By Areena FxInsider Trading: Definition and When It’s Legal
Definition:
Insider trading refers to the buying or selling of a publicly traded company’s stock or other securities by someone who has material, nonpublic information about the company.
This type of information might include:
- Upcoming earnings results
- Mergers or acquisitions
- Regulatory approvals or investigations
- Major changes in leadership
Insider trading can be legal or illegal depending on how the information is obtained and used.
When Insider Trading Is Illegal:
It becomes illegal when:
- A person trades based on material, nonpublic information that was obtained in breach of a fiduciary duty or through misappropriation.
- The person knows (or should know) that the information was confidential and trades anyway.
Examples of illegal insider trading:
- A company executive sells shares before bad earnings are announced.
- A lawyer working on a merger leaks info to a friend who trades on it.
- A hacker steals confidential data and uses it for trading.
This type of activity is prohibited by the U.S. Securities and Exchange Commission (SEC) and other regulators, and can result in fines, disgorgement of profits, and jail time.
When Insider Trading Is Legal:
Insider trading is legal when corporate insiders (e.g., executives, directors, or employees) trade shares of their own company but follow regulatory rules:
Requirements:
- Trade must be reported to the SEC (e.g., via Form 4).
- No material nonpublic information can be used.
- Proper disclosures and trading windows must be followed.
One common legal method is through 10b5-1 plans, which allow insiders to set up pre-arranged trading schedules to sell or buy stock at a future date, reducing suspicion of manipulation.
Example of Legal Insider Trading:
- A CFO sells shares during an open trading window, after disclosing the sale in advance and without possessing any undisclosed material information.
Key Takeaway:
- Legal insider trading is transparent and compliant with SEC rules.
- Illegal insider trading involves unfair use of confidential information and violates securities laws.