Insider Trading

Insider trading is a part of securities fraud law. For more information on securities fraud in general, click here.

Insider trading is one of the most common forms of securities fraud and has led to some of the highest-profile prosecutions (and longest sentences) for white-collar crime. So what exactly is it?

What is Insider Trading?

In its most basic definition, insider trading is the buying, selling, or other trading in a security based on material, non-public – “insider” – information. For example, assume that a company employee learns through his job that his employer is about to acquire a competitor at a hefty premium. If the employee were to buy shares of the competitor and then sell when the acquisition was announced and the competitor’s stock price had risen, this would amount to quintessential insider trading: the employee used information not available to the open market to profit from the purchase of stock.

Securities & the SEC (Securities Exchange Commission)

The reason insider trading is illegal is to ensure the securities markets enjoy an appearance of fairness. If investors felt that others in the market were easily able to profit off inside information while they were left out in the cold, they would likely pull back from the market entirely, which hurts the economy as a whole. As a result, government entities – most specifically the Securities and Exchange Commission (SEC) – are tasked with ensuring that securities transactions occur on a level playing field, seeking to punish those who trade based on information not available to the public at large.

Charges & Penalties

Given the reasons behind insider trading, it should come as no surprise that it first became illegal shortly after the stock-market crash of 1929. The primary legal authorities banning insider trading are Section 10(b) of the 1934 Securities Exchange Act and its associated SEC rule 10b-5, although other laws and regulations apply as well. Penalties for insider trading are severe – up to 20 years in prison and up to a $5 million fine – and, according to an article in the New York Times, sentences for insider trading have been increasing since 2009. In addition to jail time and fines, profits unlawfully obtained also can be ordered disgorged, and civil penalties can be imposed, including an outright ban from the securities industry.

Impactful Cases

There have been several highly publicized insider-trading prosecutions over the past few decades. For example, Jeff Skilling, the CEO of energy giant Enron Corporation, was accused of dumping his shares in the company knowing that its financial situation was being misrepresented to investors and the public. He was convicted in 2006 of insider trading and conspiracy and sentenced to 24 years in prison (although that sentence was later reduced to 14 years).

Perhaps the best-known recent example of insider trading involved celebrity chef and media personality Martha Stewart. Stewart owned shares of stock in a pharmaceutical company called ImClone, which was attempting to develop a cancer drug. Stewart had invested in the company on the recommendation of ImClone’s founder, Stuart Waksal, who had once dated Stewart’s daughter. In late 2001, ImClone learned that the Food and Drug Administration was about to deny approval to its drug; Waksal passed that information on to Stewart, who promptly sold all of her shares in the company. When the announcement of the FDA denial came the following day, ImClone’s price tanked; Stewart had saved more than $45,000 by selling her shares early. Waksal and Stewart were later arrested and charged with insider trading. Waksal pled guilty and received a sentence of 87 months’ imprisonment, along with more than $4 million in fines. Stewart maintained her innocence and proceeded to trial, where she was convicted. She received a sentence of five months’ imprisonment, another five months of home confinement, two years of probation, and a $30,000 fine. She was also ordered to disgorge three times the money she had saved by selling her shares.

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