Insider trading
Insider trading is the trading of a public company's stock or other securities (such as bonds or stock options) based on material, nonpublic information about the company. In many countries, trading based on insider information is illegal. The rationale for this prohibition of insider trading differs between countries and regions. Some view it as unfair to other investors in the market w
Overview
Insider trading is the trading of a public company's stock or other securities (such as bonds or stock options) based on material, nonpublic information about the company. In many countries, trading based on insider information is illegal. The rationale for this prohibition of insider trading differs between countries and regions. Some view it as unfair to other investors in the market who do not have access to the information, as the investor with inside information can potentially make larger profits than an investor without such information. Insider trading is also prohibited to prevent the directors of a company (the insiders) from abusing a company's confidential information for the directors' personal gain. The rules governing insider trading are complex and vary significantly from country to country, as does the extent of enforcement. The definition of 'insider' in one jurisdiction can be broad and may cover not only insiders themselves but also any persons related to them, such as brokers, associates, and even family members. In some jurisdictions, a person who becomes aware of non-public information and then trades on that basis may be guilty of a crime. Trading by specific insiders, such as employees, is commonly permitted as long as it does not rely on material information not available to the general public. Many jurisdictions require that such trading be reported so the transactions can be monitored. In the United States and several other jurisdictions, trading conducted by corporate officers, key employees, directors, or significant shareholders must be reported to the regulator or publicly disclosed, usually within a few business days of the trade. In such cases, insiders in the United States are required to file Form 4 with the U.S. Securities and Exchange Commission (SEC) when buying or selling shares of their own companies. The authors of one study concluded that illegal insider trading raises the cost of capital for securities issuers, thus decreasing overall economic growth. On the other hand, some economists, such as Henry Manne, have argued that insider trading should be allowed and can, in fact, benefit markets. There has long been "considerable academic debate" among business and legal scholars over whether insider trading should be illegal. Several arguments against outlawing insider trading have been identified: for example, although insider trading is illegal, most insider trading is never detected by law enforcement, and thus the illegality of insider trading might give the public the potentially misleading impression that "stock market trading is an unrigged game that anyone can play." Some legal analysis has questioned whether insider trading actually harms anyone in the legal sense, since it can be argued either that insider trading does not cause anyone to suffer an actual "loss" or that anyone who suffers a loss is not owed an actual legal duty by the insiders in question. Opponents of political insider trading also point to conflicts of interest and social distrust.
Legal framework
Rules prohibiting or criminalizing insider trading on material non-public information exist in most jurisdictions around the world (Bhattacharya and Daouk, 2002), but the details and the efforts to enforce them vary considerably. In the United States, Sections 16(b) and 10(b) of the Securities Exchange Act of 1934 directly and indirectly address insider trading. The U.S. Congress enacted this law after the stock market crash of 1929. While the United States is generally viewed as making the most serious efforts to enforce its insider trading laws, the broader scope of the European model legislation provides a stricter framework against illegal insider trading. In the European Union and the United Kingdom, all trading on non-public information is, under the rubric of market abuse, subject at a minimum to civil penalties and possible criminal penalties as well. UK's Financial Conduct Authority has the responsibility to investigate and prosecute insider dealing, defined by the Criminal Justice Act 1993. Financial Action Task Force on Money Laundering (FATF) can apply to domestic politically exposed persons.
Definition of "insider"
In the United States, Canada, Australia, Germany and Romania for mandatory reporting purposes, corporate insiders are defined as a company's officers, directors and any beneficial owners of more than 10% of a class of the company's equity securities. Trades made by these types of insiders in the company's own stock, based on material non-public information, are considered fraudulent since the insiders are violating the fiduciary duty that they owe to the shareholders. The corporate insider, simply by accepting employment, has undertaken a legal obligation to the shareholders to put the shareholders' interests before their own, in matters related to the corporation. When insiders buy or sell based on company-owned information, they are said to be violating their obligation to the shareholders or investors. For example, illegal insider trading would occur if the chief executive officer of Company A learned (prior to a public announcement) that Company A would be taken over and then bought shares in Company A while knowing that the share price would likely rise. In the United States and many other jurisdictions, "insiders" are not just limited to corporate officials and major shareholders where illegal insider trading is concerned but can include any individual who trades shares based on material non-public information in violation of some duty of trust. This duty may be imputed; for example, in many jurisdictions, in cases where a corporate insider "tips" a friend about non-public information likely to have an effect on the company's share price, the duty the corporate insider owes the company is now imputed to the friend and the friend violates a duty to the company if he trades on the basis of this information.
Liability
Liability for inside trading violations generally cannot be avoided by passing on the information in an "I scratch your back; you scratch mine" or quid pro quo arrangement if the person receiving the information knew or should have known that the information was material non-public information. In the United States, at least one court has indicated that the insider who releases the non-public information must have done so for an improper purpose. In the case of a person who receives the insider information (called the "tippee"), the tippee must also have been aware that the insider released the information for an improper purpose. One commentator has argued that if Company A's CEO did not trade on undisclosed takeover news, but instead passed the information on to his brother-in-law who traded on it, illegal insider trading would still have occurred (albeit by proxy, by passing it on to a "non-insider" so Company A's CEO would not get his hands dirty).
Misappropriation theory
The misappropriation theory of insider trading is now accepted in U.S. law. It states that anyone who misappropriates material non-public information and trades on that information in any stock may be guilty of insider trading. This can include elucidating material non-public information from an insider with the intention of trading on it or passing it on to someone who will. This theory constitutes the background for the securities regulation that enforces the insider trading. Disgorgement represents ill-gotten gains (or losses avoided) resulting from individuals violating the securities laws. In general in the countries where the insider trading is forbidden, the competent Authority seeks disgorgement to ensure that securities law violators do not profit from their illegal activity. When appropriate, the disgorged funds are returned to the injured investors. Disgorgements can be ordered in either administrative proceedings or civil actions, and the cases can be settled or litigated. Payment of disgorgement can be either completely or partially waived based on the defendant demonstrating an inability to pay. In settled administrative proceedings, Enforcement may recommend, if appropriate, that the disgorgement be waived. There are several approaches in order to quantify the disgorgement; an innovative procedure based on probability theory was defined by Marcello Minenna by directly analyzing the time periods of the involved transactions in the insider trading.
Proof of responsibility
Proving that someone has been responsible for a trade can be difficult because traders may try to hide behind nominees, offshore companies, and other proxies. The SEC prosecutes over 50 cases each year, with many being settled administratively out of court. The SEC and several stock exchanges actively monitor trading, looking for suspicious activity. The SEC does not have criminal enforcement authority but can refer serious matters to the U.S. Attorney's Office for further investigation and prosecution.
Trading on information in general
In the United States and most non-European jurisdictions, not all trading on non-public information is illegal insider trading. For example, a person in a restaurant who hears the CEO of Company A at the next table tell the CFO that the company's profits will be higher than expected and then buys the stock is not guilty of insider trading—unless he or she had some closer connection to the company or company officers. However, even where the tippee is not himself an insider, where the tippee knows that the information is non-public and the information is paid for, or the tipper receives a benefit for giving it, then in the broader-scope jurisdictions the subsequent trading is illegal. Notwithstanding, information about a tender offer (usually regarding a merger or acquisition) is held to a higher standard. If this type of information is obtained (directly or indirectly) and there is reason to believe it is nonpublic, there is a duty to disclose it or abstain from trading. In the United States in addition to civil penalties, the trader may also be subject to criminal prosecution for fraud or where SEC regulations have been broken, the U.S. Department of Justice (DOJ) may be called to conduct an independent parallel investigation. If the DOJ finds criminal wrongdoing, the department may file criminal charges.
Commercialisation
The advent of the Internet has provided a forum for the commercialisation of trading on insider information. In 2016 a number of dark web sites were identified as marketplaces where such non-public information was bought and sold. At least one such site used bitcoin to avoid currency restrictions and to impede tracking. Such sites also provide a place for soliciting for corporate informants, where non-public information may be used for purposes other than stock trading.
Legislative trading
Politicians are not insiders in the traditional sense, because they do not have access to company-internal information. However, legislators know substantially more than retail investors about imminent or possible corporate regulation. Empirically, U.S. Congresspersons trade more when the legislature is in session and in periods with higher geopolitical risk.
Legality
Legal trades by insiders are common, as employees of publicly traded corporations often have stock or stock options. These trades are made public in the United States through SEC filings that are also being made available by academic researchers as structured datasets. In 2000, U.S. SEC Rule 10b5-1 clarified that the prohibition against insider trading does not require proof that an insider actually used material nonpublic information when conducting a trade; possession of such information alone is sufficient to violate the provision, and the SEC would infer that an insider in possession of material nonpublic information used this information when conducting a trade. However, SEC Rule 10b5-1 also created for insiders an affirmative defense if the insider can demonstrate that the trades conducted on behalf of the insider were conducted as part of a pre-existing contract or written binding plan for trading in the future. For example, if an insider expects to retire after a specific period of time and, as part of retirement planning, the insider has adopted a written binding plan to sell a specific amount of the company's stock every month for two years, and the insider later comes into possession of material nonpublic information about the company, trades based on the original plan might not constitute prohibited insider trading. In addition to regulatory enforcement, private enforcement through shareholder derivative lawsuits acts as a legal deterrent, with empirical evidence showing that legal restrictions on derivative suits lead to an increase in opportunistic insider trading.
Arguments for further prohibition
Trading on non-public legislative information is considered a conflict of interest, contributing to social distrust; and has motivated legislation restricting politicians to engage in trading, such as the STOCK Act. A 2025 study demonstrated that insider trading by members of Congress reduces political legitimacy and public willingness to comply with the law. There are very limited laws against "shadow trading", where insiders trade on information which affect the commodities markets (corn, wheat, steel, etc.) or which indirectly impacts other companies. Due to similar consequences to traditional insider trading some studies recommend a prohibition on shadow trading as well.
Arguments for legalizing
Some argue that insider trading is a victimless act: a willing buyer and a willing seller agree to trade property that the seller rightfully owns, with no prior contract (according to this view) having been made between the parties to refrain from trading if there is asymmetric information. Writing for The Atlantic in 2011, journalist Megan McArdle has described the process as "arguably the closest thing that modern finance has to a victimless crime". In 2002, Milton Friedman, laureate of the Nobel Memorial Prize in Economics, said: "You want more insider trading, not less. You want to give the people most likely to have knowledge about deficiencies of the company an incentive to make the public aware of that." Friedman did not believe that the trader should be required to make his trade known to the public, because in his view the buying or selling pressure itself is information for the market. Advocates of legalization have also cited free speech, arguing that punishment for communicating about a development pertinent to the next day's stock price could be seen as an act of censorship. Some authors have used these arguments to propose legalizing insider trading on negative information (but not on positive information). Since negative information is often withheld from the market, trading on such information theoretically has a higher value for the market than trading on positive information.
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