Insider Trading Under the Microscope

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For those of us who don’t play the stock market, our experience with insider trading might be limited to the movie Wall Street. But for those who routinely invest—or even do so on occasion—it’s important to understand exactly what insider trading involves. Mainly so that it can be avoided.

Insider Trading Defined

Per the US Securities and Exchange Network (SEC), there are two types of insider trading: one is legal, the other illegal.

Legally, insider trading occurs when people on the inside of a corporation (such as employees, administrators, or officers) buy and sell stock within their own companies. As long as they report these trades to the SEC (and the trades are made based on public knowledge), they are considered legitimate.

Illegally, insider trading occurs when people buy or sell stock based on confidential information not available to the public. For example, if someone comes into possession of leaked information that Yahoo is merging with Google, and then goes and purchases shares of Yahoo before this info becomes public, they would be guilty of insider trading.

Under the law, illegal insider trading includes: employees and officers of a company who trade stocks after learning confidential information about corporate developments; friends, family, or business associates of the aforementioned employees and officers who act on confidential tips they have received; government employees who trade based on confidential information they learned through their jobs; and employees of law, banking, brokerage, and printing firms who act on confidential information they come into contact with through services they are offering the corporation in question.

The Prevalence of Insider Trading

According to Wharton College, insider trading is probably not a mainstay of the financial market, but it’s not exactly a rarity either. In fact, studies indicate that there are much more insider trades than there are cases prosecuted. A reason for this is that insider trading doesn’t always have a smoking gun. While emails, texts, and paper trails can help with prosecution, confidential information delivered via word of mouth is often impossible to prove.

It can also be difficult to prove that the stock trader knew the information was confidential in the first place. If someone on a bus or train overhears something about a merger, they could feasibly trade stock and then feign ignorance, claiming that they didn’t know the overheard information was not public knowledge.

For these reasons, the SEC is often forced to go after cases that they can prove, or those where a large sum of money was made as a result of the illegal actions.

Notable Insider Trading Cases

Insider trading has been in the news for decades, yet only some cases receive wide-spread attention. The following includes three cases that were reported on a national, if not international, level:

Mike Milken: According to the New York Times, Mike Milken earned $550 million in one year during the 1980s through insider trading. This number not only shocked those in his now-defunct firm Drexel Burnham Lambert, but it was also the talk of Wall Street. To put it into perspective, if he accomplished this in present day, he would have made $1.07 billion. Even when you take into consideration inflation, he made over five times more than the United States spent to purchase Alaska.

Raj Rajaratnam: In what prosecutors declared to be, as reported by the New York Times, the “biggest insider trading case in a generation,” Raj Rajaratnam was found guilty of 14 counts of security fraud and conspiracy. He was accused of making $63 million off of illegal information received from a variety of sources on Wall Street and throughout Corporate America.

Martha Stewart: While Martha Stewart didn’t make any money off of her insider trading—rather, she avoiding losing $45,673 dollars—her case made headlines because of her celebrity status. She sold her 3,928 shares after an assistant to her Merrill Lynch broker leaked her information about an imminent implosion of ImClone Systems. She was found guilty and sentenced to jail, where she likely decorated her cell quite nicely.

Byline

Morgan Woods is a freelance writer who specializes in Consumer Rights, Insider Trading, Criminal Defense, Constitutional Law and other associated topics.