Insider selling and buying is the selling of shares or other instruments based on data that has not been disclosed to the public. It involves a breach of trust or fiduciary duty towards the public investors. The traders involved in insider selling and buying do it to get gains from such transactions. There have been several high-profile cases that have involved insider trading. But several investors still do not know what this is. You may be one of the people who may not know how insider selling and buying functions and why it is a crime to do so. Let us find out more about this in this article.
Insider trading occurs when a trader executes a trade in the financial markets based on data not presented to the public before the trade. In terms of the financial markets, this could be any detail that could affect a firm's share price. In a wider definition, any data that, if known, would affect the outcome of any plan of the trader to sell or purchase the instrument. Knowing this data gives the trader an edge when it comes to selling or purchasing shares. Only a few others have the same type of edge. So, it gives an undue advantage to them. In many scenarios, the investor or the trader must be an individual with a fiduciary duty to another entity, firm, partnership, corporation, institution, or person in the financial markets. Most of the people that are in the financial markets have such duties. This includes agents or brokers that execute trades on behalf of a client. You may have a fiduciary duty to another person. Then you can get into legal issues if you do insider selling and buying based on data that no other person has access to.
Insider data helps a trader get gains in various cases and avoid making a loss in the others. In any case, it is an abuse of the power or knowledge of that individual. It is not legal because it gives an undue benefit to traders involved in insider selling and buying. Traders who have access to such data have a great chance to create some money. But the people who do not hold the same data do not have equal chances of profit. The people found guilty of insider selling and buying include government officials, employees, and corporate officers. Any individual who tips off any person with insider data can also be charged and indicted. Such insider selling and buying can also take place when no fiduciary duty is involved. In such cases, the crime happens because another crime has happened. One such kind of crime may be corporate espionage. For instance, any organized crime might utilize certain legal or financial institutions to get access to private data.
The individuals involved may be found guilty of insider selling or buying if they are caught. They may also get convicted of various other charges for associated crimes. But not all types of insider selling and buying are considered illegal. Various factors determine whether the Commission will start any charges against any individual for insider trading. The major problems that the Commission must prove are that the individual had a fiduciary duty to the firm and that they planned to profit from the insider selling and buying of shares.
There are fines and time in jail associated with insider selling and buying. The activity can lead to one or the other of the options. But quite often, both are imposed on the individual who is found guilty. The particular fine hinges on how severe the case is. There may be several other results to a case also. These can be professional or financial, or both. The Commission also wants to ban those individuals who take part in trading violations from being a board member at any publicly traded firm. There have been several rules that have been developed to control the menace of insider selling and buying. There are some rules that permit it to some extent. When an insider purchases a firm's shares and sells them within half a year, all gains obtained from such a transaction must get to the firm. All directors, officers, and owners who have double-digit ownership percentages count as insiders in this situation.
A lot of the attraction gained from such type of trading is eliminated when the insiders cannot profit from small movements. The insiders of the firm must also disclose any modifications in the ownership of the positions. This includes all the shares that are sold and bought.
There was a time when insider selling and buying were not frowned upon. It was not termed illegal or a bad practice about a century ago. There was a time when a ruling from the Supreme Court said that it was one of the advantages of being an executive of a listed firm. But the practices related to trading in the financial markets came under the spotlight after the crash of the markets and the subsequent Great Depression. There were a number of court cases. So, new laws were created to curb this practice, and a significant amount of fines were introduced. But it was not until the passing of the Securities Exchange Act and the creation of the Commission that there was a legal body put in charge of developing natural laws around the problem. The Act did not completely prevent insider selling and buying. It did not properly define it also. But in a set of new regulations, the Commission was able to make some actions illegal.
Any fraud that happened due to a share sale was against the law. This rule was added to buying of shares also. This resulted in a piecemeal set of rules that were not easy to learn. So, there were some restrictions on what the Commission could do to act with the support of the new rules. But everything has changed since then. In the past few years, the reports from the Commission say that it has filed complaints of insider trading against numerous financial pros. The complaints have also been filed against hedge fund managers, corporate insiders, and lawyers.
There have been some insider selling and buying cases in the past. Some of them have happened in the past few decades. Barry Switzer was a football coach. He was prosecuted after he bought shares in Phoenix Resources. It was an oil firm. The coach was at a track meet when he overheard the executives talking about their plans to liquidate the firm. He purchased the shares at about forty dollars per share and later sold them off at nearly sixty dollars per share. He earned nearly a hundred thousand dollars in the process. But the charges against him were dismissed by a federal judge because there was an absence of incriminating evidence. It can be said that he got off easy. He might have been fined and also gone to jail if any player had been the ward of the firm's executive, and he would have received the tip from them. But here, the Supreme Court said that the tipper had not overlooked their fiduciary duty for personal profit.
Insider selling and buying in the financial markets involve selling or buying shares or instruments based on private data because of a violation of fiduciary duty or others' trust. The Commission can charge the people who get the data and the people who give it with charges of promoting insider trading. If the people involved in the process are found guilty, there could be heavy penalties that include jail time.