What Makes Insider Trading Illegal?
“Insider trading” is one those terms most have heard but don’t necessarily fully understand. Insider trading wasn’t always considered as illegal and punishable as it is today, and it causes many to still ask “why is insider trading illegal?”
An exploration into the meaning of the term and its repercussions can help foster a clearer understanding of what constitutes illegal insider trading.
Insider Trading Defined
Insider trading occurs when an investor or individual has access to nonpublic information about a public company’s stocks and bonds. When that individual trades that public company’s securities via information unavailable to the public, making a profit not available to outside investors, insider trading has occurred.
In addition to making a profit, insider trading and information can also be used to avoid monetary losses. This is illegal because the playing field is not level. Investors need to be operating under the same availability of information; otherwise, large profits and the avoidance of substantial losses are only available to some while not to others.
Insider trading does not always involve fiduciary duty (when one person owes a standard of care to another), but it can also occur when a different crime is committed: Corporate espionage is a good example of this and has been found to occur in organized crime rings.
This involves the actions of a crime ring in gaining inside access to legal or financial institutions with the goal of gaining non-public information for the means of exploitation. This insider information can be obtained via hacking into computer systems or through the use of illegally-planted sound or video recording devices, or even by an individual infiltrating the company as an employee and obtaining information to pass along to the outsiders wishing to exploit the information.
A lawyer who handles SEC whistleblower cases can help expose these types of illegal insider trading.
Insider Trading Becomes Illegal
As recent as the beginning of the 20th century, insider trading was not considered an illegal practice. In fact, a ruling made by the Supreme Court once referred to it as a valid “perk” of the executive career.
It is a controversial issue with many arguing against the illegality of it and going so far as to suggest that it can benefit certain markets. The term “insider trading” varies greatly from country to country, as does its penalties.
Generally speaking, a person who gains access to non-public information, trades it, and gains profits or avoids a loss based upon it, is guilty of a crime. Under this umbrella, insider trading isn’t necessarily only the venue of high-powered executives and investors, but it can also be extended to people connected to them, such as brokers, associates, or even friends and family members.
After insider trading became illegal in the United States in 1934, due in part to the financial excesses of the 1920s and the resultant shift in public perception, the Securities and Exchange Commission (SEC) was formed.
This United States government agency is in charge of overseeing the actions, transactions, and activities of financial institutions, individuals, and mutual fund trades. Made up of five commissioners, these watchdogs have the daunting task of preventing fraudulent acts and intentional duplicity within the financial markets.
While many still struggle to understand the term “insider trading,” high-profile individuals like Martha Stewart and her broker Peter Baconovic pushed the matter into the public spotlight. As more public cases emerge, questions into the nature of insider trading prompt more of an inquiry into what constitutes some trades as legal while proclaiming others illegal.
A crucial factor regarding illegal trading is when the trade occurs, who has access to what information, and how it is used. The dichotomy of public and non-public information is also of pivotal importance when determining whether a case of insider trading is legal or illegal. The creation of agencies such as the Securities and Exchange Commission are instrumental in combating insider trading.