip she received about Waksal selling his shares, which was not public information.

Following a trial in 2004, Stewart was found guilty of obstructing a proceeding, engaging in a conspiracy, and making false statements to federal investigators, but she was not convicted of insider trading. As a result, she was sentenced to five months of imprisonment in a federal correctional institution.

- Amazon

In September 2017, Brett Kennedy, a former financial analyst at Amazon.com Inc. (AMZN), was accused of insider trading. According to authorities, Kennedy provided information about Amazon's first-quarter earnings in 2015 to his fellow alumnus from the University of Washington, Maziar Rezakhani, before the official release of the earnings report. In exchange for this information, Rezakhani paid Kennedy $10,000. The SEC also alleged that Rezakhani profited $115,997 by trading Amazon shares based on the insider information provided by Kennedy. These charges are related to the insider trading case involving the two individuals.

Legal Instances of Insider Trading

The phrase "insider trading" often carries a negative implication. However, legal insider trading takes place on a regular basis in the stock market. The Securities and Exchange Commission (SEC) mandates that these transactions be reported electronically within a specified timeframe. Furthermore, the transactions must be disclosed on the company's website in addition to being submitted to the SEC electronically.

The Securities Exchange Act of 1934 initiated the legal requirement for disclosure of transactions involving company stock. Under this act, directors and significant shareholders are obligated to disclose their ownership, transactions, and changes in ownership.

To disclose a stake in the company, Form 3 is filed as an initial document. For reporting a purchase or sale of company stock, Form 4 is filed within two days of the transaction. Finally, for earlier or deferred transactions, Form 5 is filed.

Has Insider Trading a Negative Connotation?

photo: www.thestreet.com

The term "insider trading" is generally viewed negatively because it is seen as unfair to the average investor. Insider trading involves trading in a public company's stock by someone who has access to non-public, material information about that stock. Whether insider trading is legal or illegal depends on whether it follows the SEC rules or not.

When Is Insider Trading Illegal?

Insider trading is considered illegal if the individual with access to non-public, material information about a company uses that information to trade in the company's stock or securities. This is particularly the case if the information is not yet available to the general public. The consequences of illegal insider trading include both potential fines and imprisonment.

The term "material nonpublic information" refers to any information that could significantly impact a company's stock price. Access to such information can give an investor an unfair advantage over the public, who do not have this information. Martha Stewart's 2001 ImClone trading is a well-known example of illegal insider trading.

When Is Insider Trading Legal?

photo: investbro.id

Insider trading is considered legal when it adheres to SEC regulations. The Securities Exchange Act of 1934 required companies to disclose transactions of company stock, and insiders must report their trades to the SEC and disclose them on the company's website. This enables transparency and allows the SEC to monitor insider trading activities. The SEC requires that insiders submit their transactions electronically and in a timely manner. These transactions occur regularly, and the SEC recognizes that legal insider trading is part of a healthy stock market.

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Read More: What is Day Trading

Source: https://www.investopedia.com

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