Insider trading happens when someone purchases or sells stocks while possessing private, material information about that stock.
What Is Insider Trading?
Insider trading is one of the most notorious offenses investors on the stock market can be accused of. For a trade, either a sell or a buy one, to be considered insider trading, the person involved in the trade should be in possession of undisclosed, private information that can influence the future price of said stock.
The Securities and Exchange Commission (SEC) is the main governing body overlooking all trading in the United States. The SEC is also the institution that determines whether insider trading has occurred. According to their official definition of insider trading, this is: “the buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security.”
One of the main arguments against the legality of insider trading is the stance that non-public, material information can serve as an unfair advantage. For example, suppose a trader receives insider information that a company is planning to buy another company. In that case, this can easily be interpreted as a pre-condition for the increase of the first company’s stock value.
There are instances when insider trading might be legal. Examples of legal insider trading might include:
The CEO of a company purchases additional shares in the company, and this trade is reported to the SEC.An employee of a company exercises his stock options and buys stock in the company that he works for.A board member of a company purchases shares in the company and reports it to the SEC.
While these are the extraordinary circumstances when trading on insider information might be permitted, the SEC closely monitors all signals it receives with suspicions of insider trading.
One notable case of insider trading involves The Wall Street Journal columnist R. Foster Winans, who shared information with stockbrokers about an article he was about to publish. Thanks to this insider information, the two stockbrokers pocketed around $690,000, while the journalist’s share of the gains was $31,000. The SEC tried Mr. Winans and the brokers and successfully convicted them of insider trading.
Insider trading can also happen in the world of cryptocurrencies, however, it is not as tightly regulated as with stocks. For example, if a Bitcoin whale shares his plans to sell a big portion of his assets, this can be taken as a sign that the token’s price will fall. However, he will not be convicted of insider trading.