Insider trading refers to trading an open company's stock by an individual with access to non-public information on the stock for whatever reason. Depending on when the insider performs the transaction, insider trading may be legal or illegal. Insider trading is unlawful if the information used to make the trade is not public, and grave consequences accompany this kind of insider trading.
Understanding Insider Trading
Material information refers to any information that can significantly influence the decision of an investor to purchase or trade securities. Non-public information refers to information that isn't legally accessible to the general public. The issue of legality arises from the SEC's effort to keep a fair market. Anyone with access to insider knowledge would enjoy an advantage over investors who don't have access to the same information and may be able to earn higher profit margins than their counterparts in the market.
Illegal insider trading can involve giving others tips whenever you have important non-public information. Legal insider trading occurs when directors of a business buy or sell shares; however, they must lawfully disclose their transactions. In the United States, the Securities and Exchange Commission has guidelines to ensure that investments are protected from the negative consequences of insider trading. It doesn't matter how the information considered non-public was obtained or whether the business employs the individual. Let's say you learn about non-public information from an acquaintance and then can share it with an acquaintance. If the friend utilizes this information to profit from the stock market, all three people involved may be charged with a crime.
What Insider Trading Means for Investors
Insider trading sanctions typically include penalties of fines and imprisonment. The consequences could be either or both; however, it usually involves both. The precise penalty will depend on how severe the situation is. There could be other consequences to the case. They can be professional or financial, or, more often, both. The SEC has decided to stop those involved in trade violations from sitting on boards of public companies.
Insider Trading Events
SEC vs Switzer
Barry Switzer was the University of Oklahoma football coach in the year 1981. He was prosecuted by the SEC following the fact that he and a group of friends bought shares in Phoenix Resources. Switzer was at an event when the executives of Phoenix were discussing plans to take the business off the market. He purchased the stock for approximately $42 per share. He then sold it for just $59 per share. He earned about $98,000 during the sale.
The federal judge eventually dropped his charges because of insufficient evidence. However, Switzer could have been fined and imprisoned if one of his employees was the daughter or son of the executive and spoke of that tips to him. In this case, the U.S. Supreme Court found that the person who gave a tip had not violated their fiduciary obligation to gain personal profit.
U.S. vs O'Hagan
James O'Hagan was a lawyer in the company of Dorsey & Whitney in 1988. O'Hagan purchased a lot of options within the company based on this information. He was aware that the options would rise in value once the tender offer went available to the public. He traded his options at an ideal time. O'Hagan made $4.3 million.
Negative Connotation?
The phrase "insider trading" has an unfavorable connotation due to the belief that it's unfair to investors regularly. In essence, insider trading is trading on a public company's stock by someone who is not public and has information regarding the stock. Insider trading may be legal or illegal based on whether it conforms to SEC regulations.
When Is Insider Trading Illegal?
Insider trading is considered illegal if the relevant information is private and carries severe penalties, including possible fines and prison time. Non-public material information is any information that can significantly influence the value of the company's stock. Access to this kind of information can affect the decision of an investor to purchase and sell their security. This could give them an edge over other investors who do not have that access. Martha Stewart's ImClone trading is a great illustration of this.
When Is Insider Trading Legal?
Legal insider trading occurs in the market on an annual basis. The issue of legality stems from the SEC's efforts to keep a fair marketplace. It is, in essence, legal for company insiders to be involved in trading shares of the company if they promptly report the trade to the SEC. It is the Securities Exchange Act of 1934 was the first step to the legally-binding disclosure of transactions in company stock. Directors and the major stock owners must disclose the stakes they hold, their transactions and changes in ownership.
