Insider trading can be defined as the selling or buying of publicly traded stocks using critical information that might still not have been made public. In 1934, the United States government established the Securities and Exchange Commission or the SEC. It is their job to surveil the market for cases of manipulation, fraud, and more. One of their most important purposes is to investigate insider trading.
By law, anyone who is a part of a company or even close to someone in a company can be an insider. This could mean a company’s director, an employee, a close family member, or any external official who could gain insider information about a company before public knowledge.
Non-public information about a company can affect large investments in a company. Whenever someone uses this non-public information to buy or sell a company’s securities for someone’s personal gain, it is insider trading.
Any trading of stocks and securities before the shareholders have proper information is unfair and could result in great losses. Insiders will have to either reveal whatever insider info they have or wait until the information is public knowledge before making any trades.
Insider trading can be legal and illegal. It is legal when they report their trade and it complies with the regulations set by the SEC. It is only illegal when you buy or sell the stock while breaching your fiduciary duty, which is the relationship between a trustee and a beneficiary.
Examples of Insider Trading
An example of insider trading to make it even simpler for you to understand is when a board member of a public company knows that a big merger is coming up. They thus know their stocks will soar once the announcement happens. They could purchase a 100 or 1,000 or whatever number of stocks in someone else’s name to make a huge profit when the news finally goes public.
Another example could be an employee or close friend overhearing sensitive information about potential bankruptcy from a high-level employee or board member. That person could then sell their own stocks and warn family and friends about the potential upcoming loss to make them sell their stocks. These both are cases of insider trading if they happen without reporting the trades to the SEC.
What are the Consequences or Punishments of Insider Trading?
The punishment for insider trading could be civil sanctions, or they could also involve criminal prosecution. Laws say that an offender could end up paying upwards of $5 million in penalties. In addition to fines, the offender could face a prison sentence of up to 20 years. If the SEC brings a civil action lawsuit against an offender, they could be fined three times the amount they had profited from insider trading.