Insider trading is the trading of a public company’s stock or other securities (such as bonds or stock options) based on material, nonpublic information about the company. In various countries, some kinds of trading based on insider information are illegal. This is because it is seen as unfair to other investors who do not have access to the information, as the investor with insider information could potentially make larger profits than a typical investor could make. The rules governing insider trading are complex and vary significantly from country to country. The extent of enforcement also varies from one country to another. The definition of insider in one jurisdiction can be broad, and may cover not only insiders themselves but also any persons related to them, such as brokers, associates, and even family members. A person who becomes aware of non-public information and trades on that basis may be guilty of a crime.
Trading by specific insiders, such as employees, is commonly permitted as long as it does not rely on material information not in the public domain. Many jurisdictions require that such trading be reported so that the transactions can be monitored. In the United States and several other jurisdictions, trading conducted by corporate officers, key employees, directors, or significant shareholders must be reported to the regulator or publicly disclosed, usually within a few business days of the trade. In these cases, insiders in the United States are required to file a Form 4 with the U.S. Securities and Exchange Commission (SEC) when buying or selling shares of their own companies. The authors of one study claim that illegal insider trading raises the cost of capital for securities issuers, thus decreasing overall economic growth. However, some economists, such as Henry Manne, have argued that insider trading should be allowed and could, in fact, benefit markets.
There has long been “considerable academic debate” among business and legal scholars over whether or not insider trading should be illegal. Several arguments against outlawing insider trading have been identified: for example, although insider trading is illegal, most insider trading is never detected by law enforcement, and thus the illegality of insider trading might give the public the potentially misleading impression that “stock market trading is an unrigged game that anyone can play. “Some legal analysis has questioned whether insider trading actually harms anyone in the legal sense, since some have questioned whether insider trading causes anyone to suffer an actual “loss”, and whether anyone who suffers a loss is owed an actual legal duty by the insiders in question.
Liability for inside trading violations generally cannot be avoided by passing on the information in an “I scratch your back; you scratch mine” or quid pro quo arrangement if the person receiving the information knew or should have known that the information was material non-public information. In the United States, at least one court has indicated that the insider who releases the non-public information must have done so for an improper purpose. In the case of a person who receives the insider information (called the “tippee”), the tippee must also have been aware that the insider released the information for an improper purpose.
One commentator has argued that if Company A’s CEO did not trade on undisclosed takeover news, but instead passed the information on to his brother-in-law who traded on it, illegal insider trading would still have occurred (albeit by proxy, by passing it on to a “non-insider” so Company A’s CEO would not get his hands dirty).
A newer view of insider trading, the misappropriation theory, is now accepted in U.S. law. It states that anyone who misappropriates material non-public information and trades on that information in any stock may be guilty of insider trading. This can include elucidating material non-public information from an insider with the intention of trading on it, or passing it on to someone who will.
Proof of responsibility
Proving that someone has been responsible for a trade can be difficult because traders may try to hide behind nominees, offshore companies, and other proxies. The Securities and Exchange Commission (SEC) prosecutes over 50 cases each year, with many being settled administratively out of court. The SEC and several stock exchanges actively monitor trading, looking for suspicious activity. The SEC does not have criminal enforcement authority, but can refer serious matters to the U.S. Attorney’s Office for further investigation and prosecution.
Trading on information in general
In the United States and most non-European jurisdictions not all trading on non-public information is illegal insider trading. For example, a person in a restaurant who hears the CEO of Company A at the next table tell the CFO that the company’s profits will be higher than expected and then buys the stock is not guilty of insider trading unless he or she had some closer connection to the company or company officers. However, even where the tippee is not himself an insider, where the tippee knows that the information is non-public and the information is paid for, or the tipper receives a benefit for giving it, then in the broader-scope jurisdictions the subsequent trading is illegal.
Notwithstanding, information about a tender offer (usually regarding a merger or acquisition) is held to a higher standard. If this type of information is obtained (directly or indirectly) and there is reason to believe it is nonpublic, there is a duty to disclose it or abstain from trading.