Insider trading is a complex topic with many moving parts. Insider trading is constitutional (though not always a good idea) in numerous situations. Which makes up illegal insider trading depends heavily on the specific facts and circumstances involved.
If you are a seasoned investor who makes speculative purchases or sales of stock on occasion, you should be aware of the rules and what can get you into legal trouble. In this piece, we’ll show you how to stay ahead of the curve.
Because of the number of factors involved, even seemingly cut-and-dry instances involving this unlawful conduct can drag on in court for months, if not years. Let’s take a look at what “insider trading” is and how to stay away from it when trading stocks.
You overhear a conversation in public.
A well-dressed couple is talking about retiring to Mallorca while you’re in line at Starbucks. They were among the initial founders of a publicly traded company, but the agreement has not been announced. Before the purchase is made public, you invest all of your money into buying as many of the shares as possible.
Is This Insider Trading?
It would be against the rules for that couple to buy or sell a stock, or for them to call you and give you insider information. To engage in illegal insider trading, however, you must not only take action based on material, non-public information but also be under some duty to keep the information secret. In a similar case from 1981, previous soccer mentor Barry quickly Switzer was found not guilty of insider trading since he had no obligation to disregard an exchange he noticed in an open space.
You learn the rumor on the Dark Web
You’re an IB chatting with colleagues on your preferred Deep Web forum when you hear that an unrelated public company is being eyed for a merger or acquisition. Overhearing something private in public will not get you in trouble for as long as you’re able to ” demonstrate” it.
The SEC’s resources continue to evolve and improve. With their help, the FBI can easily monitor your online activity. This intricate subject warranted its own article, so we wrote one.
You are now employed by a major business. You are tidying up when you accidentally listen in on a meeting of the business’s board of directors. The sale was approved by the board of directors at a substantial premium over the company’s share cost as of the vote in elections. You intend to make a significant investment in stock. Do you have concerns about possible insider trading?
You’re in deep trouble now. We are not in a public place, and “You’ll be in the position to understand that private data is being shared, thereby altering the arithmetic.”
You get a hot tip from a talkative cab driver
As the taxi pulls up, your eyes are drawn to the driver’s Armani, a suit and gold ring. The driver told you that he only agreed to work this shift because he wanted to be nice to his friend. After retiring, the driver of the vehicle is currently living off his savings. In response to your complaint, he says, “Look; I’m going to give you a chance.” Invest heavily in Google stock. You do. Could it be related to insider trading?
Never blindly follow the advice of a complete stranger when it comes to your financial well-being. It’s possible that the cabbie has less information than you do. However, you have probably already heard what he’s telling you. Under those conditions, you did nothing wrong.
You get a hot tip from a talkative cab driver who has a connection
Another piece of investment advice from the taxi driver, this time mentioning his son’s job as a mergers and acquisitions attorney at a major law firm. Dealing amongst the in-crowd?
Insider trading could have occurred. The SEC’s scrutiny will be difficult, but potential consequences could be avoided if handled properly.
Whether or not you have reason to believe you are getting private, immediate data from an individual who is obligated to maintain its secrecy depends on the specifics of the situation. The taxi industry would undoubtedly be outlawed. There is a lot of danger and not many ways to protect yourself.
You realize that corporate insiders are selling, so you sell too
You may have recently read that high-ranking company officials are selling shares. They seem to have inside information, so you make the decision to liquidate your possessions as well. You worry that the authorities will start cracking down soon. I was wondering if you had any background in insider trading.
Nothing to be afraid of, really. However, the fate of the top brass may be at stake.
If a company executive’s decision to sell shares does not depend on information that has not been made public, then the executive is free to do so. The Securities and Exchange Commission of the United States (SEC) filed a lawsuit against former Countrywide CEO Angelo Mozilo and other insiders for allegedly engaging in improper trading following the banks of America acquired Countrywide Financial in 2009.
Mozilo settled the lawsuit for $67.5 million, without admitting wrongdoing, and gave up the roughly 140 million dollars that he would have earned by selling Countrywide stock before its collapse.
Mozilo’s trading activities became public knowledge through news reports and SEC filings. It is not illegal to make financial decisions using publicly available data.
You put two and two together and make a trade
A female member of your group has shared that she wants to leave her job as a doctor because she can’t handle the stress of working with terminally ill patients. You already know that some of the patients at this clinic are taking part in a new drug’s preliminary trials because of our previous discussions. You are familiar with the drug and its manufacturer. By betting that the drug company’s stock price will go down, you sell short the company’s shares. Have you broken any laws regarding insider trading?
The SEC might take notice, but this is probably not illegal insider trading.
Your gambling partner has given you too much general information to determine if the research study will be unsuccessful. As a result, we cannot consider the suggestion to be material. The stock price wouldn’t react significantly to such news. Moreover, no one appears to have a duty of confidentiality since the woman is only disclosing details regarding the status of the office’s patients and not the clinical study (which includes whether or not the sick patients were given the new drug or a placebo).
You trade on the information you have received in the course of your work.
You have been given access to sensitive data after a major data breach at your company. You are attempting to profit from a drop in stock price by purchasing options in the company’s stock prior to the public announcement of a security breach.
Become immersed in the action right now. Don’t forget about the Equifax hack. Bonthu broke the law by using proprietary information to figure out that his business experienced a massive data breach.
Your stock broker advises you to sell based on non-public knowledge.
The CEO of the company, who is also a client of your broker, has decided to sell all of his shares. Dealing amongst the in-crowd?
The SEC will investigate, but it’s possible you won’t face criminal charges.
If the story seems familiar, it’s because it’s based on real events in Martha Stewart’s life. In 2003, the housewife was also sued for the exact same reason by the Securities and Exchange Commission. Stewart was incarcerated, but not for engaging in dishonest business practices. She lied to police and was found guilty of interfering with an SEC investigation.
Stewart paid a fine to the SEC in exchange for an admission of guilt and a promise to comply with securities regulations in the future. The settlement eliminates the need for the court to rule on the question of whether she is “required” to disregard the hint. However, the Stewart’s background as a stockbroker complicated matters. The SEC claimed that, given the stakes, she ought to have known better.
Find out how the SEC uses data analysis to track down suspicious trends, like a string of profitable insider trades, over time.
You pay professionals for research, analysis, and advice
Your broker has a client who is the CEO of the company and who has decided to liquidate all of his shares. Forging alliances with the elite?
The SEC will investigate, and you might get in trouble with the law, but that’s not a given.
Any similarity to actual events can be traced back to the fact that they were based on Martha Stewart’s life. In 2003, the housewife was also sued for the identical reason by the Securities and Exchange Commission. Stewart was incarcerated, but not for any illegal activity. After she lied to investigators, she was determined guilty of obstructing justice.
For the promise of future adherence to securities laws, Stewart paid a fine to the SEC and admitted guilt. Because of the settlement, the court will not decide if she was necessary to disregard the tip. However, Stewart’s background as a stockbroker complicated matters. The SEC argued that, given the stakes, the woman should have known better.
Hedge fund managers typically employ a large team of consultants and analysts to guide their portfolio decisions. You should still do your own investigation into the companies as well as their industries, even if your advisor has access to insider information. Dealing amongst the in-crowd?
This is unlikely to be insider trading, but the SEC may still take note.
important proof in the 2009 prominent the event toward e.g.-Galleon Group CEO Raj Rajaratnam. The outcome of the case would depend on whether or not his legal team could prove that he used multiple data sources (a “mosaic”) to make choices regarding trading, or whether they could demonstrate that he paid “consultants” for access to confidential information. The former is supported by established laws.
Who Can Be Charged With Insider Trading?
Using private data obtained in breach of a fiduciary obligation or another arrangement of trust and confidence is illegal under SEC regulations. The SEC classifies insiders into four categories:
Workers who are physically located within an organization (such as the CEO, CFO, and CIO)
Aliens in charge
personnel with access to confidential information
When an insider violations their duty of loyalty by purchasing or selling securities while in possession of material or nonpublic information, this is known as insider trading. Insiders include any director, officer, or shareholder who owns over ten percent of the company’s stock. Those who serve on a company’s board of directors but do not have a controlling interest in the business are considered “outside” directors. It’s just another big company. Those who serve on a company’s board of directors but do not have a controlling interest in the business are considered “outside” directors.
The officers of a company are its highest-ranking executives, such as the chief executive officer (CEO), president (President), and vice presidents (VPs). An “beside trader” is an employee who purchases or sells shares prior to the general dissemination of important private data.
What Are the Consequences of Insider Trading?
To engage in insider trading is for an insider to trade stock while in possession of important, private data about the company’s operations. Many prominent businesspeople in recent years have been accused of engaging in insider trading, such as entrepreneurs Martha Stewart and Rajat Gupta. The act of conducting business on the basis of confidential information obtained dishonestly goes by various names.
The United States and state securities laws make it illegal to trade on nonpublic information. Legal charges, a fine, or even jail time could result. The penalties for breaking these laws are severe, including lengthy prison terms and heavy fines.
Ex-McKinsey & Co. head Rajat Gupta is a recent example of this trend. After learning inside information about Goldman Sachs from a colleague and Galleon Group founder Rajaratnam, he was found guilty of insider trading in 2012.
What Are the Implications of Insider Trading?
Some would say that those who benefit from insider trading simply have more information than the average investor. Making sure that no staff or buyers within the business have access to non-public information is one way to prevent insider trading. Insider trading is a serious offense with serious consequences.
For instance, you could face criminal and/or civil penalties if you are found guilty of unlawful insider trading based on private data. Some may find this unfair because only the fortunate few can actually benefit from such resources. However, there are those who think that the practice of insider trading is nothing more than an example of an individual with privileged access to information making smarter choices as a result.
Both sides can agree that the issue of insider trading ultimately comes down to a matter of personal ethics and the choice between living one’s life as a cheating or an honest citizen.
What Are the Risks of Insider Trading?
When an investor buys or sells a security while in control of material, nonpublic information, they are engaging in insider trading. Infractions of the law carry severe penalties, so doing so carries a high degree of risk. Consider these potential repercussions of insider trading.
Trading has the potential to yield financial rewards but also legal complications.
If the company fails, you could lose everything.
The significance of insider information is hard to assess, and even if you do, you may end up taking unwarranted risks.
Another excellent method of gaining useful insight into a company is through a careful reading of its financial statements.
Consider the special connections you might have in the business world. These connections may be seen as an argument of interest by the SEC.
Illegally sharing private information. You could face jail time, fines, and legal action if investors lose money after acting on your false stock tips.
How Can Insider Trading Be Prevented?
When insiders leak information to their loved ones, everyone wins. The group can now pool there insider information and make better choices regarding trading in the future as a result. One way to prevent insider trading is to have a policy that prohibits staff members from sharing any private or insider data they discovered while working for their company. Any suspected misuse of confidential knowledge must be reported immediately by employees.
Insider trading occurs when high-ranking company executives use confidential, proprietary information to make financial gains. The management team may then use this knowledge to engage in strategic trades in an effort to boost the firm’s value. One executive could purchase contributes in the business he owns before it becomes public knowledge that a novel item will be distributed the following year, with the goal to profit from the resulting rise in the price of the stock.
How Can You Avoid Being Charged With Insider Trading?
Since you have no information at your disposal that would let you trade based on inside knowledge, you have nothing to worry about insider trading. Insider trading occurs when a person with access to important non-public data makes an economic choice prior to its public release. Do not buy or sell stocks based on any non-public information in order to avoid possible insider trading charges.
If you have material nonpublic information and are an insider, you must wait until it has been made public before you can trade on it. Breaking these laws carries serious repercussions, including possible imprisonment. There is a potential for a fine of up to $5 million per violation, or three times the value of any profits made or losses avoided. Victims of wrongdoing in the financial market may file civil suits against those responsible.
Disclaimer: This article and the information it contains are not intended to be a source of legal advice. We don’t promote any illegal activities such as insider trading or any other crime.