Most people think of wealthy people when they think of insider trading. Insider trading is illegal regardless of wealth or fame. You can be guilty of insider trading if you don’t know you are doing it. The consequences of insider trading can be severe.
You can make sure that your investments are legal if you know what the term means. If you have any questions or concerns about the legality of your investments, you should consult a financial advisor or other qualified professional. That way, you won’t be setting yourself up for a jail stint. Before taking any action, it is best to consult a lawyer or legal professional.
What is Insider Trading?
You might be surprised to hear that the definition of insider trading is fairly simple. Making a profit in the stock market involves using confidential information. The practice of taking information that is not available to the public and using it as the basis for trade decisions is covered. Insider knowledge of a company’s financial situation is illegal in most countries.
Essentially, when you have access to non-publicly available details, you have an unfair advantage from an investing perspective. It was illegal to prevent people from buying or selling investments if they were aware of certain information that was going to be released to the public. Insider trading is a serious offense that can lead to fines and even jail time.
Many investors find it hard to resist the temptation to get information from an inside source. Insider trading is illegal. It is not worth your reputation to engage in insider trading, as breaking the law can have serious consequences. If the evidence suggests that the proper course of action is to investigate and prosecute, the SEC is more than willing to do so. The SEC works hard to make sure that investors have a fair, safe, and transparent market to trade in.
The SEC’s Insider Trading Definition
According to the SEC, insider trading involves the “buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security.” The SEC adds, “Insider trading violations may also include ‘tipping’ such information, securities trading by the person ‘tipped,’ and securities trading by those who misappropriate such information.”
The definition of insider trading can be a bit confusing at first. To ensure compliance with applicable laws and regulations, it is important to understand the different types of insider trading. You can make sure you don’t act outside of the law by understanding the various activities that are illegal.
Types of Insider Trading
There are five main types of insider trading.
1. Organization Members
Members of publicly traded companies, such as employees and people on the board, usually have access to information that isn’t widely available. They must keep this information confidential and not use it to their advantage. Details like an upcoming merger, planned product recall, new product announcement, or anything else that is in development but not official, can be included. This type of information can be very valuable to those in the know, and is often kept confidential until the right time.
Insider trading is when an employee of an organization makes trade decisions based on nonpublic information. Penalties for violating the law can include civil and criminal fines. When workers have access to stock options, those lines are blurry and a securities purchase can fall on either side. If the stock options are part of a larger compensation package, it is important for the employee to understand the terms and conditions of the stock options purchase.
2. Professionals Who Do Business with the Company
Other professionals have access to information. Attorneys and auditors often have access to non-public information. For example, lawyers, bankers, brokers, and a range of consultants may have confidential details in their purview, depending on their function.
Even though they aren’t an employee, using that information to make trade decisions qualifies as insider trading. Insider trading is considered to be a very serious offense.
3. Family, Friends, and Acquaintances
People talk about their work with friends and family. Professionals share details that are not available to the public during a conversation. Those who know what to look for and how to use it can benefit from this information. If the person’s intention is to help those they know get ahead as investors, it is insider trading. Insider trading carries serious consequences for those who engage in it.
If an employee trades through their family, friends, or acquaintances, even if the insider information isn’t directly shared, that qualifies as it is done to avoid the SEC. If an employee is found to have engaged in insider trading, they may face severe penalties including jail time.
4. Government Officials and Employees
During the course of their duties, government officials and employees may learn about a company. The public trust placed in government officials and employees must be upheld by adhering to the highest ethical standards. Insider trading occurs when someone gets access to confidential information and uses it to make trade decisions. Those found guilty of engaging in illegal tradingface severe consequences.
5. Hackers, Spies, and Thieves
There are ways to get inside information. These methods can lead to serious consequences. Hacking into a company’s network or email, using social engineering to gather insight from employees, or similar actions can support insider trading objectives.
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The Investigation and Prosecution of Insider Trading Cases
The SEC gets wind of insider trading through their standard monitoring practices. Whistle blowers and other government agencies are further investigated by the SEC. Unusual patterns that may indicate an issue are the kind of investing behaviors that the systems seek out. Financial organizations can protect against fraud and other potential risks that could have a negative impact on their business. The SEC works to track down those involved when they notice anomalies. The markets are run fairly and efficiently by the SEC. Obtaining warrants for financial records, tapping phones, or anything else that allows them to gather evidence and determine what is happening is included. Interviews with witnesses and collecting physical evidence are some of the tactics law enforcement officers must use. The person or people involved can be arrested if enough information is found to show that insider trading is to blame. If criminal charges are to be brought, the evidence will be presented to the relevant authorities.
It is rare for the SEC to receive a tip about insider trading. The SEC takes these tips and complaints very seriously and will investigate any potential cases of insider trading. Should that happen, they should gather records and look at evidence to see if they need to pursue the matter. Criminal charges may be filed in some cases. They will move forward if they find enough to spot themselves. If they can’t find enough, they can look for other options or use the help of experts to make sure the activity is safe.
The prosecution proceeds as it would for any other kind of criminal case after an arrest. The burden of proof is on the prosecution to prove that the accused is guilty. The person could face up to 20 years in prison and up to $5 million in fines for each act of insider trading. The typical sentence is below the maximums. The maximums are rarely used in practice.
Martha Stewart Insider Trading Case
Considered by many to be one of the most famous recent examples, the Martha Stewart insider trading case involved ImClone’s stock. The FDA let the public know that Erbitux was rejected. ImClone’s stock fell because of this. Many panicked as their investments plummeted in value.
The friends and family of ImClone CEO Samuel Waksal did not experience losses. Many of the people closest to Waksal made a lot of money from his trading. They sold some of their shares before the FDA made its decision. The move was seen as a sign that they had doubts about the FDA’s verdict and caused panic among investors.
Martha Stewart sold 4,000 shares when the stock was still high because she knew what was coming. She used the money to invest in other ventures. She tried to claim that she had a pre-existing sell order as the reason for the sale, but it didn’t work out. She sold her shares at an opportune time, indicating that the sale was more than just a coincidence. She was sentenced to at least five months in prison and was fined $30,000.
Waksal was sentenced to more than seven years in prison and was fined $4.3 million.
Ivan Boesky, Dennis Levine, Michael Milken, and Martin Siegel
Ivan Boesky was an arbitrageur. He was sentenced to three years in prison for his involvement in an insider trading scandal. He was able to make huge profits when the announcement went public because he had a knack for buying stocks before takeover offers were made. He was able to retire at the age of 40 with a lot of wealth.
Merrill Lynch contacted the SEC about someone possibly leaking information about the trades. Dennis Levine and Martin Siegel were sharing information. The stock market was being manipulated by the two.
The SEC was able to find similar activity on the part of Michael Milken after identifying Boesky.
The Curious Case of R. Foster Winans
Possibly one of the most unique insider trading cases. Foster Winans was the first journalist to be sentenced on charges of insider trading, and his case set an important precedent for future cases. Foster Winans was a A columnist for the Wall Street Journal. He gives readers advice on what to buy and sell in the stock market. The price went up when he wrote about Winans.
Winans began sharing information about his columns with brokers before they were printed, allowing them to execute trades ahead of the mass. This caused an uproar on Wall Street and led to an investigation into Winans’ activities.
The case was unique because Winans’ columns were opinion pieces, so they didn’t represent accurate information on the surface. The information contained in Winans’ columns was not unique enough to constitute insider trading according to the US Supreme Court. The Wall Street Journal’s property was deemed to be the property of the SEC, so revealing the details in advance was a crime. The SEC found that the columnist had given his friends an unfair advantage.
How to Avoid Insider Trading
Innocent investors can commit the crime if they accidentally commit the crime. The Securities and Exchange Commission takes insider trading allegations very seriously and those who are found guilty of insider trading may face significant fines and imprisonment. You can take precautions that will help you stay on the right side of the law and not put yourself at risk. It’s important to understand the rules that apply to your investments in order to stay compliant.
1. Ask with Care
Make sure you are careful when asking about a security. Before making any decisions about security investments, be sure to check with a financial professional. You are on thin ice if your inquiry encourages someone to give you confidential information. It is important to be aware of the implications of what you are asking. Execution of a trade is dangerous if you know something that isn’t public knowledge. When conducting any kind of trade, you should always be aware of potential insider trading regulations. It comes with legal ramifications that are similar to participating in insider trading if someone believes you are trying to dig such details out of them. It is importantto be aware of the legal consequences of trying to get information from an individual that may be considered an inside trader.
2. Verify the Information
Before you use a piece of information about a company to make a trade decision, make sure it is public. It is important to remember that not all information you find on the internet is reliable, so be sure to verify it before making an investment. You might want to abandon the trade if you can’t find that information elsewhere. It’s important to remember that insider information can be very valuable and can result in a risky or illegal trade.
3. Report What You Hear
If you receive information that could affect your portfolio and you don’t know if the information is public, contact the proper authorities. It is important to remember that you can make informed decisions about your investments if you verify information with the proper authorities. It helps prove that your intention is not to take advantage of the information. It shows that you are acting in good faith.
4. Consider Confidentiality
Hearing details that are likely to be covered in a confidentiality agreement is always a warning of potential insider information. Changes in behavior, such as an increase in secretive conversations or an employee trying to restrict access to sensitive information, are important to be aware of. If someone is violating a contract when they discuss the topic with you, you should be wary of what you hear, as it could be considered illegal if you execute a trade after the conversation. Before entering into any agreements based on what you have heard, it is best to seek independent advice or contact your legal representative.
5. Hold Your Tongue
Even if you help someone take advantage of a nonpublic piece of information, you can still be guilty of insider trading. Insider trading can have serious legal and financial consequences. If you have access to sensitive information, don’t share it. Don’t share sensitive information without permission and keep it secure. You could be guilty of securities fraud if you give someone else confidential information.
