The Truth About Insider Trading

“Insider trading” is one of the most widely-recognizable terms in the complex financial industry — but it is one that is often misunderstood, as well. Though some insider trading is a form of broker misconduct, it is also frequently committed by firms’ top management. An article published on August 18, 2011, “Insider Trading: CNBC Explains,” spells out the difference between legal and illegal insider trading, as well as cites major insider trading cases.

There are two types of insider trading: legal and illegal. Legal insider trading takes place when employees own stock or stock options in their firm that they are able to trade within a set time frame and at a set price. Because the public may not have access to all the information the employees have, it is considered insider trading but remains legal as long as the employees report their trades to the SEC within a certain time period following the trade and that the trade is made after some sort of press release or announcement makes the information on which the trade was based public. This type of insider trading can also be preformed by individuals who own at least 10 percent of a company’s stock.

Illegal insider trading takes place when any “insider” makes trades based on knowledge that the public doesn’t have. An “insider,” according to the SEC, is anyone who has access to “temporary” or “constructive” material information on a firm and is not restricted to employees of the company.

Penalties for insider trading are serious and can include both financial and criminal repercussions. Individuals who are found guilty could receive up to 20 years in prison for criminal securities fraud; an additional charge of mail and wire fraud usually accompanies those being charged with insider trading. Mail and wire fraud can also earn an individual up to another 20 years in prison. Other charges one might face for insider trading are securities fraud, racketeering, obstruction of justice and/or tax evasion. Financial penalties can include the entirety of their profits, as well as a penalty that can amount to as much as three times the insider’s total profit. In addition, a $5 million fine per “willful” violation of the Sarbanes-Oxley Act of 2002 often is given.