Insider Trading

Overview of Insider Trading

The crime of insider trading has made recent headlines as a handful of senators have come under scrutiny for unloading millions of dollars in stock after receiving security briefings about the coronavirus pandemic.

Prior to that, insider trading received national attention when Martha Stewart made the news for a 2003 insider trading scandal that landed her in prison. More recently, in 2011, prominent hedge fund manager Raj Rajaratnam received an 11-year prison sentence for insider trading.

Despite these cases dominating the news for weeks at a time, many people are still fuzzy on what exactly insider trading entails.

What Is Insider Trading?

It may come as a surprise, but insider trading hasn’t always been against the law. Prior to the stock market crash of 1929 and the Depression that followed, business owners and leaders could “trade” on information they gained by being business insiders.

However, lawmakers enacted sweeping changes to the law in the 1930s, including creating the federal Securities and Exchange Commission (SEC).

Today, insider trading is a crime that occurs when an individual using insider knowledge not accessible to the public for the purpose of making a stock trade. This can include buying or selling stocks based on some kind of special knowledge an ordinary person wouldn’t be able to get.

For a trade to be considered insider trading, the person must have be in a position of owing a fiduciary duty to a company, another individual, or some other entity.

You don’t necessarily have to make a profit for a stock trade to qualify as insider trading. You can also be charged with a crime if you sell stock for the purpose of avoiding a loss. For example, if you act on a tip or piece of information that alerts you to the likelihood of a stock going down in price, and you sell your stock based on that information, this can be insider trading.

What If You Don’t Owe a Fiduciary Duty?

In some cases, a person can still be charged with insider trading even if they didn’t owe a fiduciary duty to a person or entity. In these cases, the person can still engage in insider trading if they committed a related crime, such as stealing information and then trading on it. In this instance, they could be charged with theft or fraud of information, which is often a type of corporate espionage, along with a separate crime of insider trading.

Examples of Insider Trading

There are several notorious examples of insider trading throughout U.S. history. While the cases involving high-ranking corporate executives and millions of dollars tends to grab the most attention, it’s important to remember that anyone with a fiduciary duty who acts on inside information can be charged with the crime of insider trading.

Perhaps one the most famous examples of insider trading involved Enron Corporation. In 2006, the company’s CEO Jeffrey Skilling was charged with 10 counts of insider trading after he sold his shares in the company based on insider knowledge that Enron wasn’t performing well financially.

Skilling was only convicted on a single count of insider trading, but other charges landed him in prison for 24 years. He was released in 2019 after serving 12 years.

In another case, Joseph Nacchio, who headed up Qwest Communications, spent six years in prison after he was convicted on 19 counts of insider trading. He was originally charged with 42 counts of insider trading after he sold over $50 million worth of stock in 2005. The court found that he had made the stock sales based on information not available to the general public.

Penalties for Insider Trading

Insider trading is a white collar crime, which means it’s a non-violent financial crime. However, prosecutors and federal agencies can be aggressive when it comes to pursuing investigations of insider trading.

Despite its status as a white collar crime, an insider trading conviction can result in a lengthy federal prison sentence, as well as expensive fines. In many cases, business executives convicted of insider trading are prohibited from serving in any position in which they have a fiduciary duty.

Regulations Designed to Prevent Insider Trading

The SEC has an interest in making sure that publicly traded stocks aren’t being manipulated by company insiders with information the public can’t access. To prevent insider trading, one of the regulations put in place by the SEC requires company insiders to turn over any profit they make off a sale or purchase to go directly to the company within six months of the sale or trade. This is intended to discourage company officers and owners from making purchases or sales that will benefit them personally. Corporate officers and owners who own a certain percentage of stock are also required to file disclosures when they sell stock.

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