Insider Trading: What is it and Why is it Illegal?

You may have heard the term “insider trading” before, whether it be in news headlines or in movies. It is important not only to understand what insider trading is and how to make sure you are not engaging in it, but also to be aware of the reasons why it is illegal.

Insider Trading Defined

Insider trading happens when someone who owes a fiduciary duty to another - whether it is a person, institution, or business entity - makes an investment decision based on information received related to that duty that is not available to the public. A fiduciary duty is an ethical or legal relationship of trust with another party, and the person who holds that duty is aptly called a fiduciary. Generally, a fiduciary prudently manages money or other assets for another.

Why Insider Trading Became Illegal

At the beginning of the 20th century, insider trading was not considered against the law. At one point the United States Supreme Court labeled insider trading a mere perk of being an executive. After the 1920s and its extravagances as well as the crash of the stock market and a shift in public opinion during the Great Recession, insider trading was prohibited under the law.

There are several factors that the Securities & Exchange Commission (SEC) - the federal agency tasked with protecting investors, maintaining orderly and fair securities markets, and facilitating capital formation - considers to determine whether or not insider trading has taken place. Put simply, however, the SEC must show that the defendant had a fiduciary duty to the company and that he or she bought or sold shares based upon insider information for the purpose of personal gain.

Penalties for Insider Trading

Like most crimes, the penalties imposed for insider trading are dependent upon the severity of the case at hand. Generally, the penalties for insider trading include a monetary fine and jail time. Recently, the SEC has also banned those found to have conducted insider trading from being executives on any publicly traded company. Some of the most infamous insider trading case defendants in United States history include:

  • Albert H. Wiggin, American banker;

  • Jeff Skilling, former Enron CEO;

  • Levine, Siegel, Boesky & Milken;

  • R. Foster Williams, former Wall Street Journal writer; and

  • Martha Stewart, lifestyle brand maven.

Of note, the law does allow for cases where inside information has been acquired that do not fall under the umbrella of insider trading. Specifically, the SEC’s Rule 10b5-1 covers this specific scenario for trades that are based on preexisting investment plans. This exception only applies when the plan, instruction, or contract to buy or sell securities was entered into or given in good faith and not as part of a scheme.

Seek Out Legal Help

In short, insider trading is absolutely illegal and you should not do it if you value your liberty. If you or someone you know has more questions about this topic, or any other legal question in Nevada, contact the skilled Las Vegas attorneys at Parry & Pfau today.

(image courtesy of Markus Spiske)