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Insider Trading

Updated: Apr 16


Publication date: 14.03.2024


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Anyone who grew up in the times when cooking and home shows were all over the TV is probably all familiar with the marvellous Martha Stewart. An excellent chef turned criminal. In the early 2000s, she was arrested and then served time for insider trading. Insider trading is classed as a white-collar crime due to its non-violent nature, but what exactly is it and why is it  illegal? Well, we’re going to take a look at this popular yet not-so-popular financial crime.



What is Insider Trading?


Insider trading as already mentioned is a white-collar crime in which individuals use information that’s not available in the public domain to make stock trades and thus financially benefit themselves. The definition is very vague and ambiguous as the term “insider” isn’t just limited to CEOs, stockholders and company directors. Family members of the aforementioned three groups could also be considered insiders due to their proximity to these groups. The SEC(Securities and Exchange Commission) does narrow insiders down to four types but there’s still some overlap that may exist among them. The four groups consist of:


●      Officers: Typically higher-up individuals like the CEO, CFO, COO, and CIO.

●      Directors: All company directors.

●      10% owners: Individuals and/or institutions that own at least 10% of the firm.

●      Other: Other types of insiders like family or friends.


Why is Insider Trading Illegal?


Insider trading has many legal and ethical implications in the financial markets and for those involved in buying and selling stocks. It’s illegal because firstly those with unpublished information have an unfair advantage over those who don’t, especially in cases where they know of stocks that are not doing well on the market. This creates an “information symmetry” (Cariaga, 2023) that can weaken the confidence of investors and also cause more people to not participate in the stock market. Financial institutions also have their credibility questioned and destroyed due to their participation in unfair and unethical activities.


Consequences


The United States has strict laws to deter insider trading. The SEC is the primary regulator regarding securities and also in enforcing federal security laws. There are three main acts in the US that supplement the SEC framework. They consist of:


  • Section 10(b) and Rule 10b-5: This provision prohibits any omission that could be fraudulent and deceitful when buying or selling securities.

  • Section 14(e) and Rule 14e-5: This provision targets fraudulent activities regarding corporate takeovers.

  • Section 16: Establishes reporting requirements on insiders and liability for short-swing profits.


Violating these laws can result in perpetrators paying hefty fines and also potentially being imprisoned for a maximum of 20 years. Other penalties also include court injunctions and profit disgorgements wherein offenders have to repay the money they’ve accumulated from illegal trades with interest. Insider trading, as with many  white collar crimes, is still very difficult to prove and it may take a long time before perpetrators are proven guilty and dealt with in the legal system.


Conclusion


To conclude, insider trading is a criminal offence with severe penalties. It’s an unfair business practice that affects individuals and firms alike. Insider trading in the US subjects perpetrators to severe penalties such as fines and imprisonment for up to 20 years. While perpetrators are subject to heavy penalties, the crime is still difficult to prove and the legal procedures could take a long time. Insider trading is illegal because those with unpublished knowledge have an advantage over those who don’t which can contribute to less stock market participants.


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