Using insider information for financial benefit on the stock market
What is Insider Trading?
Insider trading refers to the practice of purchasing or selling a publicly-traded company’s securities while in possession of material information that is not yet public information. Material information refers to any and all information that may result in a substantial impact on the decision of an investor regarding whether to buy or sell the security.
By non-public information, we mean that the information is not legally out in the public domain and that only a handful of people directly related to the information possessed. An example of an insider may be a corporate executive or someone in government who has access to an economic report before it is publicly released.
Detailed rules regarding insider trading are complicated and generally, vary from country to country. The definition of an “insider” can differ significantly under different jurisdictions. Some may follow a narrow definition and only consider people within the company with direct access to the information as an “insider.” On the other hand, some may also consider people related to company officials as “insiders.”
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.
Real-life Examples of Insider Trading
1. Martha Stewart
Shares of ImClone took a sharp dive when it was found out that the FDA rejected its new cancer drug. Even after such a fall in the share price, the family of CEO Samuel Waskal seemed to be unaffected. After receiving advance notice of the rejection, Martha Stewart sold her holdings in the company’s stock when the shares were trading in the $50 range, and the stock subsequently fell to $10 in the following months. She was forced to resign as CEO of her company and Waskal was sentenced to more than seven years in prison and fined $4.3 million in 2003.
2. Reliance Industries
The Securities and Exchange Board of India banned RIL from the derivatives sector for a year and levied a fine on the company. The exchange regulator charged the company with the intention of making profits by skirting regulations on its legally permissible trading limits and lowering the price of its stock in the cash market.
3. Joseph Nacchio
Joseph Nacchio made $50 million by dumping his stock on the market while giving positive financial projections to shareholders as chief of Qwest Communications at a time when he knew of severe problems facing the company. He was convicted in 2007.
4. Yoshiaki Murakami
In 2006, Yoshiaki Murakami made $25.5 million by using non-public material information about Livedoor, a financial services company that was planning to acquire a 5% stake in Nippon Broadcasting. His fund acted upon this information and bought two million shares.
5. Raj Rajaratnam
Raj Rajaratnam made about $60 million as a billionaire hedge fund manager by swapping tips with other traders, hedge fund managers, and key employees of IBM, Intel Corp, and McKinsey & Co. He was found guilty of 14 counts of conspiracy and fraud in 2009 and fined $92.8 million.
Penalties for Insider Trading
If someone is caught in the act of insider trading, he can either be sent to prison, charged a fine, or both. According to the SEC in the US, a conviction for insider trading may lead to a maximum fine of $5 million and up to 20 years of imprisonment. According to the SEBI, an insider trading conviction can result in a penalty of INR 250,000,000 or three times the profit made out of the deal, whichever is higher.
Related Readings
Thank you for reading CFI’s guide on Insider Trading. To keep learning and advancing your career, the following resources will be helpful:
FAQs
Insider trading is when one with access to non-public, price-sensitive information about the securities of the company subscribes, buys, sells, or deals, or agrees to do so or counsels another to do so as principal or agent. Price-sensitive information is information that materially affects the value of the securities.
What is insider trading and why is it illegal? ›
Essentially, insider trading involves trading in a public company's stock by someone with non-public, material information about that stock. Insider trading is illegal, but if an insider trades their holdings and reports it properly, it is an insider transaction, which is legal.
What is an example of insider trading? ›
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.
What is considered insider trade? ›
Insider trading happens when a director or employee trades their company's public stock or other security based on important or “material” information about that business.
What is insider trading legal examples? ›
Legal insider trading happens often, such as when a CEO buys back shares of their company, or when other employees purchase stock in the company in which they work. Often, a CEO purchasing shares can influence the price movement of the stock they own.
How does one get caught for insider trading? ›
The Securities and Exchange Commission plays a pivotal role in detecting and prosecuting insider trading. The agency monitors trading activities and investigates unusual spikes in trading volume or price changes that precede significant corporate events, such as mergers or earnings reports.
Is it insider trading if you overhear? ›
The individual charged with insider trading must have been aware that the information was material and nonpublic. For example, if you overhear a conversation on a train but have no knowledge that it is insider information, you cannot be convicted if you act on this information.
Who are the most famous insider traders? ›
Four insider trading cases that received a lot of media coverage in the U.S. were those of Albert H. Wiggin, Ivan Boesky, R. Foster Winans, and Martha Stewart. Financial Markets Standards Board (FMSB).
What famous person went to jail for insider trading? ›
CONVICTION AND JAIL TIME
With testimonies such as these and the failure to provide proof that a stop-call order existed, the situation looked bad for Stewart. The jury found Martha Stewart guilty on four counts of obstructing justice and lying to investigators.
Who was found guilty of insider trading? ›
Boesky, involved in one of the biggest insider trading scandals, dies at 87. Catch up on the developing stories making headlines.
Market surveillance activities: This is one of the most important ways of identifying insider trading. The SEC uses sophisticated tools to detect illegal insider trading, especially around the time of important events such as earnings reports and key corporate developments.
Can I buy stock of the company I work for? ›
One of the most common ways that employees pick up shares of employer stock is through a 401(k) plan. In addition to the usual mutual funds and ETFs offered in 401(k) plans, employers will offer employees the option of investing in company stock. Matching contributions may also be offered in the form of company stock.
What is the 10 am rule in stock trading? ›
Traders that follow the 10 a.m. rule think a stock's price trajectory is relatively set for the day by the end of that half-hour. For example, if a stock closed at $40 the previous day, opened at $42 the next, and reached $43 by 10 a.m., this would indicate that the stock is likely to remain above $42 by market close.
What is a real life example of insider trading? ›
A lawyer who represents the CEO of a company learns in confidence that the company will experience a substantial revenue decline. The lawyer reacts by selling off his stock the next day, because he knows the stock price will go down when the company releases its quarterly earnings.
How common is insider trading? ›
They estimate that insider trading occurs in one in five mergers and acquisition events and in one in 20 quarterly earnings announcements. These estimates imply that there is at least four times more actual insider trading than there are prosecution cases.
What is the penalty for insider trading? ›
According to the SEC, a conviction for insider trading can result in: Fines of up to $5 million. Imprisonment of up to 20 years. Being banned from serving as an officer or director of a public company.
How does the IRS catch insider trading? ›
Market surveillance activities: This is one of the most important ways of identifying insider trading. The SEC uses sophisticated tools to detect illegal insider trading, especially around the time of important events such as earnings reports and key corporate developments.
Why is insider trading such a big crime? ›
Why Is Insider Trading an Issue? Insider trading has been associated with unethical trading behavior by people who have information about a company that could affect the market prices of its issued securities. Some people believe it should be legal, and others support rules that make it illegal.
How long do you go to jail for insider trading? ›
Under Section 32(a) of the Securities Exchange Act of 1934, as amended by the Sarbanes-Oxley Act of 2002, individuals face up to 20 years in prison for criminal securities fraud and/or a fine of up to $5 million for each "willful" violation of the act and the regulations under it.
Is it illegal to buy stock in a company you work for? ›
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. A common misconception is that only directors and upper management can be convicted of insider trading.
