- Insider trading is an illegal practice that helps traders minimize losses or increase profits.
- SEC made some strict laws and regulations to control unfair practices.
Let’s understand insider trading using an example!
Example Of Insider Trading
In 2003, Stewart Martha, founder of Martha Stewart Living Omnimedia and host of Emmy Award-winning television, was accused of insider trading. She lost her billion-dollar empire because of the SEC’s conviction for involvement in insider trading.
According to new reports, Stewart sold 4,000 shares of ImClone (a biopharmaceutical company) based on the information Merill Lynch provided. She sold shares just before ImClon’s share went down by 16%. As a result, she saved $45,673.
In the above scenario, what is the problem? What made the SEC suspicious in the above scenario?
The tip provided by Merill Lynch (broker) is a piece of insider information only available to insiders or top executives. The early information available to only a few people is unfair to other investors who do not have the information. Anyone with such exclusive information can make huge profits compared to other investors.
At large companies and MNCs, such pieces of information can result in market movements. This is considered an illegal and unfair practice by others. Let’s understand insider trading in detail!
What Is Insider Trading?
As the name suggests, insider trading involves an ‘insider’ who has access to exclusive information about corporations or organizations. The information helps traders and investors make profits or minimize losses. In most cases, ‘insiders’ are top executives, CEOs, and government officers. This can be family, friends, or relatives as well.
In simple terms, insider trading is when unauthorized information sources are used to drive profits or minimize losses.
What Makes Insider Trading Illegal?
Insider trading is termed ‘illegal’ only when information is not public. If its insider’s information is available publicly, then trading is not considered illegal. So, in this scenario, there are only two possible situations:
- If information is available in the public domain, then it is legal.
- If early access to or use of information that isn’t public is used, then it is termed illegal.
When traders have early access to information, they save themselves from severe losses. While for other traders, it is unfair and unethical.
To control unethical activities, the Securities and Exchange Commission (SEC) made rules and regulations. They specifically defined who is considered an insider and what action would be taken when someone is found guilty.
First and foremost, the SEC defines ‘insider’ as anyone who owns more than 10% of any company. According to the rules, insiders have to file SEC Form 3, an initial statement of beneficial ownership of securities, within 10 days of assuming an insider role. Further, insiders have to follow all the rules and regulations.
Even after all these rules and regulations, insider trading still has various aspects that go unnoticed.
Conclusion
Insider trading is an unethical practice in which early access to an organization’s insider information helps traders earn profit or minimize loss. This is considered unfair to traders who do not have access to the exclusive information. To control such activities, the SEC issued some strict rules and regulations.
