Insider Trading

Insider Trading

One of the greatest investors of all time, Peter Lynch, was noted as saying that "insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise" (Macey).

"Insider trading" is a term that most investors have heard and usually associate with illegal conduct. But what most investors don't know is that it includes both legal and illegal conduct. Legal insider trading is when corporate insiders--officers, directors, and employees--buy and sell stock in their own companies. When corporate insiders trade in their own securities, they must report their trades to the SEC.

Proving that someone has been responsible for insider trading can be difficult. Traders are sometimes able to hide behind nominees, offshore companies, and other agents. Nevertheless, the SEC prosecutes over 50 cases each year, with many being settled out of court. The SEC and several stock exchanges actively monitor trading, looking for suspicious activity. One way that the SEC is able to get people to provide information that leads to the recovery of a civil penalty from those who violate the insider trading laws is to pay a bounty. With some exceptions, the SEC is permitted to award a bounty from the civil penalties actually recovered from violators. The limit for the bounty pay out is ten percent of the penalty.

The SEC has complete discretion in whether or not to pay a bounty, the amount of the payment, and to whom the payment would be made. The SEC is not authorized to pay bounties for information about any other securities laws excluding insider trading.

Illegal insider trading, as defined from the official SEC website, "refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security." Insider trading violations may also include "tipping" such information, securities trading by the person "tipped," and securities trading by those who misappropriate such information.

As stated earlier insider trading is something that includes both legal and illegal conduct (SEC). First off, let's discuss the legal variety of insider trading. Legal insider trading is when corporate insiders buy and sell stock in their own companies based on material and information that has already been made public. Insiders legally buy and sell stock in their own company all of the time. Their trading is limited and illegal only at certain times and under certain conditions (Macey). According to the SEC, corporate insiders include a company's officers, directors, employees and any beneficial owners of more than ten percent of a class of the company's equity securities registered under Section 12 of the Securities Exchange Act of 1934. In addition to corporate insiders having to file with the SEC a statement of ownership regarding their securities, corporate insiders must also report their trades to the SEC when they buy and sell their own securities (SEC). Insiders are required to report their insider transactions within two business days of the date the transaction occurred. Previously, before the 2002 Sarbanes-Oxley Act it used to be the tenth day of the following month (SEC).

Any changes in insider holdings are sent to the SEC electronically as a Form 4, which details a company's insider trades or loans. A Form 14a, also filed by the company, lists all the directors and officers along with the share interest they have (SEC). Insiders must file a Form 5 to report any transactions that should have been reported earlier on a Form 4 or were eligible for deferred reporting. If a Form must be filed, it is due 45 days after the end of the company's fiscal year. The SEC also mandates to companies that run websites to now post the forms by the end of the next business day after filing them with the SEC. In addition to the filing, insiders can not buy or sell their company stock for a six month period, meaning that insiders only buy stock when they feel it will do well over the long term.

These forms, filings and other insider information have value to individual investors. Additionally, with all the advancements in technology these days, all this information is getting easier and easier for investors view. If an investor goes online and notices insiders are buying shares in their own companies, they usually know something that everyday investors don't. They could be buying because they see good things to come, a merger, acquisition or because they think their stock is undervalued (Macey). For years, professional and novice investors have been basing their investing on what insiders do, but they should be aware of some of the patterns they see, because in some instances companies can have hundreds of insiders or companies