What You Should Know About Insider Trading

Insider trading is the term used to describe the trading of a public company's stock by someone who has a non-public, material information about that stock

Insider trading is one term that comes to mind when we talk about the crimes of investing and trading. While it does not typically involve any form of violence, it is a punishable offence in the world of investment, and you’ll get to know why. Yet, not all insider trading is illegal.

First, What Is Insider Trading?

Insider trading is the term used to describe the trading of a public company's stock by someone who has a non-public, material information about that stock. A person is defined as an “insider” if they have a relationship with a business that makes them privy to information that has yet to be released to the public.

This means that nearly anybody, including brokers, family, friends, and employees, can be considered as insiders.

Insiders are expected to maintain a fiduciary relationship with their companies and shareholders. As such, trying to profit from insider information violates his or her duty to maintain the confidentiality of such knowledge by using it for financial gain.

Insider information is “material” if its release would affect a company's stock price. It might be a pending merger, the announcement of a tender offer, a product recall, a positive earnings report, the pending release of a new product, a shortfall in earnings, or the failure of a major project.

In extreme cases, it might be a financial scandal that is about to burst into public view.

The legality (or illegality) of it

Insider trading can be legal or illegal and this is primarily determined by the time in which the said insider makes the trade.

It is illegal when a transaction, whether the purchase or sale of a stock is influenced by knowledge that is available to only a small group of people inside of the company whose stocks are being traded whereas the material information is still non-public.

There are harsh consequences for this sort of insider because it undermines confidence in the integrity of the market and can dampen economic growth.

More so, insider trading is deemed illegal because it gives the insider trader an unfair advantage in the market that allows them to profit from information about a potential up or down tick in a company's trading value before others.

Primarily, it puts the insider's interests above those of the entities to whom they owe a fiduciary duty and allows an insider to artificially influence the value of a company's stocks.

However, sometimes people outside of a company can circumvent these laws by using information obtained from those on the inside to seek a profit, even if the insider does not directly profit.

In these situations, there is a “tipper” and a “tippee.” The tipper is the person who has broken his or her fiduciary duty by intentionally revealing confidential information to outsiders and the tippee is the person who knowingly uses that confidential information to make a trade for purposes of turning a profit or avoiding a financial loss.

There are government agencies responsible for monitoring and persecuting these kinds of transactions with laid down rules regarding insider trading. An insider or his or her accomplices could face considerable fines and even prison sentences.

However, insiders do not always have their hands tied. Insiders can (and do) buy and sell stock in their own company legally all of the time; their trading is restricted and deemed illegal only at certain times and under certain conditions.

Written by Lawretta Egba