What is an 'Insider'

Insider is a term describing a director or senior officer of a company, as well as any person or entity that beneficially owns more than 10% of a company's voting shares. For purposes of insider trading, the definition is expanded to include anyone who trades a company's shares based on material nonpublic knowledge. Insiders have to comply with strict disclosure requirements with regard to the sale or purchase of the shares of their company.

BREAKING DOWN 'Insider'

Securities legislation in most jurisdictions has stringent rules in place to prevent insiders from taking advantage of their privileged position for pecuniary gain through insider trading. Offenses are punishable by disgorgement of profits and fines, as well as incarceration for severe offenses. In the United States, the U.S. Securities and Exchange Commission (SEC) makes rules concerning insider trading. While the term often carries the connotation of illegal activity, corporate insiders can legally buy, sell or trade stock in their company if they notify the SEC.

People the SEC Considers Insiders

Investors gain insider information through their work as corporate directors, officers or employees. If they share the information with a friend, family member or business associate and the person who receives the tip exchanges stock in the company, he is also an insider. Employees of other companies in a position to gain insider information, such as banks, law firms or certain government institutions can also be guilty of illegal insider trading. Insider trading is a violation of the trust investors place in the securities market, and it undermines a sense of fairness in investing.

An Early Example

In one of the first cases of insider trading after the United States formed, William Duer, an assistant to the secretary of the Treasury, used information he gained from his government position to guide his purchases of bonds.

Albert Wiggin and the Stock Market Crash

Wiggin was a respected head of Chase Bank who used insider information and family-owned corporations to bet against his own bank. When the stock market crashed in 1929, Wiggin made $4 million. In the fallout from this incident, the 1933 Securities Act was revised in 1934 with stricter regulations against insider trading.

Martha Stewart

Stewart was convicted of insider trading when she ordered the sale of 4,000 shares of ImClone Systems Inc. at $50 per share just days before the Food and Drug Administration rejected the corporation's new cancer drug. After the announcement, the stock priced dropped to $10 per share. For her role, Stewart was fined $30,000 and spent five months in prison.

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