Investor Facts: What Is Insider Trading?

Insider trading is when someone with corporate information not yet known by the public trades a stock on the basis of that knowledge.

Officers, directors and company employees often have access to information that is considered confidential. It doesn’t matter if the information is negative or positive.

What matters is that the public doesn’t know this information. They are at a disadvantage in terms of the likely short-term direction of the company’s stock as result.

It also doesn’t matter if the insider makes or loses money.

All that matters is that the person took action to buy or sell the stock based on non-public information.

The U.S. Securities and Exchange Commission (SEC), which oversees U.S. stock markets, defines an “insider” as any person in a company who has a fiduciary duty toward investors.

Usually, that’s corporate officers who learn of developments at a company before the public is informed.

An investor with 10% or more of the company’s stock also is considered an insider.

For instance, a company might be about to release earnings. An officer or employee learns that the numbers are well above or below the expectations of the market.

But it goes beyond just the insiders. Any person who acts on a tip from an insider also can be accused of insider trading, if it can be shown that they knew the information was private.

This might be family or friends of an insider. Any brokerage, law firm or printing company that traffics in non-public data also could be charged.

Similarly, government employees or consultants who learn of non-public information in the course of their work is at risk if they share what they know.

Companies must report all stock trading done by officers, directors and others with insider knowledge.

It may turn out that such trading is normal, everyday investment choices made by a given individual. Nevertheless, the SEC vigorously looks for trades that seem to be responding to insider data.

Watching

In recent years, the law has broadened on insider trading. Now, just about anyone who can be demonstrated to have non-public information on any company could be prosecuted.

While it can be difficult to prove in some cases, the SEC is always watching stock trades in search of unusual timing of trades. If it can come up with evidence of an insider trade, charges could follow.

The median sentence for fraud at the federal level is 24 months. Yet there have been high-profile insider trading cases in recent years where CEOs and others have been sentenced for 10, 15 and even 25 years for insider trades.

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