Insider trading can mean that a person buys or sells stock based on information that is not available to the public. The person may be a corporate officer, director employee or someone who has received the non-public information. Insider trading can be legal if the trading occurs on the basis of information which is available to the public.
The Securities and Exchange Commission explains that while most people hear the words "insider trading" and think of the illegal act, "insider trading" can also be legal under some circumstances. Examples of insider trading that are legal include:
- A CEO of a corporation buys 1,000 shares of stock in the corporation. The trade is reported to the Securities and Exchange Commission.
- An employee of a corporation exercises his stock options and buys 500 shares of stock in the company that he works for.
- A board member of a corporation buys 5,000 shares of stock in the corporation. The trade is reported to the Securities and Exchange Commission.
Illegal insider trading is very different than legal insider trading. A person who engages in illegal insider trading may work for the company that he buys the stock for, but does not necessarily have to. The key is that the person who buys or sells the stock acts on insider information (not public information) in violation of the law.
- A lawyer representing the CEO of a company learns in a confidential meeting that the CEO is going to be indicted for accounting fraud the next day. The lawyer shorts 1,000 shares of the company because he knows that the stock price is going to go way down on news of the indictment.
- A board member of a company knows that a merger is going to be announced within the next day or so and that the company stock is likely to go way up. He buys 1,000 shares of the company stock in his mother's name so he can make a profit using his insider knowledge without reporting the trade to the Securities and Exchange Commission and without news of the purchase going public.
- A high-level employee of a company overhears a meeting where the CFO is talking about how the company is going to be driven into bankruptcy as a result of severe financial problems. The employee knows that his friend owns shares of the company. The employee warns his friend that he needs to sell his shares right away.
- A government employee is aware that a new regulation is going to be passed that will significantly benefit an electricity company. The government employee secretly buys shares of the electricity company and then pushes for the regulation to go through as quickly as possible.
- A corporate officer learns of a confidential merger between his company and another lucrative business. Knowing that the merger will require the purchase of shares at a high price, the corporate officer buys the stock the day before the merger is going to go through.
These are some of the many examples of insider trading that occur. Insider trading is a white collar crime and a person who has been found guilty of insider trading can be sent to prison.