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Encyclopedia > Insider trading

Insider trading is the trading of a corporation's stock or other securities (e.g. bonds or stock options) by corporate insiders such as officers, key employees, directors, or holders of more than ten percent of the firm's shares.[1] Insider trading may be perfectly legal, but the term is frequently used to refer to a practice, illegal in many jurisdictions, in which an insider or a related party trades based on material non-public information obtained during the performance of the insider's duties at the corporation, or otherwise misappropriated.[2] Image File history File links Gnome-globe. ... For other uses, see Corporation (disambiguation). ... For other uses, see Stock (disambiguation). ... For security (collateral), the legal right given to a creditor by a borrower, see security interest A security is a fungible, negotiable instrument representing financial value. ... For alternative meanings, see bond (a disambiguation page). ... A stock option is a specific type of option with a stock as the underlying instrument (the security that the value of the option is based on). ...

All insider trades must be reported in the United States. Many investors follow the summaries of insider trades, published by the United States Securities and Exchange Commission (SEC), in the hope that mimicking these trades will be profitable. Legal "insider trading" may not be based on material non-public information. Illegal insider trading in the US requires the participation (perhaps indirectly) of a corporate insider or other person who is violating his fiduciary duty or misappropriating private information, and trading on it or secretly relaying it. SEC redirects here. ... The court of chancery, which governed fiduciary relations prior to the Judicature Acts The fiduciary duty is a legal relationship between two or more parties, most commonly a fiduciary or trustee and a principal or beneficiary, that in English common law is arguably the most important concept within the portion...

Insider trading is believed to raise the cost of capital for securities issuers, thus decreasing overall economic growth.[3]


Illegal insider trading

Rules against insider trading on material non-public information exist in most jurisdictions around the world, though the details and the efforts to enforce them vary considerably. The United States, the United Kingdom, and Canada are viewed as the countries who have the strictest laws and make the most serious efforts to enforce them.[4]

According to the U.S. SEC, corporate insiders are a company's officers, directors and any beneficial owners of more than ten percent 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 to be fraudulent since the insiders are violating the trust or the fiduciary duty that they owe to the shareholders. The corporate insider, simply by accepting employment, has made a contract with the shareholders to put the shareholders' interests before their own, in matters related to the corporation. When the insider buys or sells based upon company owned information, he is violating his contract with the shareholders.

For example, illegal insider trading would occur if the chief executive officer of Company A learned (prior to a public announcement) that Company A will be taken over, and bought shares in Company A knowing that the share price would likely rise. “Chief executive” redirects here. ...

Liability for insider trading violations cannot be avoided by passing on the information in an "I scratch your back, you scratch mine" or quid pro quo arrangement, as long as the person receiving the information knew or should have known that the information was company property. For example, if Company A's CEO did not trade on the 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.[5] Quid pro quo (Latin for something for something [1]) indicates a more-or-less equal exchange or substitution of goods or services. ...

A newer view of insider trading, the "misappropriation theory" is now part of US law. It states that anyone who misappropriates (steals) information from their employer and trades on that information in any stock (not just the employer's stock) is guilty of insider trading. For example, if a journalist who worked for Company B learned about the takeover of Company A while performing his work duties, and bought stock in Company A, illegal insider trading might still have occurred. Even though the journalist did not violate a fiduciary duty to Company A's shareholders, he might have violated a fiduciary duty to Company B's shareholders (assuming the newspaper had a policy of not allowing reporters to trade on stories they were covering).[6] The court of chancery, which governed fiduciary relations prior to the Judicature Acts The fiduciary duty is a legal relationship between two or more parties, most commonly a fiduciary or trustee and a principal or beneficiary, that in English common law is arguably the most important concept within the portion...

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. Nevertheless, the U.S. Securities and Exchange Commission 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 U.S. Securities and Exchange Commission, commonly referred to as the SEC, is the United States governing body which has primary responsibility for overseeing the regulation of the securities industry. ...

Not all trading on information is illegal inside trading, however. For example, while dining at a restaurant, you hear the CEO of Company A at the next table telling the CFO that the company will be taken over, and then you buy the stock, you wouldn't be guilty of insider trading unless there was some closer connection between you, the company, or the company officers.

Since insiders are required to report their trades, others often track these traders, and there is a school of investing which follows the lead of insiders. This is of course subject to the risk that an insider is making a buy specifically to increase investor confidence, or making a sell for reasons unrelated to the health of the company (e.g. a desire to diversify or buy a house).

As of December 2005 companies are required to announce times to their employees as to when they can safely trade without being accused of trading on inside information.

American insider trading law

The United States has been the leading country in prohibiting insider trading deemed illegal. Thomas Newkirk and Melissa Robertson of the SEC, summarize the development of U.S. insider trading laws.[7]

U.S. insider trading prohibitions are based on English and American common law prohibitions against fraud. In 1909, well before the Securities Exchange Act was passed, the United States Supreme Court ruled that a corporate director who bought that company’s stock when he knew it was about to jump up in price committed fraud by buying while not disclosing his inside information.

Section 17 of the Securities Act of 1933[8] contained prohibitions of fraud in the sale of securities which were greatly strengthened by the Securities Exchange Act of 1934.[9] // Congress enacted the Securities Act of 1933 (the “1933 Act,” the Truth in Securities Act or the Federal Securities Act) 48 Stat. ... The Securities Exchange Act of 1934 was a sweeping piece of legislation in the United States regulating the participants in the financial markets. ...

Section 16(b) of the Securities Exchange Act of 1934 prohibits short-swing profits (from any purchases and sales within any six month period) made by corporate directors, officers, or stockholders owning more than 10% of a firm’s shares. Under Section 10(b) of the 1934 Act, SEC Rule 10b-5, prohibits fraud related to securities trading. The Securities Exchange Act of 1934 was a sweeping piece of legislation in the United States regulating the participants in the financial markets. ... SEC Rule 10b-5 is one of the most important rules promulgated by the U.S. Securities and Exchange Commission, pursuant to its authority granted under the Securities Exchange Act of 1934. ...

The Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 provide for penalties for illegal insider trading to be as high as three times the profit gained or the loss avoided from the illegal trading.[10]

S.E.C. regulation FD ("Full Disclosure") requires that if a company intentionally discloses material non-public information to one person, it must simulataneously disclose that information to the public at large. In the case of an unintentional disclosure of material non-public information to one person, the company must make a public disclosure "promptly."[11]

Insider trading, or similar practices, are also regulated by the SEC under its rules on takeovers and tender offers under the Williams Act. A takeover in commerce refers to one company (the acquirer) purchasing another (the target). ... Tender offer is a term typically used in corporate finance to mean a public, open offer by an entity to buy stock from the existing stockholders of a publicly traded corporation under specific terms in effect for a specific period. ... The Williams Act refers to amendments to the Securities Exchange Act of 1934 enacted in 1968 regarding tender offers. ...

Much of the development of insider trading law has resulted from court decisions. In SEC v. Texas Gulf Sulphur Co. (1966), a federal circuit court stated that anyone in possession of inside information must either disclose the information or refrain from trading.

In 1984, the Supreme Court of the United States ruled in the case of Dirks v. SEC that tippees (receivers of second-hand information) are liable if they had reason to believe that the tipper had breached a fiduciary duty in disclosing confidential information and the tipper received any personal benefit from the disclosure. (Since Dirks disclosed the information in order to expose a fraud, rather than for personal gain, nobody was liable for insider trading violations in his case.) Federal courts Supreme Court Circuit Courts of Appeal District Courts Elections Presidential elections Midterm elections Political Parties Democratic Republican Third parties State & Local government Governors Legislatures (List) State Courts Local Government Other countries Atlas  US Government Portal      The Supreme Court of the United States (sometimes colloquially referred to by the...

The Dirks case also defined the concept of "constructive insiders," who are lawyers, investment bankers and others who receive confidential information from a corporation while providing services to the corporation. Constructive insiders are also liable for insider trading violations if the corporation expects the information to remain confidential, since they acquire the fiduciary duties of the true insider.

In United States v. Carpenter (1986) the U.S. Supreme Court cited an earlier ruling while unanimously upholding mail and wire fraud convictions for a defendant who received his information from a journalist rather than from the company itself. The journalist R. Foster Winans was also convicted. [12] R. Foster Winans (born August 5, 1948) is a former columnist for The Wall Street Journal who co-wrote the [2] Heard on the Street Column from 1982 to 1984 and was convicted of insider trading. ...

"It is well established, as a general proposition, that a person who acquires special knowledge or information by virtue of a confidential or fiduciary relationship with another is not free to exploit that knowledge or information for his own personal benefit but must account to his principle for any profits derived therefrom."

However, in upholding the securities fraud (insider trading) convictions, the justices were evenly split.

In 1997 the U.S. Supreme Court adopted the misappropriation theory of insider trading in United States v. O'Hagan, 521 U.S. 642, 655 (1997),. O'Hagan was a partner in a law firm representing Grand Met, while it was considering a tender offer for Pillsbury Co. O'Hagan used this inside information by buying call options on Pillsbury stock, resulting in profits of over $4 million. O'Hagan claimed that neither he nor his firm owed a fiduciary duty to Pillsbury, so that he did not commit fraud by purchasing Pillsbury options.[13] The Supreme Court Building, Washington, D.C. The Supreme Court Building, Washington, D.C., (large image) The Supreme Court of the United States, located in Washington, D.C., is the highest court (see supreme court) in the United States; that is, it has ultimate judicial authority within the United States... // The United States Reports, the official reporter of the Supreme Court of the United States Case citation is the system used in many countries to identify the decisions in past court cases, either in special series of books called reporters or law reports, or in a neutral form which will...

The Court rejected O'Hagan's arguments and upheld his conviction.

The "misappropriation theory" holds that a person commits fraud "in connection with" a securities transaction, and thereby violates 10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. Under this theory, a fiduciary's undisclosed, self-serving use of a principal's information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of the information. In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the company's stock, the misappropriation theory premises liability on a fiduciary-turned-trader's deception of those who entrusted him with access to confidential information.

The Court specifically recognized that a corporation’s information is its property: "A company's confidential information...qualifies as property to which the company has a right of exclusive use. The undisclosed misappropriation of such information in violation of a fiduciary duty...constitutes fraud akin to embezzlement – the fraudulent appropriation to one's own use of the money or goods entrusted to one's care by another."

In 2000, the SEC enacted Rule 10b5-1, which defined trading "on the basis of" inside information as any time a person trades while aware of material nonpublic information — so that it is no defense for one to say that she would have made the trade anyway. This rule also created an affirmative defense for pre-planned trades. // SEC Rule 10b5-1 is an administrative rule enacted by the United States Securities and Exchange Commission, or SEC, in 2000. ... An affirmative defense is a defense used in litigation between private parties in common law jurisdictions. ...

In May of 2007, representatives Brian Baird and Louise Slaughter introduced a bill entitled the "Stop Trading on Congressional Knowledge Act, or STOCK Act." that would hold congressional and federal employees liable for stock trades they made using information they gained through their jobs. The bill would also seek to regulate so called "Political Intelligence" firms that research government activities and sell the information to financial managers.[14] Third Congressional District of Washington Brian Lenis Baird (born December 19, 1984 in Denver, Colorado) is an American politician. ... Louise McIntosh Slaughter (b. ...

Security analysis and insider trading

Security analysts gather and compile information, talk to corporate officers and other insiders, and issue recommendations to traders. Thus their activities may easily cross legal lines if they are not especially careful. The CFA Institute in its code of ethics states that analysts should make every effort to make all reports available to all the broker's clients on a timely basis. Analysts should never report material nonpublic information, except in an effort to make that information available to the general public. Nevertheless, analysts' reports may contain a variety of information that is "pieced together" without violating insider trading laws, under the mosaic theory. This information may include non-material nonpublic information as well as material public information, which may increase in value when properly compiled and documented. Security Analysis, written by Benjamin Graham and David L. Dodd in 1934, is an influential book on the subject of financial analysis and fundamental analysis. ... The CFA Institute, headquartered in the USA at Charlottesville, Virginia and formerly known as the Association for Investment Management and Research (AIMR), awards the prestigious Chartered Financial Analyst(CFA) designation. ...

Arguments for legalizing insider trading

Some economists and legal scholars (e.g. Henry Manne, Milton Friedman, Thomas Sowell, Daniel Fischel, Frank H. Easterbrook) argue that laws making insider trading illegal should be revoked. They claim that insider trading based on material nonpublic information benefits investors, in general, by more quickly introducing new information into the market. Considered a founder of the Law and economics discipline. ... Milton Friedman (July 31, 1912 – November 16, 2006) was an American Nobel Laureate economist and public intellectual. ... Thomas Sowell (born June 30, 1930), is an American economist, political writer, and commentator. ... Frank Hoover Easterbrook (born 1948) is Chief Judge of the United States Court of Appeals for the Seventh Circuit. ...

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 the buying or selling pressure itself is information for the market.[15] Milton Friedman (July 31, 1912 – November 16, 2006) was an American Nobel Laureate economist and public intellectual. ... The Bank of Sweden Prize in Economic Sciences (Swe. ...

Other critics argue that insider trading is a victimless act: A willing buyer and a willing seller agree to trade property which 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. In economics, information asymmetry occurs when one party to a transaction has more or better information than the other party. ...

Legalization advocates also question why activity that is similar to insider trading is legal in other markets, such as real estate, but not in the stock market. For example, if a geologist knows there is a high likelihood of the discovery of petroleum under Farmer Smith's land, he may be entitled to make Smith an offer for the land, and buy it, without first telling Farmer Smith of the geological data. Of course there are also circumstances when the geologist could not legally buy the land without disclosing the information, e.g. when he had been hired by Farmer Smith to assess the geology of the farm. Real estate is a legal term that encompasses land along with anything permanently affixed to the land, such as buildings. ... This article includes a list of works cited but its sources remain unclear because it lacks in-text citations. ... Petro redirects here. ...

Advocates of legalization make free speech arguments. Punishment for communicating about a development pertinent to the next day's stock price might seem to be an act of censorship [1]. If the information being conveyed is proprietary information and the corporate insider has contracted to not expose it, he has no more right to communicate it than he would to tell others about the company's confidential new product designs, formulas, or bank account passwords, but not all of what would be considered "inside information" is proprietary in any sense that doesn't just beg the question here.

There are very limited laws against "insider trading" in the commodities markets, if, for no other reason, than that the concept of an "insider" is not immediately analogous to commodities themselves (e.g., corn, wheat, steel, etc.). However, analogous activities such as front running are illegal under U.S. commodity and futures trading laws. For example, a commodity broker can be charged with fraud if he or she receives a large purchase order from a client (one likely to affect the price of that commodity) and then purchases that commodity before executing the client's order in order to benefit from the anticipated price increase. Front Running is the unethical practice of a broker trading an equity based on information from the analyst department before his or her clients have been given the information. ...

Legal differences among jurisdictions

The US and the UK vary in the way the law is interpreted and applied with regard to insider trading.

In the UK, the relevant laws are the Financial Services Act 1986 and the Financial Services and Markets Act 2000, which defines an offence of Market Abuse.[16] It is not illegal to fail to trade based on inside information (whereas without the inside information the trade would have taken place), since from a practical point of view this is too difficult to enforce. It is often legal to deal ahead of a takeover bid, where a party deliberately buys shares in a company in the knowledge that it will be launching a takeover bid.[citation needed] The Financial Services and Markets Act 2000 is an act of the United Kingdom parliament which created the Financial Services Authority (FSA) as a regulator for insurance, investment business and banking. ...

Japan enacted its first law against insider trading in 1988. Roderick Seeman says: "Even today many Japanese do not understand why this is illegal. Indeed, previously it was regarded as common sense to make a profit from your knowledge."[17]

In accordance with EU Directives, Malta enacted the Financial Markets Abuse Act in 2002, which effectively replaced the Insider Dealing and Market Abuse Act of 1994. A European Union Directive is the (mutally binding) collective decision made by the member states, acting through their national Government Ministers in the Council of the European Union and the Parliament. ...

The "Objectives and Principles of Securities Regulation"[18] published by the International Organization of Securities Commissions (IOSCO) in 1998 and updated in 2003 states that the three objectives of good securities market regulation are (1) investor protection, (2) ensuring that markets are fair, efficient and transparent, and (3) reducing systemic risk. The discussion of these "Core Principles" state that "investor protection" in this context means "Investors should be protected from misleading, manipulative or fraudulent practices, including insider trading, front running or trading ahead of customers and the misuse of client assets." More than 85 percent of the world's securities and commodities market regulators are members of IOSCO and have signed on to these Core Principles. The International Organization of Securities Commissions (IOSCO) is an international organization that brings together the regulators of the world’s securities and futures markets. ... Front Running is the unethical practice of a broker trading an equity based on information from the analyst department before his or her clients have been given the information. ...

The World Bank and International Monetary Fund now use the IOSCO Core Principles in reviewing the financial health of different country's regulatory systems as part of these organization's financial sector assessment program, so laws against insider trading based on non-public information are now expected by the international community. Enforcement of insider trading laws varies widely from country to country, but the vast majority of jurisdictions now outlaw the practice, at least in principle. The World Bank logo The World Bank (the Bank) is a part of the World Bank Group (WBG), is a bank that makes loans to developing countries for development programs with the stated goal of reducing poverty. ... IMF redirects here. ...

See also

The Private Securities Litigation Reform Act of 1995 (PSLRA) implemented several significant substantive changes affecting certain cases brought under the federal securities laws, including changes related to pleading, discovery, liability, and awards fees and expenses. ... For a discussion of the legal actions for securities fraud in the United States under the Securities Exchange Act of 1934 and SEC Rule 10b-5 promulgated thereunder, see the Wiki entry for the Private Securities Litigation Reform Act. ... Eat pizza everyday. ...


  1. ^ Larry Harris, Trading & Exchanges, Oxford Press, Oxford, 2003. Chapter 29 "Insider Trading" p. 584
  2. ^ Laws that Govern the Securities Industry U.S. Securities and Exchange Commission, accessed March 30, 2007
  3. ^ "The World Price of Insider Trading" by Utpal Bhattacharya and Hazem Daouk in the Journal of Finance, Vol. LVII, No. 1 (Feb. 2002)
  4. ^ Larry Harris, Trading & Exchanges, Oxford Press, Oxford, 2003. Chapter 29 "Insider Trading" p. 584
  5. ^ Larry Harris, Trading & Exchanges, Oxford Press, Oxford, 2003. Chapter 29 "Insider Trading" p. 589
  6. ^ Larry Harris, Trading & Exchanges, Oxford Press, Oxford, 2003. Chapter 29 "Insider Trading" p. 586-587
  7. ^ Insider Trading – A U.S. Perspective
  8. ^ Laws, at sec.gov
  9. ^ Laws, at sec.gov
  10. ^ Testimony, at sec.gov
  11. ^ Larry Harris, Trading & Exchanges, Oxford Press, Oxford, 2003. Chapter 29 "Insider Trading" p. 586
  12. ^ Christopher Cox, U.S. Securities and Exchange Commission Speech by SEC Chairman:Remarks at the Annual Meeting of the Society of American Business Editors and Writers
  13. ^ Law.com
  14. ^ Gross, Daniel. "Insider Trading, Congressional-Style", Slate, The Washington Post Company, 2007-05-21. Retrieved on 2007-05-29. 
  15. ^ Larry Harris, Trading & Exchanges, Oxford Press, Oxford, 2003. Chapter 29 "Insider Trading" p. 591-597
  16. ^ cato.org
  17. ^ Japanlaw.info
  18. ^ Objectives and Principles of Securities Regulation, IOSCO, May 2003
  • Stephen M. Bainbridge, Securities Law: Insider Trading (1999) ISBN 1-56662-737-0.
  • Larry Harris, Trading & Exchanges, Oxford Press, Oxford, 2003. Chapter 29 "Insider Trading" ISBN 0-19-514470-8.
  • Grechenig, The Marginal Incentive of Insider Trading: an Economics Reinterpretation of the Case Law, 37 The University of Memphis Law Review 75-148 (2006).
  • Grechenig, Positive and Negative Information - Insider Trading Rethought (http://ssrn.com/abstract=1019425).

Daniel Gross is a gay American author, and writes for Slates Moneybox column. ... Slate is an online news and culture magazine created in 1996 by former New Republic editor Michael Kinsley and owned by Microsoft (as part of MSN). ... The Washington Post Company is an American media company, best known for owning the newspaper it is named after, The Washington Post, and Newsweek magazine. ... Year 2007 (MMVII) is the current year, a common year starting on Monday of the Gregorian calendar and the AD/CE era in the 21st century. ... is the 141st day of the year (142nd in leap years) in the Gregorian calendar. ... Year 2007 (MMVII) is the current year, a common year starting on Monday of the Gregorian calendar and the AD/CE era in the 21st century. ... is the 149th day of the year (150th in leap years) in the Gregorian calendar. ...

External links

General Information

Articles and Opinions

Larry Elder Laurence Allen Larry Elder (born April 27, 1952 in Los Angeles, California) aka the Sage from South Central is an American libertarian-minded Republican (he has sometimes referred to his views as conservatarian) radio and former TV talk show host and author whose program The Larry Elder Show... Considered a founder of the Law and economics discipline. ...

Data on Insider Trading

  • SEC Edgar Database on current Form 3, Form 4 and Form 5 filings

  Results from FactBites:
Insider trading - Wikipedia, the free encyclopedia (1860 words)
Illegal insider trading in the US requires the participation (perhaps indirectly) of a corporate insider or other person who is violating his fiduciary duty to corporate shareholders by trading on or secretly relaying the corporation's information.
Insider trading is usually performed by the already wealthy, who can afford the best lawyers available and have the resources to drag a case out and cost the prosecutors millions along the way.
Insider trading can make markets more efficient by increasing the amount of information that is known about the company, and can motivate outsiders such as analysts to increase their knowledge about the company.
INSIDER TRADING (3016 words)
Insider trading is thus a prime example of the need to distinguish between the ethical and the legal: it is important to identify exactly what is wrong, so that appropriate action can be taken and legislation can be properly judged.
The immorality of insider trading is that information which belongs to the corporation (and thus ultimately to the shareholders), and which should in a business corporation be used to promote owner value, is instead misappropriated for the insiders' own interests.
Trading on information obtained by virtue of conscientious observation and analysis, or assiduous investigation, must be distinguished from trading on information acquired through a breach of confidence or theft.
  More results at FactBites »



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