subject: Understanding Insider Buying And Selling [print this page] Just a few days ago, Rajat Gupta former managing partner of McKinsey and director at Goldman Sachs and P&G, was convicted by the U.S. federal jury of leaking inside information to hedge-fund manager Raj Rajaratnam. Out of the 68 insider-trading cases since 2009, following a nationwide crackdown into illicit information trafficking, the federal prosecutors have scored 62 convictions. Guptas, by far, is the most prominent. Such developments, of late, have really brought the securities fraud, conspiracies and the ugly underbelly of the financial world, into the limelight. In this article we touch up the basics of insider buying and selling. And though the term is frequently used to refer to illegal practices currently, it is performed legally as well. Insider trading is also relevant to common traders, who mostly do not have links to companys top brass or key insiders. Though the fact is not totally implausible but there are ways a common trader can legally benefit by following moves of insider traders. In any case, investor awareness about some general facts and rules should help to identify or keep off the illegal aspect of this practice.
Insider trading can be broadly defined as buying or selling of a security by someone who has access to material nonpublic information about the security. It can be legal and illegal depending on when the insider or an affiliate of the insider makes the trade. The defining line between whats legal and whats not is based on the simple premise that trading while having special knowledge is unfair to other investors who do not have access to such knowledge.
In view of that, illegal insider trading is a practice when corporation insiders such as the officers, directors, key employees, and large shareholders conduct trades in the companys stock based on material nonpublic information. These trades are considered to be fraudulent as the insiders are violating the fiduciary duty that they owe to the shareholders. However, insiders are not just limited to company officials or large shareholders but also includes any individual who trades based on the material nonpublic information. For example, lets say a corporate insider tips a friend about nonpublic information that is likely to have an effect on the companys share price, the duty that the insider owes to the company is now imputed to the friend and the friend violates a duty to the company if he or she trades. The insider, in the example, is liable for trading violations by passing on the nonpublic information. While this illegal practice is a vast subject and has several counts under which one can be booked, misappropriation theory in one of the newer views of insider trading and is now part of the U.S. law. According to the theory anyone who misappropriates, on in other words steals, information from their employer and trades on the information in any stock, i.e. either the employers stock or the companys competitor stocks, is guilty of insider trading.
Moving on, to ensure that trading is done in a way that does not take advantage of nonpublic information, market regulators in most countries apply special trading rules and restrictions that the corporate insiders are required to abide by in order to perform legal insider trade. Legal insider trading is a very common, as employees of publicly traded companies usually have stocks or stock derivatives. Mostly all insider buying or selling is legal once the material information has been made public, at which time the insider has no direct advantage over other investors. In the United States, SEC, however, still stipulates all corporate insiders to report their transactions, usually within a few business days of the trade. These fillings mainly include form 4, whereby these trades are made public.
From an investors point of view, these trades can give important cues about the stocks future. Many investors mimic insider traders as they believe corporate insiders may have better insight into the health of a company and that their trades otherwise convey important message. So as the bottom line, insider trading is not just illegal, it is in fact a very common legal practice from which a common investor can also benefit. Therefore, it may be wise for an investor to look into summaries of these trades to analyze how insiders are legally trading their stock.
