What is Insider Trading?

What is Insider Trading?

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What is Insider Trading

When someone with access to a company’s confidential information buys or sells their publicly traded stocks based on private information, it may constitute insider trading. Insider trading is a form of fraud that relies on investors acting on insider information by buying or selling more stock in anticipation of a rise or decrease in value, respectively.

If you suspect insider trading is happening in your organization, continue reading to learn about how to handle the situation.

Insider Trading Definition

Before you accuse someone of committing insider trading, it is important to get a good understanding of how the law defines it. Insider trading deals with a company’s public stock. Since the stock is public, everyone should have an equal and fair opportunity to earn a profit (or suffer a loss) from investing in it. Despite that, insiders often have specific information that could be used to gain money on the stock market if they act on it.

If someone does use inside (i.e., private) information to buy or sell publicly traded company stock to gain an unfair advantage, that is considered illegal insider trading.

Why is Insider Trading Illegal?

Insider trading is illegal because the individual with the proprietary information has an unfair advantage over everyone else investing in the same stock. Since the stock is public, there should be no instances of unfair advantages.

If this behavior was legal, then a nefarious company could tell employees to sell their stocks to the public, let the company’s stock value plummet, and then repurchase those same stocks at a very low price. The public would lose out, while the insiders would earn a hefty profit.

What Are the Categories of Insider Trading?

There are two main categories of insider trading, both of which are illegal. Here is an overview of both:

Purchasing Securities Prior to a Good News Announcement

The most common type of insider trading happens when a company is about to explode in value. When insiders know that the value of a company’s stocks is about to go up, they may purchase a good chunk of them first. That way, when the good news hits the public and more people start to buy stocks, the insiders can make a substantial profit.

Selling Securities before a Bad News Announcement

Another common type of insider trading is when a company is about to experience financial hardship. If a company is about to go public about a bankruptcy, bad PR event, or other negative event, insiders might predict that the company stock’s value is about to plummet. In these cases, insiders can sell off that stock to prevent suffering a tremendous loss.

When is Insider Trading Legal?

There is a legal type of insider trading. The SEC outlines specific rules that dictate what is illegal and what is not. In most cases, the trading can be legal if the directors of the company disclose their transaction in a legal and fair way.

To be legal and fair, the insiders must report their trades to the SEC in a timely manner. On top of that, these transactions cannot be based on insider information.

Famous Cases of Insider Trading

Unfortunately, insider trading has been an issue for decades, and many massively successful businesses and famous individuals have been caught engaging in this illegal activity. Learn about some of the most iconic and famous cases of insider trading below.

Enron

The story of Enron and the insider trading that derailed the company is full of ups and downs. At its peak, Enron’s shares were worth $90.75 per share. At its lowest, however, it was only valued at $0.26. Basically, Enron’s top executives intentionally decided to fool regulators and lie about the company’s true assets and debts, resulting in an unfair ballooning of the company’s value.

Furthermore, the company was recording its estimated profits as actual profits. Eventually, Enron’s debt caught up with it, and several executives were charged with insider trading, securities fraud, and conspiracy. The company plummeted and is now infamous for its failure.

Martha Stewart

Martha Stewart was also arrested and accused of insider trading when she sold 4,000 ImClone shares only one day before the firm’s stocks plummeted. Later, it was revealed that she was tipped off by Sam Waksal, the founder of the company, that the FDA was going to decline to review the company’s application for a new cancer drug.

Goldman Sachs

In a more recent case, Brijesh Goel, a former Goldman Sachs banker, was also arrested for insider trading. While he has not yet been convicted, prosecutors allege that he spoke with a friend about specific information that was later used by that friend to buy stocks. The MNPI stock buy allegedly resulted in a profit of $280,000 for the friend.

What Are the Ethical Implications of Insider Trading?

All trading on the securities market should be fair. When insiders act upon proprietary information, they are acting unethically because they have an advantage over everyone else who does not have that same information. Furthermore, they could even be directly financially harming individuals who do not have the opportunity to act on the information.

For instance, a public figure and an insider might both own $400 worth of stock. If the insider sells his stock prior to a bad news announcement, they have an opportunity to successfully avoid a loss. The public figure, on the other hand, will not only lose when the bad news announcement happens, but they will lose even more as a result of insiders who already sold their stock.

What Should I Do if I am Aware of Insider Trading?

If you suspect insider trading is occurring, you should submit your tip to the SEC whistleblower program. Before you do, though, it makes sense to consult with an attorney about your situation. An attorney can help you proactively protect yourself and your interests before you sound the alarm.

What you may not know is that you can financial benefit from filing a successful whistleblower claim. Whistleblowers whose information about insider trading leads to the successful recovery of defrauded funds are entitled to a percentage of the amount recovered.

SEC Whistleblower Program

When they report wrongdoing, a whistleblower is very likely to encounter intimidation or fear. After all, the whistleblower in these cases is almost always someone who works with other insiders that are committing the illegal activity.

The good news is that the SEC whistleblower program offers protection to whistleblowers who expose securities fraud such as insider trading. Specifically, whistleblowers are protected against employer retaliation.

This program also gives a financial incentive to whistleblowers who provide tips to the Securities and Exchange Commission. For more information, check out this Securities Fraud FAQ page.

Learn More about Insider Trading from a Qui Tam Lawyer

Insider trading happens when someone gains an unfair advantage in public trading markets based on insider information. Considering that the general public does not have the same opportunity granted by access to insider information, this type of behavior is not only illegal, but also unconscionable.

If you have become aware of an insider trading situation, you have an incentive to blow the whistle. You could get a financial reward if the court does find proof of your claims.

About the author

Daniel Tan is a professional blogger and currently working with Webvizards.com. Web Vizards offers articles, news, and guest post on a wide range of topics.

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