Insider Trading

Most investors are familiar with the term "insider trading." However, many assume it to be an illegal activity. In fact, insider trading may include behavior that can be both legal and illegal, depending on the actions involved.

Legal insider trading refers to the buying or selling of stock by people inside the company, such as those in a corporate position like employees, officers and directors. These traders are considered to be insiders, as per their positions in the company. The activity mentioned is legal. The trade of these securities requires reporting to the Securities and Exchange Commission (SEC), in the United States.

Illegal insider trading occurs when the buying or selling of a security takes place in breach of a fiduciary duty or when a relationship of trust and confidence is overridden. This happens in instances where an insider conducts the trade through the means of having possession of non-public information and breaking trust accordingly. Sometimes illegal instances of insider trading involve "tipping" information or information being misappropriated.

The SEC prioritizes cases pertaining to insider trading violations, given the integrity of the securities markets that they wish to maintain. Prosecution of these violations is thus rigorously enforced, to ensure confidence regarding fair market practice. It is not always straightforward to ascertain the identity of the traders, given that it is occasionally masked by an offshore company, nominee or proxy. There are numerous examples of cases where the SEC has dealt with insider trading illegalities. Situations have arisen where corporate staff, directors and employees have conducted trading activities by gaining access to confidential information. At times bank employees, and those associated with legal firms or brokerage organizations, have provided information in an illicit manner. Those who have been "tipped" and the associates who have given the information to secure the trading of the securities have also found themselves on the illegal side of the insider trading fence. The SEC has also dealt with government officials who, by virtue of their office, gain access to information deemed to be private and utilize that knowledge in an inappropriate, unlawful way. Misappropriation of confidential information by any person is a serious offense, and is dealt with by the SEC as per insider trading guidelines.

New rules adopted by the SEC pertain to matters of material non-public information, and to clarification of the misappropriation theory. The former relates to a person trading when the trader is aware of the material non-public information at the time of buying or selling the securities. Certain exceptions to liability are built into the law. Trade is permitted in specific circumstances when the information is not considered to determine the decision to trade. Examples comprise a contract, instruction or a pre-existing plan that indicates this clearly. Misappropriation theory is clarified in the second law. In terms of non-business relationships, it is understood that there is a duty of trust and confidence existing between parties. Thus, receipt of confidential information presupposes treating it as such; if not, liability according to the misappropriation theory would be relevant.

A corporate insider has been characterized by the U.S. government and Germany as employees, officers and directors of a company. Beneficial owners of more than 10 percent of a class of the company's equity securities are considered insiders too.

Previous images of corporate insider trading involved high-power executives sharing confidential material in a hushed way. The trading then took place via an unfair advantage. More recently, cases have emerged revealing the speed and relative ease with which information can be misappropriated during this new digitalized era. Innovative ways have had to be constructed in order to pursue non-traditional methods of finding culprits.

The fine for illegal insider trading is high in the United States, indicating the level of seriousness with which this crime is met. Joseph Nacchio, former chief executive of Qwest, a telecommunications company, received the largest penalty ever imposed. He was required to pay $19 million for contravening insider dealing law. In addition he was forced to return the $52 million he had earned illegally. Nacchio also was committed to a prison sentence of six years. The largest fine in the United Kingdom involved an amount of 750,000 pounds sterling.

Insider Trading: Selected full-text books and articles

Save Martha Stewart? Observations about Equal Justice in U.S. Insider Trading Regulation By Heminway, Joan MacLeod Texas Journal of Women and the Law, Vol. 12, No. 2, Spring 2003
From Chiarella to Cuban: The Continuing Evolution of the Law of Insider Trading By Sabino, Anthony Michael; Sabino, Michael A Fordham Journal of Corporate & Financial Law, Vol. 16, No. 4, October 1, 2011
Insider Trading: A Moral Problem By Strudler, Alan Philosophy and Public Policy Quarterly, Vol. 29, No. 3-4, Summer-Fall 2009
Insider Trading Inside the Beltway By Bainbridge, Stephen M Journal of Corporation Law, Vol. 36, No. 2, Winter 2011
Insider Trading: Is There an Economist in the Room? By Padilla, Alexandre; Gardiner, Brian Journal of Private Enterprise, Vol. 24, No. 2, Spring 2009
Peer-reviewed publications on Questia are publications containing articles which were subject to evaluation for accuracy and substance by professional peers of the article's author(s).
Insider Trading and Hedge Funds: A Dangerous Pair By Strohmenger, Richard Fordham Journal of Corporate & Financial Law, Vol. 15, No. 2, January 1, 2010
When Is It Wrong to Trade Stocks on the Basis of Non-Public Information? Public Views of the Morality of Insider Trading By Green, Stuart P.; Kugler, Matthew B Fordham Urban Law Journal, Vol. 39, No. 2, December 2011
Insider Trading around Open-Market Share Repurchases By Leng, Fei; Zhao, Kevin Min Journal of Economics and Finance, Vol. 38, No. 3, July 2014
Peer-reviewed publications on Questia are publications containing articles which were subject to evaluation for accuracy and substance by professional peers of the article's author(s).
Are Chinese Walls the Best Solution to the Problems of Insider Trading and Conflicts of Interest in Broker-Dealers? By Gorman, Christopher M Fordham Journal of Corporate & Financial Law, Vol. 9, No. 2, January 1, 2004
Insider Trading: Hayek, Virtual Markets, and the Dog That Did Not Bark By Manne, Henry G Journal of Corporation Law, Vol. 31, No. 1, Fall 2005
Insider Trading and CEO Pay By Henderson, M. Todd Vanderbilt Law Review, Vol. 64, No. 2, March 2011
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