How to Get Away with Insider Trading, Legally
Dear Penny Stock Millionaire,
The words “insider trading” might make you think of Martha Stewart behind bars… but there’s a whole lot more to the story than that.
For instance, did you know that not all insider trading is illegal? It depends on who’s buying, when they buy, and how they got the information.
And actually, there’s a lot to be learned from the different types of insider trading… both the legal and illegal types
Over the next two days, I’ll break it all down for you: What is insider trading? Why is it sometimes illegal? And (most fun of all) I’ll share some of the most compelling stories of illegal insider trading.
What Is Insider Trading?
Insider trading is pretty much what it sounds like: making trades with the benefit of insider information.
Typically, insider trading refers to an individual or entity trading a company stock or other security based on information that isn’t readily available to the public.
Types of Insider Trading
Did you know that there’s more than one type of insider trading?
In spite of the negative connotation of the phrase, insider trading isn’t always illegal. It depends on who’s doing the trading, how they got their information, and when they buy or sell.
Let’s talk a little more about both: illegal insider trading and legal insider trading.
Illegal Insider Trading
Per the U.S. Securities and Exchange Commission (aka the SEC), illegal insider trading refers to “buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate such information.”
Put simply, this means that if someone somehow obtains information about a company or its stock that isn’t available to the public and uses that information to give themselves an edge in trading, it’s considered an unfair advantage, and one deemed punishable by law.
Why Is Insider Trading Illegal?
As you know, I’m a big proponent of doing your own research. Doing your own research isn’t always fun, and it requires a ton of effort … but it can potentially pay off.
But say that you’ve done all of the necessary research on a stock before making a trade, created a solid trading plan and made $1,000.
… and then someone else who gets an insider tip that you don’t have access to doesn’t have to do any research, executes a trade, and earns $100K more than you.
You’d be pretty annoyed, right? You’d think it was unfair, right?
Well, the SEC agrees. It’s not fair, and they like to try to maintain a level playing field.
Insider trading is illegal because it gives certain individuals or entities an advantage that others don’t have due to a lack of access to information.
United States Law
Insider trading has been a problem in the market for over a century.
There have been incidents of insider trading since as early as 1914, when Goodrich Rubber failed to disclose some dividend information. This prompted the NYSE to begin requiring companies to issue reports relating to interest and dividends.
Then, in the 1930s, the Securities Exchange Act of 1934 was established. This put stricter rules around disclosures about company stock transactions and conflicts of interest.
It made it necessary for major stock owners to disclose their stake in the company, as well as their personal transactions and any ownership shifts.
But it wasn’t until much later that the Insider Trading and Securities Fraud Enforcement Act of 1988 (usually just referred to as the Insider Trading Act) was actually put into effect.
With it, bigger penalties and punishments for insider trading were put into effect. This followed an uptick in cases involving insider trading and an escalation in the amounts being traded.
How to Avoid It
The easiest way to avoid insider trading penalties? Avoid trading stocks based on nonpublic information.
But wait … what exactly classifies as nonpublic information?
According to the SEC, this is all company information that hasn’t been disseminated to the public with ample time to react.
Or as they put it, “Generally, information which has not been available to the investing public for at least two (2) full business days is considered to be nonpublic. Recognized channels of distribution include annual reports, prospectuses, press releases, marketing materials, and publication of information in prominent financial publications, such as The Wall Street Journal.”
If the information could affect the market value or influence decisions to buy, sell, or hold, it could be considered insider information.
As for where to draw the line? Better safe than sorry. As the same document advises, “If a person feels the information is material, it probably is.”
Legal Insider Trading
While “insider trading” might instantly bring up red flags and visions of execs being carted off in handcuffs, it’s not always illegal. Legal insider trading happens all the time in the stock market… no arrest montage included.
First, let’s talk about what “insider” actually means. An insider is considered a senior staff member of a company or someone who owns a significant amount of voting shares with the company.
Insiders are in fact allowed to trade shares of the stock. However, they have to adhere to pretty strict policies about how they buy and sell the shares and there are disclosure requirements in place.
The SEC requires that insiders submit their transactions and that they disclose them on the company website.
If the company insider buys or sells shares but sticks with the stipulations put forth by the SEC and fills out the required forms, it’s not illegal.
In fact, sometimes I even look for insider trading information to help choose trades… for example, if I see that a CEO has just loaded up on shares, I could look to that as a positive sign that the company is going places.
Arguments for Legalizing Insider Trading
You know what? Not everyone thinks that insider trading should be illegal. Why? Here are a few of the common reasons…
For one, what can be considered insider trading often exists in a grey area. How does one define the difference between proprietary information and insider information?
How does it differ from simply being the early bird and being on the receiving end of inside intel? Well, the answer is that there’s not always an easy answer to that. This can make it tough to determine when there’s wrongdoing at hand.
For another, in spite of what movies and TV would have you believe, insider trading doesn’t always guarantee a massively profitable outcome. Even though a stock might go up or down based on the information, it’s never a sure thing.
One more reason? Some argue that the enforcement of insider trading is “selective” at best and that makes it unfair. What do you think?
Legal Insider Trading Examples
Curious about what might constitute a legal insider trade? Here are some examples:
- A company CEO buys 5,000 shares of stock in the corporation, and reports it in a timely manner to the SEC, filling out the necessary paperwork and adhering to SEC guidelines for disclosure.
- A company employee takes advantage of stock options, loading up on shares of the company that they work for.
- A board member sells 100 shares of stock and fills out the necessary paperwork and disclosures.
Boring, right? Maybe it’s not as exciting as the stories I shared about illegal insider trading, but that’s a good thing. When it comes to the law, sticking with boring but legal is good!
The Bottom Line
Insider trading is more complicated than most people realize. Sure, there’s a reason why there are negative connotations associated with it, particularly when high-ranking insiders abuse their power and knowledge to get an edge over other traders.
However, not all insider trading is the same, and not all insider trading is illegal. In fact, the legal kind can actually tip you off to legitimate and legal potential trades.
There’s no need to be fraudulent in your trading. There are enough opportunities that you can keep things on the level and stay safe in your career.
Tomorrow I’ll go over the other side of the coin and share some stories with you. Trust me you won’t wanna miss it.
Editor, Penny Stock Millionaires