What is Insider Information?

It is challenging to pronounce someone guilty only based on holding the insider information and trading in it. One of the most arduous tasks for the SEC is to prove that the person who gained benefits from insider tradingInsider TradingInsider trading is defined as the act of taking key trading decisions related to a company’s listed stock using critical non-public information. The US Securities and Exchange Commission (SEC) penalizes offenders of illegal insider trading as it causes material loss to the investors. It also shakes their faith in the stock market. read more is also responsible for some fiduciary duty in the organization whose shares have been used for unfair personal gain.

But, this could also be used for gains or averting losses when creating or manipulating various organizations or technical bugs to use or create a loophole in the system.

Explanation

  • Every listed company has some information that comes into the public domain and would affect the price of equity in the market. For example, the announcement of dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more, new product launches, heavy losses, new contracts, etc., could make the security price volatile. This information is available only to the persons involved in the entity’s day-to-day operations or to those who have a deep connection in the organization, such as directors, senior officers, accountants, and so on.Based on the undisclosed information, if somebody tries to make personal gains by trading in the entity’s securities, it is known as insider trading. These practices interfere with the free trade policies in the equities market and put other investors devoid of information at a disadvantage.

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Example

A few examples of insider trading are as follows:

  • For instance, material information such as the finalization of a mergerMergerMerger refers to a strategic process whereby two or more companies mutually form a new single legal venture. For example, in 2015, ketchup maker H.J. Heinz Co and Kraft Foods Group Inc merged their business to become Kraft Heinz Company, a leading global food and beverage firm.read more deal with another organization would impact the company’s profitability in the future; thus, positive news for the stock market could be used to earn gains via stock purchase before the deal is announced in public.The launch of a new product that could boost the organization’s sales and would add substantially to the bottom lineBottom LineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its bottom line. read more could also be termed as a piece of insider information if the entity concerned is a public company.

To curb insider trading based on undisclosed information, Sec 16 of the Securities and Exchange Act, 1934 requires all the insiders, including senior personnel like directors, officers, and substantial equity holders of the company, i.e., holding of 10% or more is subjected to various regulations.

Any gain or losses averted due to the insider information within the six months should be deposited with the company’s account. This move has made even small benefits from malpractices in insider trading less advantageous. Also, owners of substantive equity holding who also chair the management posts in the company need to report the transactions involving the purchase or sale of shares to the Security and Exchange Commission.

Insider Trading with Insider Information

  • Insider trading denotes dealing in the entity’s share by persons (holding 10% or more of the corporation’s equity) in the equities market by surpassing the law of free trade and making profits or avoiding gains based on information not available to the general public. So, the high-level officers, directors, and owners with more than 10% holding come under the radar of insiders.Insiders could be charged for not just trading in security by using undisclosed information but also when such communication is being communicated to other persons who could benefit from that.It is permissible to do trading by the organization’s insiders, provided that the SEC is well-informed about their trades.Insider trading is a criminal offense in the U.S, and heavy penalties with imprisonment could be imposed. The SEC (Securities and Exchange Commission is responsible for persecuting the persons involved in unfair trades based on inside information.

Conclusion

Insider information on itself is of no harm unless it is being used to manipulate the trading of a listed entity for undue gain and averting losses. Insider trading based on undisclosed information in the public sphere is tough to frame and prove the charges. Over the years, the law has become very stringent on such issues due to mass exploitation and public outcry, but it is still unable to stop such rampant incidents in the corporate world.

This article has been a guide to insider information & its meaning. Here we discuss the legal implications of trading based on insider information and examples. You can learn more about it from the following articles –

  • Investment vs. SpeculationQuarterly ReportBoard of DirectorsGray ListSecurity Analysis