What constitutes insider trading?

What Constitutes Insider Trading?

Insider trading is when someone uses secret info to make money in the stock market. But what exactly counts as “insider trading” legally speaking? Like, what makes it different from just regular trading? I wanted to break it down in a simple way, so people don’t accidentally break the law.

What is Insider Information?

The key thing is that insider trading involves using special “inside information” that isn’t available to regular investors. This means stuff like:

• Confidential data about a company’s finances or business deals
• Advanced notice of an upcoming product launch or merger
• Early access to press releases that will impact stock prices
• Knowledge of an executive resignation before it’s announced

If it’s info that could move stock prices once it gets out, but only insiders know it ahead of time, that’s considered “material nonpublic information” in legal terms [1].

Who Counts as an Insider?

Insider trading laws apply to company “insiders” who have access to secret info. This includes:

• Executives like the CEO and CFO
• Directors and major shareholders
• Lawyers, accountants, and consultants working with the company
• Employees privy to confidential data

But it’s not only people directly involved with the company. If an insider passes data to an outsider, and they trade on it, that’s still illegal insider trading [2].

How Insiders Profit from Inside Information

Okay, so how do insiders actually use their secret knowledge to make money? Here are some common tactics:

• Buying stock right before good news boosts the price
• Selling before bad news tanks the stock
• Exercising stock options or bonuses before a price jump
• Trading ahead of mergers, deals, product launches, etc.

The key is using info the public doesn’t have to anticipate stock price moves. Even just avoiding losses by selling early before a drop counts as insider trading.

Why Insider Trading is Illegal

Insider trading is illegal because it gives certain people an unfair advantage and distorts financial markets. Regular investors are supposed to have equal access to info that moves stock prices [3].

If insiders could trade freely based on secret data, ordinary people would always be at a disadvantage. It would shake faith in the fairness of markets. Also, it incentivizes stealing confidential corporate information.

What About Legal Forms of Insider Trading?

There are certain circumstances where insider trading is allowed. For example:

• Company execs reporting their trades properly
• Employees participating in stock purchase plans
• Investors trading in their own company’s stock

Routine insider trades that follow reporting rules and don’t abuse secret info are legal. The issue is misusing confidential data for profit [1].

How Do They Catch Insider Traders?

Watchdogs like the SEC look for suspicious trading patterns to catch insider trading. Things like:

• Unusual trading spikes before news events
• Well-timed trades by company insiders and associates
• Sudden activity in obscure stocks
• Circumstantial evidence like communications

Computer monitoring also flags trades that seem to anticipate price swings too perfectly. But catching insider trading takes good old fashioned detective work too [2].

What are the Penalties?

If you’re caught insider trading, the penalties can be severe. We’re talking:

• Huge fines up to 3 times the profits gained
• Years or even decades in prison
• Getting barred from financial services work
• Lawsuits by investors who lost money
• Destroyed careers and reputations

Even high profile CEOs and hedge fund managers have done the “perp walk” for insider trading. The risks totally aren’t worth it.

Famous Insider Trading Cases

Some notorious insider trading cases include:

• Martha Stewart in 2001 – avoided $45k in losses using insider tip
• Raj Rajaratnam in 2009 – profited $63M from insider tips
• Billy Walters in 2017 – made $43M trading on secret data
• Chris Collins in 2018 – warned family to sell stock on bad news

These examples show how serious the consequences can be, even for the rich and powerful. Insider trading is not a victimless crime.

Bottom Line on Insider Trading

To recap the key points:

• Insider trading uses confidential company information
• Both company insiders and outsiders can be guilty
• It gives an unfair advantage over regular investors
• Routine insider trades following rules are legal
• But profiting off inside knowledge isn’t
• Penalties include huge fines, jail time, and lawsuits

I know it can get complicated, but just don’t trade stocks using nonpublic information, and you’ll be fine! Follow the rules, and leave insider trading to the crooked Wall Street types.