Introduction
When people hear the term “Insider trading,” they usually think of something bad. People usually think that insider trading is always illegal. In part because cases of illegal insider trading can get a lot of attention in the news. But whether or not insider trading is legal depends on when and how the trade is made. Because of this chance of confusion, public executives must know and follow the Securities and Exchange Commission’s (SEC) rules on Illegal Insider trading in all their financial dealings to the letter.
They also need to know some examples of insider trading to see how these things work in real life. Is insider trading always illegal, or can it occur in certain circumstances? In this article, we’ll look at the definition of insider trading. As well as the various forms it can take and the laws that govern it. You’ll have a better understanding of what insider trading is, how it works, and the legal ramifications by the end of this article.
Illegal Insider Trading Examples
Martha Stewart
In 2004, Martha Stewart was found guilty of trading on inside information. She sold her stock in ImClone Systems because she knew that the FDA had turned down the company’s request for a new drug to treat cancer. She didn’t lose $45,000 because she sold the shares before the news got out.
Raj Rajaratnam
Raj Rajaratnam, the founder of the hedge fund Galleon Group, was found guilty of trading on inside information in 2011. He broke the law by trading on secret information about companies like Google and Goldman Sachs. It made him millions of dollars.
Steve Cohen
In 2013, Steve Cohen, a billionaire runs a hedge fund. He pleaded guilty to insider trading charges against his company, SAC Capital. The company had to pay a fine of $1.8 billion. Cohen himself couldn’t manage money from outside sources for two years.
Mathew Martoma
Mathew Martoma, who used to be a portfolio manager at SAC Capital, was found guilty of trading on inside information in 2014. He made illegal profits of $276 million. It is by trading in the stock of two drug companies using information that was not public.
Michael Milken
Michael Milken, a wealthy businessman, was at the center of a big insider trading scandal in the 1980s. He was accused of trading high-yield bonds and other securities using information from insiders. Which made him and his clients a lot of money. In the end, he pleaded guilty to securities fraud and went to prison for two years.
Difference Between Legal And Illegal Insider Trading
Use of Information
Legal insider trading is the buying or selling of a security by someone who has access to material nonpublic information about the security. This type of trading is generally allowed as long as the person trading is not in possession of any material nonpublic information that could give them an unfair advantage. Illegal insider trading, on the other hand, is when an insider or someone with important information about a stock that hasn’t been made public buys or sells the stock of a publicly traded company, this is called “Illegal Insider trading.” A person is considered an insider if they have access to this kind of information or if they own more than 10% of the company’s stock.
Disclosure Requirements
For insider trading to be legal, trades based on important information that is not public must be reported. The Securities and Exchange Commission (SEC) requires insiders to file Form 4 to report any transactions they make. These disclosures help make sure that the financial markets are clear and give investors important information. On the other hand, illegal insider trading is trading without telling anyone about important information that is not public.
Benefits to the Company
Insider trading that is legal can be good for both the company and the shareholders. For example, if a company executive buys shares in their own company, it can show investors that the executive is optimistic about how the company will do in the future. This can make investors feel better about the company, which can be good for the stock price. Illegal insider trading, on the other hand, is bad for the company. And its shareholders because it hurts the integrity of the financial markets.
Penalties
There are strict rules and regulations about legal insider trading. And people who break these rules can get fined or go to jail. For example, an executive who doesn’t tell anyone about a trade he or she made based on important information that isn’t public can be fined, put in jail, or even banned from being a corporate officer. On the other hand, illegal insider trading can lead to big financial gains. But it also has a high risk of getting you into trouble with the law. Offenders can get fines, time in jail, and civil penalties, like giving back any money they made from illegal trades.
Intent
When deciding whether insider trading is legal or not, the reason for the trade is also important. Insider trading that is legal is based on public information. And is done with the same goal as any other investor to make money. Illegal insider trading, on the other hand, is based on private information that is gained through illegal means . It is done to get an unfair advantage in the market.
Take A Look At The Following Examples Of Legal Insider Trading
Open Market Purchases
Open market purchases are a legal form of insider trading, as long as the insider is not in possession of material, non-public information. Under SEC Rule 10b-5, an insider is allowed to buy or sell stock in the company they work for on the open market, as long as they do not have any material, non-public information. Open market purchases can be used to signal to the market that the insider believes the stock is undervalued which is a bullish sign.
Rule 10b5-1 Trading Plan
Insiders can set up a Rule 10b5-1 trading plan that lets them buy or sell company securities in a pre-planned way. Even if they have important information that the public doesn’t know about at the time of the trade. This kind of trade plan can help insiders avoid accusations of illegal insider trading. The trades are made on a set schedule and not based on any inside information the insider may have.
Options Grants
Legal insider trading often takes the form of option grants. As part of their compensation, they are awarded to corporate officers, directors, and other high-ranking employees. Option holders are granted the right, for a predetermined time period, to purchase a predetermined number of shares of the company’s stock at a predetermined price (the strike price). Option holders can save money by exercising their contracts when the stock price rises above the option’s strike price. This method allows businesses to show their appreciation for their employee’s contributions to the company’s success without giving up too much control.
Plans For Employees To Buy Stock (Espps)
An Employee Stock Purchase Plan (ESPP) is legal. And common way for employees to buy company stock at a discounted rate. With an ESPP, employees set aside a portion of their wages for each pay period. And the company uses those funds to purchase company stock at a predetermined price. The discounted rate of the stock is usually based on the market price at the beginning and end of the offering period. Employees may be eligible to receive tax advantages from their ESPP investments. And may also be able to sell their shares for a profit.
Stock-Based Compensation
Stock-based compensation is the practice of including equity-based incentives like stock or stock options in employee pay packages. It is often used to entice and keep skilled workers and top executives. Stock-based compensation can motivate employees to contribute to the company’s long-term success by making them feel like they have a personal stake in its success.
The Following Are Examples Of Illegal Insider Trading
Front-running
When a trader makes a transaction in securities based on information obtained from a client, they have committed the illegal practice of front-running. If a broker knows that a client is planning to buy a certain stock, he or she may make a trade in that stock for personal gain.
Tipping
Tipping refers to the unethical practice of sharing information about a potential security transaction with a third party for personal gain. The outsider puts that data to good use in investment.
Misappropriation of Non-Public Information
Market-NonPublic Information (MNPI) is data that is not widely available and could give a trader an unfair advantage. This occurs, for instance, when a company employee obtains information about a merger or acquisition before it is made public and then uses that knowledge to buy or sell the company’s stock.
Manipulation of the Market
Using deceptive or false information to artificially boost or lower the value of a security is known as market manipulation. This happens when a trader artificially depresses the price of a company’s stock by spreading false information about the company. And then buys the stock at a lower price.
Short-Swing Trading
Buying and selling shares of a company’s stock multiple times in less than six months is known as “short-swing trading.” Because they have access to nonpublic information that could affect the stock price. Insiders such as directors or officers of a company commit insider trading, which is illegal.
Trading During Blackout Periods
During blackout periods, insiders typically aren’t allowed to buy or sell shares of the company’s stock. In the two weeks before a company reports its quarterly earnings, for instance, insiders may be barred from making any trades. Insider trading occurs if an individual makes a transaction during a blackout period.
Trading On Rumors
If you trade based on unconfirmed or unannounced information, you are said to be trading on rumors. An example of illegal insider trading is when an investor buys stock in a company based on rumors that the company is about to be acquired, and the rumors turn out to be true.
Trading Based on Privileged Access
When important information is kept secret, a trade is against the law. But if everyone has the same access to the information, the trade is legal. As long as certain rules about how to report the trade are followed. It is considered illegal insider trading if a government worker learns of an impending policy change and then makes financial transactions based on that knowledge.
Differences Between Insider Trading And Insider Information
Buying or selling a security while in possession of material, non-public information about the company is considered insider trading. Insider information, on the other hand, is defined as any knowledge about a company that is not available to the general public. But could have a material impact on the stock price or financial performance of the company. Since insider information can be used for a variety of purposes, including decision-making, market analysis, and research, it follows that insider trading is the practice of using such information for the purpose of making profitable trades.
Potential Benefits Of Using Insider Information
Investors who gain access to and use confidential information have a leg up on the competition. Investment decisions, market opportunities, and threats can all be better assessed with this information. Having access to insider information can help investors make more informed decisions about a company’s financial health, future prospects, and potential challenges.
Impact Of Illegal Insider Trading
Unfair Advantages
Illegal insider trading has many negative effects, one of the most significant of which is that it provides participants with an unfair advantage over other investors in the market. While other investors are kept in the dark, insider traders have the potential to make significant profits by trading on material information that is not publicly available. The following can result in a loss of confidence in the fairness and transparency of the market, which, in turn, can erode confidence in the entire monetary system.
A Drop In Confidence Among Investors
Trading on inside information in violation of the law can cause investors to lose faith in the stock market. When potential investors believe that the market is manipulated to benefit those with insider knowledge, they may be less likely to put their money into the market. since investment is one of the primary factors that propel an economic expansion, this may have a detrimental effect on the economy as a whole.
Damage to Companies
Unauthorized trading of inside information can be detrimental to both the companies whose securities are being traded and the companies themselves. When insider trading takes place, it has the potential to have an effect on both the stock price and the reputation of the company, which could result in a loss of value for shareholders. As a result of this, it may become more difficult for businesses to raise capital in the future, which may impede the growth and development of those businesses.
Legal and Regulatory Consequences
Those who participate in insider trading without authorization run the risk of significant legal and regulatory repercussions. This may result in monetary fines, time spent in jail, or even civil lawsuits. In addition, businesses that do not take adequate measures to prevent insider trading run the risk of incurring regulatory sanctions and suffering reputational harm.
Reduced Market Efficiency
Trading on the inside can have a negative impact on the efficiency of the stock market. The ability of the market to accurately price securities is susceptible to being distorted whenever insiders have an unfair advantage. The following can lead to a poor allocation of resources as well as an allocation of capital that is less than optimal.
Frequently Asked Questions
What are the consequences of illegal insider trading?
Insider trading is a crime with potentially devastating repercussions. Criminal and civil penalties, such as fines, jail time, and disgorgement of ill-gotten gains, may be levied against those who are found guilty of illegal insider trading. Furthermore, the SEC may prohibit a person from engaging in any securities transactions or serving as an officer or director of a publicly traded company.
