Why is insider trading illegal?
Illegal insider trading is the buying or selling of a security by insiders who possess material that’s still not public. The act puts insiders in breach of their fiduciary duty. As you can imagine, this is a definite faux pas for anyone closely involved with a company. Because the information isn’t available to other investors, a person using such knowledge is trying to gain an unfair advantage over the rest of the market.
Showing that insider trading is considered to be illegal due to it being unethical. And don’t think that those who place the trades are the only guilty ones. A common misconception is that only directors and upper management can be convicted of insider trading. Anybody who has material and nonpublic information can commit such an act.
This means that nearly anybody including brokers, family, friends and employees can be considered an insider. To someone caught “tipping” an outsider with non-public information, that tipster can also be found liable.
The following are examples of illegal insider trading:
- The CEO of a company sells a stock after discovering that the company will be losing a big government contract next month.
- The CEO’s son sells the company stock after hearing from his dad that the company will be losing the big government contract.
- A government official realises that the company will lose a big government contract, so the official sells the stock.
There are financial regulators in place that are extremely strict with those who trade unfairly and thereby undermine investor confidence and the integrity of the financial markets. Such as the United States Securities and Exchange Commission (SEC).
The SEC uses the Dirks Test to determine if an insider gave a tip illegally. The test states that if a tipster breaches his or her trust with the company and understands that this was a breach, he or she is liable for insider trading.