Insider Trading: What It Is and How to Fight It

stockFor many people the concept of insider trading is a foreign one. However, insider trading is a serious crime that can cost the United States economy millions of dollars each year. Law enforcement and government agencies are working tirelessly to investigate the allegations and prosecute the offenders.

We’ll look at some additional information on insider trading, what it is, and what you can do to stop it.

Insider Trading Defined

According to the United States Securities and Exchange Commission, there are two major aspects to insider trading. The first is legal insider trading. This occurs when employees of a company trade their own stock in that company. While these types of trades are most certainly based on some kind of information that the public might not be aware of, they are legal as long as the trades are reported to the SEC within a certain time period, and the trades are made after the critical information has been revealed to the public.

Illegal insider trading occurs in much the same way, but the trades go unreported to the SEC and the inside information that has prompted the trade is not made public. Additionally, officers or employees of a company may share critical information about the company with friends or others who own stock, and indicate to them that they should sell before a certain time to maximize gains. All of the people involved in this type of trading face serious consequences.

How Is Insider Trading Investigated?

Following the great stock market crash of 1929, the United States government formally created laws designed to protect the market from calamities like insider trading. The following year, the SEC was established to enforce those laws and investigate allegations of crime.

However, for many years the members of the SEC were unable to properly police the market, and they were only able to file injunctions against the perpetrators and try to force them to make financial restitution. In 1984, the U.S. Congress passed the Insider Trading Sanctions Act which authorized the SEC to turn over insider trading cases to the Department of Justice for prosecution.

For many years the investigations team at the SEC was forced to rely on tips from company insiders when illegal trading activities were present. Today they have numerous resources at their disposal, including sophisticated computer systems that allow them to monitor trades and specific company information in real time. This offers the SEC an advantage in their investigations and attempts to prosecute.

What Are the Penalties for Insider Trading?

After the SEC turns over cases to the Department of Justice, the case goes to court and the individuals and/or companies are tried. If found guilty, the individuals and/or companies receive severe penalties.

An individual can be fined up to $5 million for each violation of the law, and companies can be fined up to $25 million for the same. Additionally, jails sentences of up to 30 months and longer have been handed down in the case of severe violations.

Famous Insider Trading Cases

There have been numerous cases of insider trading that have been investigated and prosecuted over the years, but there are a few that stand out as particularly compelling for various reasons.

  • Raj Rajaratnam of the Galleon Group.  In one of the largest cases of insider trading in United States history, Raj Rajaratnam, the president of the Galleon Group’s hedge fund, was arrested in October of 2009. He was accused of gaining more than $60 million in profits from inside trades of companies like Google and Hilton Hotels. He was sentenced to 11 years in prison, the longest sentence for insider trading in history.
  • Martha Stewart.  In 2001, Martha Stewart received inside information from her broker at Merrill Lynch, which prompted her to sell more than 3,000 shares of stock in the company ImClone, just prior to an FDA ruling that would negatively affect the company. Stewart avoided losses of over $40,000 with this scheme. In June of 2003 she was indicted and charged with securities fraud and obstruction of justice. She was sentenced to five months in federal prison.

As greed is invariably the motive for insider trading, and humans can simply be greedy by nature, it’s not likely that we’ll see a complete end to this type of crime. However, the SEC and other enforcement agencies are working harder than ever to fight it, which means that justice will continue to be served.

About the Author:  Cameron Carter is a financial writer who specializes in issues relating to the stock market.

2 Responses to Insider Trading: What It Is and How to Fight It

  1. Money Beagle says:

    Sadly, I think that for every time illegal insider trading is discovered, there are many many more instances where it isn’t. There are so many different ways to hide your tracks, and I think just the sheer volume of trading that takes place these days (billions of shares exchanged per day), it’s got to be pretty easy to get stuff in below the radar.

Leave a reply