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Insider trading – a brief FAQ

What do you think of when you hear the words “insider trading”? Quite likely, you think of white collar criminals who got wind of some juicy information, used it to make a killing in the stock market, then got caught and winded up in jail. But most insider trading is actually legal.

Corporate insiders trade stock all the time, and that’s good news for you if you get a job with a publicly traded corporation. It means you can still climb up the rungs to claim a position with a stock option and use those stocks to your advantage. You just need to know and follow the rules.

Who is an insider?

First, not everyone is an “insider.” The U.S. Securities and Exchange Commission (SEC) identifies corporate insiders as a company’s officers and directors, as well as anyone who owns at least 10% of a class of the company’s stock. These insiders need to follow special rules, reporting their acquisitions and sales of company stock, typically by filling out a form within two business days of the transfer.

When does insider trading become illegal?

According to the SEC, insider trading becomes illegal when it involves a breach of trust or fiduciary duty and is based on “material, nonpublic information.” The SEC generally presumes that insiders have a duty to ensure the markets remain a level playing field, so using insider information to gain personal wealth can serve as a breach of trust.

What is material, nonpublic information?

“Material” refers to anything that might influence the value of a stock or equity. “Nonpublic” information refers to any information not already made public. Some examples of material, nonpublic information include:

  • Unpublished quarterly earnings reports
  • Corporate strategies
  • Planned mergers or acquisitions
  • Upcoming changes in management
  • Investment plans

Do I need to be an insider to be guilty of illegal insider trading?

No. The law prohibits anyone from using material, nonpublic information to gain an unfair advantage. If you were to receive information about an upcoming earnings report from a corporate insider and then buy or sell stock based on that information, you could be tried for illegal insider trading.

Is it illegal to share insider information with my friends or relatives?

Yes. If your friends or relatives were to make purchases or sales based upon the material, nonpublic information you gave them, you could be implicated for “tipping” them.

What makes the government suspicious?

The government may become suspicious of trades when they recognize certain patterns:

  • Large purchases or sales prior to the public announcements of notable events
  • Purchases or sales made by individuals with little or no history of trading in the stock
  • Short hold times from purchase to sale
  • The profits derived from the trading

Should I avoid trading in my companys stock or equities?

The answer to this question depends upon many different factors, including your faith in your company. You do not want to break the law, and your company may also have its own policies for buying and selling company equities. But if you’re playing by the rules and can make a profit from your company’s stock, it might be to your advantage. Analysts have noted that insider trades tend to outperform other trades by a significant margin.

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