What Is Insider Information?
Let me explain what insider information really is. It's a fact about a public company's plans or finances that hasn't been revealed to shareholders yet, and if you act on it, it could give you an unfair advantage. If you buy or sell stock based on this kind of information, you're committing a criminal offense.
This information is typically available to executives who work within or close to the public company.
Understanding Insider Information
Inside a company, a limited number of people inevitably know about events that will significantly affect the stock price once revealed. This could be something like a pending merger, a product recall, an earnings shortfall, or the failure of a major project. In extreme cases, it might involve a financial scandal about to become public.
Those in the know aren't just sworn to confidentiality; the law forbids them from using that knowledge to buy or sell the company's stock, or from passing it to someone else who then acts on it.
Insider trading becomes illegal when you trade on material information that hasn't been made public. It's viewed as an unfair manipulation of the free market, giving advantages to certain parties. In the end, this undermines confidence in the market's integrity and can slow economic growth.
Key Takeaways
- Insider information refers to non-public facts about a publicly-traded company which could provide an advantage to investors.
- The manipulation of insider information to benefit an investor in buying or selling stock is known as insider trading and is illegal.
- The Securities and Exchange Commission regulates legal insider trading.
Regulating Insider Information and Trading
If you use insider information to place trades or advise someone else to do so, you can be found guilty of insider trading.
Company insiders do own stock and buy or sell shares occasionally, but not all insider trading is illegal.
In the U.S., the Securities and Exchange Commission (SEC) regulates legal insider trades. Trading by executives, directors, and employees follows regulations in the 1934 Securities Exchange Act.
The definition of insider trading has expanded since the law's passage through high-profile rulings and legislation closing loopholes.
For example, in 2000, Congress passed Regulation Fair Disclosure (Regulation FD) to stop selective disclosure. It requires that if a firm discloses non-public information to an interested party, they must make it public and available to all traders.
The SEC treats trading on insider information as serious fraud, with guilty individuals facing heavy fines or imprisonment. Take the case of business mogul Martha Stewart, indicted in 2003 on securities fraud after trading to avoid a loss based on insider info. She served five months in prison and paid a disgorgement of $45,673 plus $12,389 in prejudgment interest, along with a $137,019 civil penalty.
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