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. How do regulators ensure that markets are conducted at arm's length?

    Learn about arm's length transactions and how the Investment Advisers Act allows stockbrokers to sell securities based on ...
  2. What is the difference between EBIT and operating income?

    Read about some of the subtle differences identified by the SEC between earnings before interest and taxes, or EBIT, and ...
  3. What kind of financial reporting requirements does GAAP set out?

    Look at some of the major financial reporting requirements set forth by the generally accepted accounting principles and ...
  4. What is the difference between a company's outstanding shares and its float?

    Understanding share counts, including outstanding shares relative to float, is an integral part of determining whether or ...
RELATED TERMS
  1. Lilly Ledbetter Fair Pay Act

    A federal law designed to ensure equal pay for all workers, regardless ...
  2. Age Discrimination In Employment Act Of 1967

    A federal statute protecting "certain applicants and employees" ...
  3. Civil Rights Act of 1964

    Landmark federal legislation that prohibits discrimination on ...
  4. Occupational Safety And Health Act

    Law passed in 1970 to encourage safer workplace conditions in ...
  5. Administrative Order On Consent (AOC)

    An agreement between an individual or business and a regulatory ...
  6. Licensed For Reinsurance Only

    A license that allows a company to engage in services related ...

You May Also Like

Related Articles
  1. Economics

    America's Most Notorious Corporate Criminals

  2. Economics

    The Economic Impact of Better US-Cuba ...

  3. Stock Analysis

    How AT&T Will Rise As America Movil ...

  4. Forex

    Bitcoin's Main Stumbling Block: Navigating ...

  5. Credit & Loans

    5 Things Debt Collectors Can't Do To ...

Trading Center