Insider trading, as its name, is a transaction of a publicly traded company’s stocks with publicly undisclosed information. Accordingly, the factor causing it to be illegal is due to the trade malpractice using a non-public material information.
Material information refers to any influential information that significantly determine investors’ decisions to buy or sell the security. Meanwhile, by definition, non-public information means any information that is not legally available in public.
Considering the impact, insider trading is highly dangerous for it can result in an unfair trade and, at the same time, considerably jeopardize a particular company. However, despite that, insider trading can be legal under certain circumstances.
Also Read: A Short Anatomy of High-Frequency Trading
What Qualifies as Insider Trading
In some cases, what qualifies as insider trading is when the trader has a fiduciary duty to a particular person, company, or institution. A fiduciary duty is, in addition, a legal obligation a fiduciary owns to take care of a party’s property or money.
In another situation, insider trading can also happen when a fiduciary duty does not exist, but another crime occurs. A corporate espionage is one of the best examples to the situation.
In the beginning of 20th century, insider trading was legal. In the defense, it belonged to the benefit company execs possessed. However, a ban on it applied in the 1920s following a public controversy.
A Famous Case
In the world of trading, this crime occurs several times. Usually, when it happened, it always became the headline news in the national newspaper.
Among all the notorious cases, the most popular one is the 2003 case of Martha Stewart in the 2001 ImClone case. The Securities and Exchange Commission (SEC) charged Martha Steward with the obstruction of justice and security fraud, including illegal trading.
In short, Steward sold roughly 4000 shares of ImClone thanks to Peter Bacanovic, a broker at Merril Lynch. The trade happened when ImClone was waiting for Food and Drug Administration’s (FDA) decision on its cancer treatment.
Shortly after the CEO of ImClone sold all his shares, FDA rejected the drug and caused the company’s shares to drop 16% in just one day. Martha Steward’s early sale, however, saved her a loss of approximately USD 45.000.
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