What Is an Insider?
"Insider" is a term describing a director or senior officer of a publicly-traded company, as well as any person or entity, that beneficially owns more than 10% of a company's voting shares. For purposes of insider trading, the definition is expanded to include anyone who trades a company's shares based on material nonpublic knowledge. Insiders have to comply with strict disclosure requirements with regard to the sale or purchase of the shares of their company.
Key Takeaways
- An insider is a director, senior officer, entity, or individual that owns more than 10% of a publicly-traded company's voting shares.
- In the United States, the Securities and Exchange Commission (SEC) has enacted stringent rules to prevent insiders from engaging in insider trading.
- Insider trading is when anyone buys or sells shares of a company based on material information not readily available to the general public.
Understanding an Insider
Securities legislation in most jurisdictions has stringent rules in place to prevent insiders from taking advantage of their privileged position for pecuniary gain through insider trading. Offenses are punishable by disgorgement of profits and fines, as well as incarceration for severe offenses.
Some investors pay close attention to heightened levels of insider buying as it can be a signal that a stock is undervalued and the share price is poised to increase.
In the United States, the Securities and Exchange Commission (SEC) makes rules concerning insider trading. While the term often carries the connotation of illegal activity, corporate insiders can legally buy, sell, or trade stock in their company if they notify the SEC. Insider buying is legal as long as the buyer is using information that is readily available to the public.
Types of Insiders
There are distinct groups of people the SEC considers insiders. Investors gain insider information through their work as corporate directors, officers, or employees. If they share the information with a friend, family member, or business associate and the person who receives the tip exchanges stock in the company, they are also an insider.
Employees of other companies in a position to gain insider information, such as banks, law firms, or certain government institutions can also be guilty of illegal insider trading. Insider trading is a violation of the trust investors place in the securities market, and it undermines a sense of fairness in investing.
Real-World Examples
In one of the first cases of insider trading after the United States was formed, William Duer, secretary to the Board of Treasury, used information he gained from his government position to guide his purchases of bonds. Duer's rampant speculation created a bubble, which culminated in the Panic of 1792.
Albert Wiggin was a respected head of Chase National Bank who used insider information and family-owned corporations to bet against his own bank. When the stock market crashed in 1929, Wiggin made $4 million. In the fallout from this incident, the Securities Act of 1933 was revised in 1934 with stricter regulations against insider trading.
Martha Stewart was convicted of insider trading when she ordered the sale of 3,928 shares of ImClone Systems Inc. just days before the Food and Drug Administration (FDA) rejected the corporation's new cancer drug. By selling when she did, Stewart avoided losses of $45,673. For her role, Stewart was fined $30,000 and sentenced to five months in prison.
What Are Examples of Insider Trading?
Insider trading occurs whenever an individual uses nonpublic information about a company to buy or sell that company's stock in order to earn a profit or avoid a loss. For example, if a CEO mentions to their friend that the company is about to lose a lot of money due to a product recall in the next month, and this friend mentions that information to their son, and the son sells his shares in the company, that would be insider trading.
What Is an Insider of a Company?
An insider of a company, as defined by the Securities and Exchange Commission (SEC), is an officer, director, or 10% shareholder of a company that has inside information into the company because of their relationship to the company or with an officer, director, or principal shareholder of the company.
Is Insider Trading a Financial Crime?
Yes, insider trading is a financial crime. Whenever information that is not public is used by an individual to profit or avoid a loss, that is insider trading and is punishable with both fines or jail time.
FAQs
For example, illegal insider trading would occur if the chief executive officer of Company A learned (prior to a public announcement) that Company A would be taken over and then bought shares in Company A while knowing that the share price would likely rise.
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.
What are the types insider trading? ›
Types of insider trading: Traditional insider trading: Buying or selling a company's securities based on material nonpublic information. Tipper-tippee trading: An insider (the tipper) provides material information to someone else (the tippee), who then trades on that information.
How is insider trading defined according to the law? ›
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, on the basis of material, non-public information about the security.
What is an example of insider trading? ›
Let's say an insider works at a company and owns some shares of its stock. This person receives private information about the company facing a major lawsuit. As a result, they opt to sell their shares before the news is made public.
What is not considered insider trading? ›
For example, a person in a restaurant who hears the CEO of Company A at the next table tell the CFO that the company's profits will be higher than expected and then buys the stock is not guilty of insider trading—unless he or she had some closer connection to the company or company officers.
How do I know if someone is 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.
What are the two versions of insider trading? ›
Insider trading can be broken down into two general categories: (1) buying securities prior to the announcement of good news, such as unexpectedly high quarterly earnings, or a promising merger; or (2) selling securities prior the announcement of bad news, such as a decline in quarterly revenue.
What is Regulation 3 of insider trading regulations? ›
REGULATION 3: RESTRICTIONS ON COMMUNICATION AND TRADING BY INSIDERS ● No Insider shall share or allow access to UPSI to any person except for legitimate purposes. Legitimate Purpose: Consultants, Partners, Lenders, Customers, Suppliers, auditors, legal advisors etc.
Is it insider trading if you overhear? ›
Roughly, it's illegal only if you have some duty not to trade on it. If you acquired the information without misappropriating it (like overhearing it from strangers in a normal public bar), then you're free to trade.
Commonly Sought Evidence in Insider Trading Cases
- Fiduciary duty: The accused must owe a fiduciary duty to the company. ...
- Material nonpublic information: The information traded upon must be material, meaning it has the potential to affect a reasonable investor's decision.
An insider of a company, as defined by the Securities and Exchange Commission (SEC), is an officer, director, or 10% shareholder of a company that has inside information into the company because of their relationship to the company or with an officer, director, or principal shareholder of the company.
What type of crime is insider trading? ›
Insider trading charges (usual charged Federally as Securities Fraud under Title 18, United States Code, Section 1348) involve the intentional trade (sale or purchase) of any security based upon material, non-public information.
What are the three types of insider trading? ›
Classic Insider Trading: Buying or selling assets based on important non-public information. Tipper-Tippee Trading: An insider gives others access to confidential information so they can trade using it. Trading During Blackout Periods: Insider trading during times when particular people are barred from trading.
What best defines insider trading? ›
Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security.
How do people 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.
What is an example of insider trading violation? ›
Ivan Boesky was an American stock trader who became infamous for his role in an insider trading scandal during the 1980s. This scandal also involved several other corporate officers, employed by major U.S. investment banks, who were providing Boesky with tips about upcoming corporate takeovers.
Which of the following scenarios could be examples of insider trading? ›
Answer. The scenario where a company executive sells shares before the public release of negative financial results is the best example of insider trading, which is illegal and considered securities fraud.So, the correct option is 4) A company executive sells shares before negative financial results are made public.
What is an example of insider trading in Congress? ›
Additionally, John Hoeven of North Dakota purchased $250,000 in health science companies in January, five days after attending a briefing about the pandemic. On January 31 and February 18, Dianne Feinstein sold stock in Allogene Therapeutics, with the estimated value to be between $1.5 million and $6 million.
