Introduction

Insider trading is the trading of a public company’s stock or other securities (such as bonds or stock options) based on material, nonpublic information about the company. In various countries, some kinds of trading based on insider information is illegal. This is because it is seen as unfair to other investors who do not have access to the information, as the investor with insider information could potentially make larger profits than a typical investor could make. The rules governing insider trading are complex and vary significantly from country to country. The extent of enforcement also varies from one country to another. The definition of an insider in one jurisdiction can be broad and may cover not only insiders themselves but also any persons related to them, such as brokers, associates, and even family members. A person who becomes aware of non-public information and trades on that basis may be guilty of a crime.

Understanding Insider Trading

The U.S. Securities and Exchange Commission (SEC) defines illegal insider trading as:

“the buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, based on material, nonpublic information about the security.”

Material information is any information that could substantially impact an investor’s decision to buy or sell the security. Non-public information is information that is not legally available to the public.

The question of legality stems from the SEC’s attempt to maintain a fair marketplace. An individual who has access to insider information would have an unfair edge over other investors, who do not have the same access and could potentially make larger, ‘unfair’ profits than their fellow investors.

Hypothetical Examples of Insider Trading

• The CEO of a company divulges important information about the acquisition of his company to a friend who owns a substantial shareholding in the company. The friend acts upon the information and sells all his shares before the information is made public.
• A government employee acts upon his knowledge about a new regulation to be passed which will benefit a sugar-exporting firm and buys its shares before the regulation becomes public knowledge.
• A high-level employee overhears some conversation about a merger and understands its market impact and consequently buys the shares of the company in his father’s account.