Insider Dealing

Published Apr 29, 2024

Definition of Insider Dealing

Insider dealing, also known as insider trading, refers to the buying or selling of a publicly-traded company’s stock by someone who has non-public, material information about that stock. Insider trading can be legal or illegal depending on when the insider makes the trade; it is illegal when the material information is still non-public, and this illegal activity can lead to severe penalties.

Example

Imagine an executive at a pharmaceutical company knows that a new drug is going to be approved by the government. Before this information is released to the public, the executive buys a significant amount of stock in their own company, predicting that the stock price will rise once the drug approval is publicized. This constitutes illegal insider dealing, as the executive used confidential, material information to make a profit or avoid a loss in the stock market.

On the other hand, if the executive waited until the drug approval was announced to the public before buying the stock, this would be considered legal trading, as the information used to make the trade is public and not material non-public information.

Why Insider Dealing Matters

Insider dealing matters because it undermines investor confidence in the fairness and integrity of the securities markets. Illegal insider trading is seen as unfair because insiders can take advantage of proprietary information to gain an unfair advantage over the general investing public, who do not have access to this information. This can lead to a lack of trust in the financial markets and can deter investment. Regulating and monitoring insider trading activities are crucial for maintaining market integrity and protecting investors.

Frequently Asked Questions (FAQ)

What are the penalties for illegal insider trading?

Penalties for illegal insider trading can be severe and include both civil and criminal punishments. Civil penalties can include fines of up to three times the profit gained or loss avoided from the illegal trading, while criminal penalties can include fines up to $5 million and prison terms up to 20 years for individuals, and fines up to $25 million for non-individuals.

How do regulators detect insider dealing?

Regulatory bodies like the U.S. Securities and Exchange Commission (SEC) use sophisticated surveillance techniques and analytical tools to detect suspicious trading patterns and investigate potential insider dealing cases. This can include the analysis of trading volumes before significant announcements and the investigation of individuals with access to material non-public information.

What is considered “material” information?

“Material” information is any information that could influence an investor’s decision to buy or sell the stock. Examples include non-public earnings reports, news of a pending merger or acquisition, or the development of a significant new product. The information is considered material if its public disclosure is likely to affect the company’s stock price.

Can insider dealing ever be legal?

Yes, insider trading can be legal if it is done in a way that does not exploit non-public, material information. Insiders are allowed to buy and sell stocks in their own companies if they report these trades to the appropriate regulatory authorities, like the SEC in the U.S., and do so during designated trading windows that typically follow the public release of the company’s financial performance.

What measures are in place to prevent insider dealing?

To prevent insider dealing, companies often implement policies that restrict trading by insiders to certain windows of time, usually after the public disclosure of financial performance. Additionally, insiders are required to report their trades to regulatory authorities. Moreover, regulatory agencies continuously monitor trading patterns and investigate suspicious activities to enforce laws against illegal insider trading.

Insider dealing remains a critical factor in the management and regulation of securities markets, with ongoing efforts from regulators, companies, and investors to safeguard fairness and transparency, ensuring the markets remain open, orderly, and efficient.