DEFINITION
The buying or selling of a security by someone who has access to material, nonpublic information about the security.
Insider trading is the trading of a public company’s stock or other securities by individuals with access to nonpublic information about the company. In various countries, trading based on insider information is illegal. This is because it is seen as unfair to other investors who do not have access to the information as the investor with insider information could potentially make far larger profits that a typical investor could not make.
How it works:
Insider trading can be legal or illegal depending on if the information used to base the trade is public.
It is illegal when the material information is still nonpublic–trading while having special knowledge is unfair to other investors who don’t have access to such knowledge. Illegal insider trading therefore includes tipping others when you have any sort of nonpublic information. Directors are not the only ones who have the potential to be convicted of insider trading. People such as brokers and even family members can be guilty.
Insider trading is legal once the material information has been made public, at which time the insider has no direct advantage over other investors. The SEC, however, still requires all insiders to report all their transactions.
For example, an executive of Company XYZ who purchases shares of the company based on a pending merger announcement is engaging in illegal insider trading.However, once Company XYZ has announced the merger publicly, insiders may legally trade the shares based on the information.
