What is Insider Information?
Insider information, also called inside information, refers to non-public fact regarding a publicly traded company that can help and provide a financial advantage in the markets. In other words, insider information is knowledge and information on the operations, products/services pipeline, affairs, financial position, etc., of a company that is not accessible to the public.
Attempting to benefit from insider information is a criminal offense. In the United States, the Securities and Exchange Commission (SEC) is in charge of prosecuting individuals who use insider information to execute illegal trades.
Understanding Insider Information
Insider information is regarded as material non-public information. Trading based on insider information, called insider trading, without filing the appropriate forms with the SEC is illegal. It is important to note that a person who possesses insider information may not necessarily need to be a person who works for the company. The information can be passed from a person working within the company to outside individuals who trade based on that inside information.
Insider Trading with Insider Information
Insider trading goes hand-in-hand with insider information and is the practice of using non-public information to execute trades.
- The chair of the board knows that a merger is about to announced shortly and that it would substantially increase the share price of the company. He purchases 500 shares of the company under his dad’s name so he can generate a profit using insider information without reporting the trade to the SEC.
- An employee overhears that the CFO is going to report dismal results in the upcoming earnings call. The employee notifies his friend, who owns shares in the company, to sell all of his shares before the earnings call.
- A Member of Parliament realizes that a new regulation will be passed soon, which would significantly benefit a specific company. He decides to secretly purchase shares of the company and push for the regulation to pass as soon as possible.
The SEC’s Role in Preventing Insider Trading
The SEC oversees instances of insider trading, cracking down on hundreds of insider trading cases over the years. However, prosecuting those who are involved in insider trading is very difficult – direct evidence of insider trading is rare. The SEC can track insider trading through various methods such as:
- Market surveillance activities: Using sophisticated tools and big data
- Tips and complaints: Receiving complaints from investors and/or traders on the losing side of a trade (this typically involves option traders)
Example of Insider Information and Trading
A classic case of using insider information to execute illegal trades is the case involving American businesswoman and media personality Martha Stewart. Ms. Stewart sold 4,000 shares in ImClone Systems one day before the U.S. Food and Drug Administration (FDA) refused to review the company’s cancer drug Erbitux. The share price of ImClone tumbled following the FDA’s announcement.
Investigations into the matter revealed that Sam Waksal, the CEO of ImClone and a close friend of Stewart, told his broker to transfer $4.9 million in stock to the account of his daughter. Waksal’s daughter then requested that the broker sell $2.5 million of her ImClone stock. The broker gave the information to Stewart, who sold her shares in the company 10 minutes after the trade was executed for Waksal’s daughter.
When questioned about the sale, Martha Stewart made false statements. As a result, she was sentenced to five months in prison, five months of home confinement, and two years of probation.
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