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What is 'Insider Trading'

Insider trading is the buying or selling of a security by someone who has access to material nonpublic information about the security. Insider trading can be illegal or legal depending on when the insider makes the trade. It is illegal when the material information is still nonpublic.

BREAKING DOWN 'Insider Trading'

Illegal insider trading includes tipping others when you have any sort of nonpublic information. Legal insider trading happens when directors of the company purchase or sell shares, but they disclose their transactions legally. The Securities and Exchange Commission has rules to protect investments from the effects of insider trading.

Martha Stewart and Insider Trading

Directors of companies are not the only people who have the potential to be convicted of insider trading. In 2003, Martha Stewart was charged by the SEC with obstruction of justice and securities fraud – including insider trading – for her part in the 2001 ImClone case.

Stewart sold close to 4000 shares of biopharmaceutical company ImClone Systems based on information received from Peter Bacanovic, a broker at Merrill Lynch. Bacanovic's tip came after ImClone Systems' chief executive officer (CEO), Samuel Waksal, sold all his shares of the company. This came around the time ImClone was waiting on the Food and Drug Administration (FDA) for a decision on its cancer treatment, Erbitux.

Shortly after these sales, the FDA rejected ImClone's drug, causing shares to fall 16% in one day. The early sale by Stewart saved her a loss of $45,673. However, the sale was made based on a tip she received about Waksal selling his shares, which was not public information.

After a 2004 case, Stewart was charged with lesser crimes of obstruction of a proceeding, conspiracy, and making false statements to federal investigators. Stewart served five months in a federal corrections facility.

Amazon Insider Trading Case

In September 2017, former Amazon.com Inc. (AMZN) financial analyst Brett Kennedy was charged with insider trading. Authorities said Kennedy gave fellow University of Washington alumni Maziar Rezakhani information on Amazon's 2015 first quarter earnings before the release. Rezakhani paid Kennedy $10,000 for the information.

In a related case, the SEC said Rezakhani made $115,997 trading Amazon shares based on the tip from Kennedy.

Legal Insider Trading

The term "insider trading" is generally negative. Legal insider trading happens in the stock market on a weekly basis. The SEC requires transactions to be submitted electronically in a timely manner. Transactions are submitted electronically to the SEC and also must be disclosed on the company’s website.

The Securities Exchange Act of 1934 was the first step to the legal disclosure of transactions of company stock. Directors and major owners of stock must disclose their stakes, transactions and change of ownership. Form 3 is used as an initial filing to show a stake in the company. Form 4 is used to disclose a transaction of company stock within two days of the purchase or sale. Form 5 is used to declare earlier transactions or those that have been deferred.

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