Insider Trading

The practice of buying and selling securities on the basis of information that is not available to the public is known as insider trading.  It is illegal and, because it violates principles of fairness, it is also immoral.

The U.S. Securities and Exchange Commission (SEC) identifies detection and prosecution of insider trading as an enforcement priority, explaining that  “[b]ecause insider trading undermines investor confidence in the fairness and integrity of the securities markets, the SEC has treated the detection and prosecution of insider trading violations as one of its enforcement priorities.[1]”

Indeed, the basis of the illegality and immorality of insider trading is that it undermines the fairness; since insider traders make transactions with the use of information of information that is not available to others, critics of insider trading argue that those transactions are inherently unfair.  By undermining investor confidence in the fairness and integrity of the market, insider trading also has detrimental practical consequences.

The SEC lists a number of examples of insider trading cases, including[2]:

• Corporate officers, directors, and employees who traded the corporation’s securities after learning of significant, confidential corporate developments;
• Friends, business associates, family members, and other “tippees” of such officers, directors, and employees, who traded the securities after receiving such information;
• Employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded;
• Government employees who learned of such information because of their employment by the government; and
• Other persons who misappropriated, and took advantage of, confidential information from their employers.

Some insider trading apologists argue that the practice should be legal, claiming that no harm comes from the practice and that it can be beneficial for individual companies as well as the market at large.

These arguments in defense of the legitimacy of insider trading have gained little traction.  Indeed, SEC and European regulators have increased their efforts to crack down on insider trading in recent years.  High profile cases, such as the Raj Rajaratnam insider trading case of 2009, demonstrate this fact.  At the same time, they highlight the need for better oversight.

[1] http://www.sec.gov/answers/insider.htm

[2] http://www.sec.gov/answers/insider.htm