What is Insider Information?
Insider Information is a piece of fact, information or an understanding (M&A, New Contracts, R&D breakthrough , new product launch etc) which could impact the prices of a listed entity or publicly-traded organizations once disclosed in the public domain. Trading based on such information is considered to be illegal.
It is a challenging task to pronounce someone guilty only based on holding the insider information and trading in it. One of the most arduous tasks for the SEC is to prove that the person who gained benefits from insider tradingInsider TradingInsider trading is buying or selling the stocks of publicly traded companies based on confidential information acquired from direct or indirect sources, which will influence the security prices. It is stated as an illegal practice in many countries.read more is also responsible for some fiduciary duty in the organization whose shares have been used for unfair personal gain.
But, this could also be used for gains or averting losses in cases of creating or manipulation of various organizations or technical bugs to use or create a loophole in the system.
Explanation
- Every listed company has some information that comes to the public domain and would affect the price of equity in the market. For example, the announcement of dividendsDividendsDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company.read more, new product launches, heavy losses, new contracts, etc. could make the price of the security volatile. This information is available only to the persons involved in the day-to-day operations of the entity, or to those who have a deep connection in the organization such as directors, senior officers, accountants, and so on.
- Based on the undisclosed information, if somebody tries to make personal gains by trading in the securities of the entity, it is known as insider trading. These practices interfere with the free trade policies in the equities market and put other investors devoid of information at a disadvantage.
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For eg:
Source: Insider Information (wallstreetmojo.com)
Example
Few examples of insider trading are as follows:
- For instance, material information such as the finalization of a mergerMergerA merger is a voluntary fusion of two existing entities equal in size, operations, and customers deciding to amalgamate to form a new entity, expand its reach into new territories, lower operational costs, increase revenues, and earn greater control over market share.read more deal with another organization that would impact the profitability of the company in the future; thus, positive news for the stock market could be used to earn gains via stock purchase before the deal is announced in public.
- The launch of a new product that could boost up the sales of the organization and would add substantially to the bottom lineBottom LineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its bottom line. read more could also be termed as a piece of insider information if the entity concerned is a public company.
Legal Implications
To curb insider trading based on undisclosed information, Sec 16 of the Securities and Exchange Act, 1934, requires all the insiders, including senior personnel like directors, officers, and substantial equity holders of the company, i.e., holding of 10% or more is subjected to various regulations.
Any gain arose or losses averted due to the insider information within the 6 months should be deposited with the company’s account. This move has made even small benefits from malpractices in insider trading less advantageous. Also, owners of substantive equity holding who also chairs the management posts in the company need to report the transactions involving the purchase or sale of shares to the Security and Exchange Commission.
Insider Trading with Insider Information
- Insider trading denotes dealing in the share of the entity by persons (holding 10% or more of the corporation’s equity) in the equities market by surpassing the law of free trade and making profits or avoiding gains based on information not available to the general public. So, the high-level officers, directors, and owners with more than 10% holding come under the radar of insiders.
- Insiders could be charged for not just trading in security by using undisclosed information, but also when such communication is being communicated to other persons who could benefit from that.
- It is permissible to do trading by the insiders of the organization provided that the SEC is well-informed about the trades made by them.
- Insider trading is a criminal offense in the U.S, and heavy penalties with imprisonment could be imposed. The SEC (Securities and Exchange Commission is responsible for persecuting the persons involved in unfair trades based on inside information.
Conclusion
Insider information on itself is of no harm unless it is being used to manipulate the trading of a listed entity for undue gain and averting losses. Insider trading based on undisclosed information in the public sphere is tough to frame and prove the charges. Over the years, the law has become very stringent on such issues due to mass exploitation and public outcry, but still, it is unable to stop such incidents that are rampant in the corporate world.
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