Open vs. Closed Market Transactions

Insiders are often blessed with owning a significant portion of a company's shares. The ownership can be in the form of share purchases or through stock options. Since these insiders own—or have the opportunity to own—a lot of shares, it is in their best interest to buy or sell the shares whenever they feel necessary, like buying when the stock seems like a bargain or selling when it is time to realize a profit.

Although some cases of insider trading are illegal, transactions by corporate insiders are often legal and can take place in two ways: an open-market transaction or a closed-market transaction.

Open-Market Transactions

Insider buying is a stock purchase by a company's officer, director, executive, or employee within the company. It is not the same as insider trading, which is the illegal buying of shares based on private, non-public information.

There are two types of insider buys or transactions: open and closed.

Open-market transactions occur on the open stock market where ordinary investors buy and sell shares. The purchase (or sale) is typically done through a brokerage firm and the shares held in a brokerage account. The only difference between an insider buy and that of a normal investor is that insiders must follow certain rules and regulations that have been set out by the Securities and Exchange Commission (SEC). After filing the appropriate documentation, the order goes through the brokerage firm the same as all other orders.

The purchase or sale made in an open-market transaction is done voluntarily by the insider and, although the transactions must be disclosed, the trading activity is not typically regulated by any company rules.

Since open-market transactions are made at the insider's discretion, they sometimes identify his or her sentiment about the stock. If, for instance, the company is reporting a sharp increase in new orders—and this information is available to the public—the insider might buy shares on the view that the company's business activity is improving. That is why some investors watch and track insider buying on an ongoing basis.

Closed-Market Transactions

A closed-market transaction is the opposite of an open-market transaction. Any trading that is done in a closed-market transaction is between the insider and the company; no other parties are involved. However, as with an insider's open-market transaction, the appropriate documents must be filed with the SEC to show investors that the transactions took place.

Most often, closed-market transactions occur when the insider is receiving shares as part of a compensation package or through stock options. As a result, they do not necessarily reflect the insider's sentiment toward the stock. Large purchases are typically part of an overall compensation package and large insider sales can be for a variety of reasons including an opportunity to realize profits, a departure from the company, or a large stock sale ahead of retirement.