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What is insider trading?

Insider trading is the trading of shares of stock or other securities on the basis of material information about the security or the company that is not known by the public. Under federal regulations issued by the Securities and Exchange Commission, the term “on the basis of” means that the person making the trade was aware of the non-public information when the purchase or sale was made. In other words, a plaintiff or prosecutor need not show that the person used the information; possession of the information is sufficient.

“Insiders” are usually corporate executives, officers, directors, or major shareholders, though they may also include employees with access to non-public information. Trades by these individuals in their company’s own securities, based on information not known to the general public, are considered fraudulent. This is because corporate officers, directors, and employees owe fiduciary duties to shareholders to put the shareholders’ interests first. By trading on information not generally known to the public at large – including shareholders – the “insider” has put his or her own interests first.

One should note that “insider trading” also includes trades made on advice received from a corporate insider. Thus, if a corporate executive tells a neighbor that his company is about to merge with another corporation, if the neighbor then buys or sells shares in the company on the basis of the information, the neighbor may also be liable for insider trading.

A famous example of an insider trading prosecution was the case involving Martha Stewart’s sale of ImClone Systems stock. Stewart sold her stock on December 27, 2001, after her broker gave her non-public information that the price of the stock was about to fall. The next day, the FDA released information that it was not approving a drug ImClone sought to market, causing the value of its shares to drop. Stewart saved roughly $45,000 by selling her stock one day earlier, on the basis of the “insider” information. Though indicted for securities fraud, that charge was dismissed at trial for lack of evidence.

Trades by insiders are not always illegal. For instance, an employee of a corporation with a stock option plan may trade in the company stock, so long as the trades follow company policy and SEC regulations.

Please Note: Rabin Kammerer Johnson provides these FAQ’s for informational purposes only, and you should not interpret this information as legal advice. If you want advice as to how the law might apply to the specific facts and circumstances of your case, please contact one of our attorneys.

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