Is Insider Trading Illegal?

Broad Definition

The broadest definition of insider trading is any stock transaction that is related to someone who works for or has special knowledge of a company's inside operations. For example, when an employee decides to sell shares associated with a stock option or bonus payment, it's a case of insider trading. The same is true when an executive decides to invest personal funds in stock of the company she works for. Lawyers, consultants and employees who buy or sell shares in a company they work for are all engaging in insider trading.

Insider trading becomes illegal when the person making the inside transaction has special knowledge that isn't publicly available. This means that anyone who comes into contact with the inner workings of a business is a possible candidate for illegal insider trading. Knowledge of upcoming products, changes in dividends and corporate restructuring are all among the information that a business would keep secret but would affect share prices once it gets out. Buying or selling shares prior to such an announcement gives the insider an unfair advantage and constitutes illegal activity.

The U.S. Securities and Exchange Commission is responsible for overseeing insider trading regulations and checking individual transactions to ensure that they comply with federal laws. Anyone who engages in insider trading must report the transaction to the Securities and Exchange Commission. The SEC can then investigate the matter by checking for large rises or drops in a stock's value just after the transaction, which might indicate insider knowledge that makes the transaction illegal. Failure to report an insider transaction or engaging in insider trading with or without reporting can result in a fine and possible jail time.

Insider trading is an important issue because it threatens the basic premise of the open market for buying and selling stock. Investors are less likely to buy and sell shares if they suspect that others have proprietary knowledge and can make better decisions. Likewise, business leaders who engage in insider trading can make business decisions for no reason other than to change the value of their own stock, thereby putting personal profit above the well-being of the company.