What is insider trading?
In one line: Illegal insider trading is buying or selling a security based on important, non-public information, in breach of a duty to keep it confidential.
Two kinds of "insider trading"
- Legal: company insiders, like officers, directors and big owners, buy or sell their own company's stock and report it to the SEC. This happens every day.
- Illegal: anyone trades based on material, non-public information in breach of a duty to keep it confidential.
The law in plain words
The SEC describes illegal insider trading as buying or selling a security, in breach of a duty of trust or confidence, while having material, non-public information about it. Each part matters:
- Material: important enough that a reasonable investor would care. An unannounced takeover, a big earnings surprise, a failed drug trial.
- Non-public: not yet released to everyone.
- Breach of a duty: the person owed it to someone (their company, a client, an employer) to keep it secret.
It also covers "tipping": passing the secret to a friend who trades. Both can be liable.
Read the SEC's own explanation at sec.gov.
A simple example
An employee learns at work that her company will be bought for $60 a share. The stock trades at $40. The news is still secret. She buys 1,000 shares, or tells her brother to.
When the deal is announced, the shares jump toward $60: a $20,000 gain on paper, made with a secret she had a duty to protect. That's illegal insider trading. Penalties can include giving back the gain, civil fines of up to three times the gain, and prison.
Why it matters for traders
Legal insider trades are public. Insiders must file a Form 4 with the SEC, generally within two business days. You can look them up free on the SEC's EDGAR system.
A common mistake
Thinking any "hot tip" is safe to trade. If a tip came from someone breaking a duty of confidence, and you know or should know that, trading on it can be illegal for you too. And many online "inside tips" are part of a Pump and dump scheme. Either way, skip it.
Big company news arrives in a Form 8-K. Trade what's public, not what's whispered.
Questions
Is insider trading always illegal?
No. Insiders can legally trade their own company's stock if they don't use material non-public information, and they report the trades.
What is a Form 4?
The SEC form insiders use to report buying or selling their company's stock, generally within two business days.
What is a 10b5-1 plan?
A pre-set trading plan insiders can set up before they have inside information, so trades happen on a schedule. The SEC tightened its rules in 2022.
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