Insider Trading

Insider Trading Meaning

Insider trading is defined as making key business decisions about a company’s listed shares using critical non-public information. It also shakes their confidence in the stock market.

How does insider trading work?

Insider trading is an illegal activity in the stock market. Company insiders have access to confidential company information, such as consequential losses that could tip its stock price. While
large-scale shareholders remain in the dark about this information until the public announcement, and violators of illegal insider trading will take action on it.

The offender will make critical business decisions about the company’s stock for undue personal advantage at the expense of unsuspecting shareholders. In 1942, lawmakers passed Rule 10b5 of the Securities Exchange Act 1934 to allow prosecution of this offence. In 2021, US lawyers also passed the Insider Trading Prohibition Act to have a law explicitly prohibiting it.

The law describes an “insider” as a company director, employee, outside officer, family member, etc., who may obtain “material non-public information” about the company by their position. position. “Material non-public information” can be of interest to large shareholders’ investment in the company, so they should be aware of it.

Any business decision without the knowledge of shareholders will be unfair and could result in their losses. Therefore, it is illegal to disseminate and act upon material non-public information acquired during employment or from a third-party source. Insiders should disclose it to everyone or refrain from disclosing it until it is made public

Insider negotiating punishments with an example

In the United States, the SEC has imposed strict restrictions on trade in illegal insiders to protect the interests of investors. He learned that corrupt Zinc officials were involved in a multi-million dollar scam. Zinc was now on the verge of bankruptcy. The board drew up a crisis management plan because they knew the company’s stock price would collapse when the news came out.

The board of directors has decided to inform the shareholders of Zinc in a press release. George owned many shares of Zinc. Before the news went public, he secretly sold them at the current price to avoid incurring losses after the press release. During the investigation, authorities also uncovered his crime. George was banned from trading in shares as a penalty and was fined heavily.

Actual cases of insider trading

One of the earliest cases of insider trading was that of the Texas Gulf Sulfur Company, in which some officials traded its shares ahead of a major public announcement. The landmark ruling suggested refraining from disclosing such things before the public announcement or disclosing them to all interested parties during the broadcast.

Another notorious historical case is that of Wall Street Journal columnist R. Foster Winans. He was accused of disclosing confidential information about the company’s shares to two stock brokers. As a result, he was paid $ 31,000 out of the income of approximately $ 690,000 from illegal disclosures. Winans was convicted and jailed for 18 months.

Indeed, financial history is colourful with many notorious cases of insider trading and examples that have threatened the sanctity of the stock markets. Arbitrator Ivan Boesky, Martha Stewart, and former Enron chairman Jeffrey Skilling are among these notorious offenders.

Legal and illegal insider trading

Numerous studies suggest that these two cases are common before a public announcement that could affect the stock price.

In an illegal form, non-public company information is used to trade securities against the law. As a result, this results in material losses for stakeholders and erodes their confidence in the system. Regulators sanction violators to deter such violations. Consequently, corporate officers must ensure that inside information is not disclosed.

Conversely, it is considered legal insider trading when insiders of a company agree to buy or sell shares in their company but regularly report it to the SEC. In addition, in doing so, the information of the organization is made public. An example of a legal nature is employee stock options, which many insiders here regularly.

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