Few subjects in finance capture as much intrigue and controversy as insider trading. Being all over the news, it is frequently associated with scandals and high-profile cases. Understanding insider trading helps people and companies follow the law correctly.
Definition of Insider Trading
Insider trading refers to purchasing or selling a stock of companies by an individual who has material and non-public information about it. Insiders include executives, directors, employees, and any other individual with access to inside information. This access can unfairly benefit them if they abuse it.
Corporate insiders can buy or sell a firm’s stock, but they have to disclose these trades with the Securities Exchange Commission (SEC) in a timely manner and not use material information not available to the general investing population. This is a wrong and unethical type of trading because it goes against the fundamental principles of true markets that information should be available to all investors simultaneously.
Material Non-Public Information
Material non-public information (MNPI) is any piece of information that might materially affect a company’s stock price but has not yet been made public, such as earnings reports before they are released to the market, or news of upcoming mergers and acquisitions. Tipping is sharing MNPI with someone who then trades on it. This creates the potential for liability on both the tipper (the person sharing info) and the person receiving it (the tippee).
Regulations Against Insider Trading
The United States has very strong anti-insider trading laws, which are designed to ensure that information released by companies is available equally and simultaneously to everyone. The SEC is the major regulatory authority and it releases rules under the Securities Exchange Act of 1934 as well as The Insider Trading Sanctions Act of 1984. The Dodd-Frank Act further addresses these activities. There is SEC oversight and investigation into inside-trading possibilities. The Financial Industry Regulatory Authority (FINRA) is another association that works with the SEC to manage protections firms and guarantee speculators.
What Are the Penalties of Insider Trading?
Penalties for insider trading convictions are severe, including fines and disgorgement of profits of the security plus any salaries or other benefits received as a result of that illegal conduct. The penalties for such crimes are up to 20 years in prison and fines of $5 million.
Well-known Cases of Insider Training
Well-known cases of insider trading include Martha Stewart, convicted in 2004 for lying to federal investigators about a stock sale, and Raj Rajaratnam, who was sentenced to prison over an extensive information abuse scheme.
Recent examples include Equifax executives who were charged with insider trading after the hack in 2017, highlighting that insider trading is a problem that continues to plague modern financial markets. These cases underscore that insider trading not only carries serious legal consequences but it also destroys the reputation and careers of all individuals involved, thus reinforcing general ethical standards in financial markets.
How Can Insider Training Be Prevented?
An active compliance program, regular training of employees, well-defined periods during which insiders cannot trade (commonly referred to as blackout periods), and the monitoring of trades conducted by insiders are just a few things that companies can do to help lessen the risks that come with insider trading. People should continue to monitor changes in insider trading laws and regulations, seeking the guidance of lawyers experienced in white collar crime. The act of trading on MNPI is a violation of both the law and market professionalism, eventually decreasing the level to which we trust our markets.
Insider trading is a somewhat intricate area of finance law appropriately subject to strict regulation. Insider trading can offer amazing profits, but it is illegal and has serious consequences. Covering the nuances of insider trading can help anybody in the stock market—from legal activities to results derived from illegal trades. In other words, staying informed and playing by the legal rules not only protects individuals from law enforcement but also upholds those who believe in a fair and open market.