Cheaters are everywhere. No matter the game, there is always someone who wants to try and get ahead of everyone else. This translates in the stock market as “insider trading” where there is a big gain to be made off of an unfair advantage. So what is it?
Insider trading refers to the practice of buying and selling stock, bonds, or other securities based on information that the general public doesn’t have access to, including having access to confidential information about a company and trading its securities. This is an illegal practice that violates the trust and fiduciary duty of trading on the stock market. Traders need to feel that they can trust the prices of the securities and the market in general. If there is no trust, then people would be less willing to participate in trading, leading to serious financial complications for public companies that rely on the market as a main source of capital.
Who Counts as an “Insider”
The SEC defines an “insider” as someone who is an officer, director, or 10% shareholder of a company that has inside information about the company because of their relationship to the company or with an officer, director, or principal shareholder of the company.
Insider information refers to the non-public knowledge about a company and its assets. Having this information is not illegal, it only becomes illegal when it is used to trade a security. This is unfair access to information and the bearer of this information shouldn’t be allowed to trade freely without first disclosing the information or waiting until the information is available to the public.
Here is an example to better paint the picture. Let’s say a family doctor sees a patient for a routine physical exam. The doctor’s patient happens to be the director of finance for XYZ Company. During the exam, the director expresses that he is under a lot of pressure at work because XYZ Company is about to report a significant loss in revenue due to their underperforming product on their next earning call. The doctor holds a significant amount of shares in XYZ Company and after hearing the news, decides to sell all his shares days before the earnings call. As a result, the doctor avoided a $50,000 loss before the bad news finally reached the public. In this scenario, the doctor had an unfair advantage of insider information that quickly turned into illegal insider trading to avoid a loss.
If you are convicted of insider trading as an individual, you can face a fine of up to $5,000,000 and a maximum time of 20 years in prison. Business entities can face up to $25,000,000 in fines and any participants in the scheme can face a maximum 20-year prison sentence.
These fines are so hefty for a reason. Trust in the market is the SEC’s number one priority and the risk to reward is simply not worth it.
Those who face insider trading penalties can be pursued differently depending on the case. A private lawsuit may be brought against the insider by a stockholder of the company or a civil enforcement action could be brought against the insider by the SEC with different orders. The securities and investment litigation lawyers at Weiss Brown note that those without a solid defense against securities and investment claims could find themselves paying out massive damages. That is why seeking legal help from experienced lawyers is so important to protect the rights and interests of the individual or entity.