Insider trading is the act of buying or selling securities in a publicly traded corporation while in possession of material information that is not yet public. Any and every information that could significantly impact an investor’s decision to buy or sell a security is referred to as material information.
By non-public information, they mean information that isn’t legally in the public domain, and only a few people who are closely related to the data have access to it. A company executive or a government official who has access to an economic report before it is made public is an example of an insider.
Insider trading regulations are intricate and, in general, differ from country to country. Depending on the jurisdiction, the term “insider” can have a wide range of meanings. Some people may use a restrictive definition of “insider” and only regard persons who work for the company and have direct access to information as “insiders.” On the other hand, people related to company authorities may be considered “insiders” by some.
What Does Insider Trading Mean How It Work?
In the Share market, insider trading is a prohibited practice. Insiders have access to non-public information about the company, such as consecutive losses that could cause its stock price to plummet. While large-scale stockholders will remain uninformed of this knowledge until it is made public, illegal insider traders will take action.
The offender will make critical trading decisions involving the company’s stock for personal gain at the expense of unsuspecting shareholders. To allow prosecution of this offence, lawmakers enacted Rule 10b-5 in the Securities Exchange Act of 1934 in 1942. In 2021, US lawyers also approved the Insider Trading Prohibition Act, making it illegal to trade insider information.
An “insider” is defined by law as a company director, employee, external officials, family members, or other individuals who have access to “non-public material knowledge” about the firm due to their position. Because “non-public material information” can affect large-scale shareholders’ investment in the company, it must be disclosed.
Any trading decisions made without the shareholders’ knowledge will be unjust and may result in losses. As a result, it is prohibited to distribute and act on non-public information obtained while working or through a third party. Insiders should either expose it to everyone or wait until it becomes public before revealing it. You can do stock market courses for better understanding about insider trading.
Insider Trading: Legal vs Illegal
According to research, both of these scenarios are prevalent before a public announcement that could affect the stock price.
In the unlawful type, non-public company information is used for trading securities against the law’s standards. As a result, the impacted parties suffer financial losses and their faith in the system is eroded. To deter these offences, regulatory agencies impose penalties on offenders. As a result, firm executives must ensure that confidential information is not disseminated.
On the other hand, legal insider trading occurs when a company’s insiders buy or sell its stock but report it to the Securities and Exchange Commission regularly. Furthermore, doing so exposes the organization’s information to the public. Employee stock options, for example, are a legitimate kind of insider trading that many insiders engage in daily.
Hypothetical Insider Trading Examples
- A firm’s CEO shares sensitive information about the company’s purchase with a friend who holds a significant stake in the company. Before the information is made public, the friend acts on it and sells all his shares.
- A high-level employee overhears a talk about a merger and realizes the implications for the market, so he buys the company’s stock in his father’s account.
Insider Trading Penalties
If someone is found insider trading, he can face prison time, a fine, or both if he is caught. According to the Securities and Exchange Commission, a conviction for insider trading could result in a fine of up to $5 million and a sentence of up to 20 years in jail. According to the SEBI, a conviction for insider trading can result in a forfeiture of INR 250,000,000 or three times the profit gained on the deal, whichever is higher.
Is there a negative connotation to insider trading?
The word “insider trading” has a negative connotation because it is perceived as unfair to the typical investor. Insider trading is defined as trading in a public firm’s stock by someone who has non-public, substantial information about the store. Insider trading might be legal or criminal, depending on whether or not it follows SEC guidelines.
When Is It Illegal To Trade Insider Information?
Any information that could significantly impact the company’s stock price is considered material non-public information. Having access to such knowledge could affect an investor’s decision to buy or sell a share, giving them an advantage over the general public.