What exactly is insider trading?

By Investopedia Staff AAA
A:

An "insider" is any person who possesses at least one of the following:

1) access to valuable non-public information about a corporation (this makes a company's directors and high-level executives insiders)

2) ownership of stock that equals more than 10% of a firm's equity

A common misconception is that all insider trading is illegal, but there are actually two methods by which insider trading can occur. One is legal, and the other is not.

An insider is legally permitted to buy and sell shares of the firm - and any subsidiaries - that employs him or her. However, these transactions must be properly registered with the Securities and Exchange Commission (SEC) and are done with advance filings. You can find details of this type of insider trading on the SEC's EDGAR database.

The more infamous form of insider trading is the illegal use of undisclosed material information for profit. It's important to remember that this can be done by anyone, including company executives, their friends and relatives, or just a regular person on the street, as long as the information is not publicly known. For example, suppose the CEO of a publicly-traded firm inadvertently discloses his/her company's quarterly earnings while getting a haircut. If the hairdresser takes this information and trades on it, that is considered illegal insider trading, and the SEC may take action.

The SEC is able to monitor illegal insider trading by looking at the trading volumes of any particular stock. Volumes commonly increase after material news is issued to the public, but when no such information is provided and volumes rise dramatically, this can act as a warning flag. The SEC then investigates to determine precisely who is responsible for the unusual trading and whether or not it was illegal.

To learn more about insider trading, check out the articles Uncovering Insider Trading, Delving Into Insider Investments and When Insiders Buy Should You Join Them?

RELATED FAQS

  1. What was the Mahonia company and why did it become the subject of a lawsuit?

    In 1992, J.P.Morgan went into the energy trading business by creating a venture company called Mahonia Limited. At least, ...
  2. What are unregistered securities or stocks?

    Before securities, like stocks, bonds and notes, can be offered for sale to the public, they first must be registered with ...
  3. How does FINRA differ from the SEC?

    With all the financial organizations out there, knowing what they all do can be as complicated as knowing where to invest. ...
  4. What are the dangers of using the Electronic Federal Tax Payment System (EFTPS)?

    The Electronic Federal Tax Payment System (EFTPS) is a convenient way to file your taxes, but you need to be aware of some ...
RELATED TERMS
  1. patent attorney

    A lawyer with expertise in intellectual property law as it pertains ...
  2. Patent Pending

    Wording inventors use to let the public know they've filed a ...
  3. Provisional Patent Application

    A short-term means of protecting an invention that requires less ...
  4. Utility Patent

    A patent that covers the creation of a new or improved – and ...
  5. Design Patent

    A patent protecting the unique visual qualities of a manufactured ...
  6. Banker Trojan

    A malicious computer program designed to gain access to confidential ...
comments powered by Disqus
Related Articles
  1. How The Patriot Act Works & Why Is It ...
    Investing News

    How The Patriot Act Works & Why Is It ...

  2. Material Adverse Effect A Warning Sign ...
    Markets

    Material Adverse Effect A Warning Sign ...

  3. Changes In Tax Legislation And Regulation
    Taxes

    Changes In Tax Legislation And Regulation

  4. SEC Filings: Forms You Need To Know
    Investing Basics

    SEC Filings: Forms You Need To Know

  5. Footnotes: Early Warning Signs For Investors
    Retirement

    Footnotes: Early Warning Signs For Investors

Trading Center