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 the insider trading 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 dividends, 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.

Example

Few examples of insider trading are as follows:

For instance, material information such as finalization of a merger 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.
Launch of a new product that could boost up the sales of the organization and would add substantially to the bottom line 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, for owners of substantive equity holding who also chairs the management posts in the company, needs to report the transactions involving purchase or sale of shares to the Security and Exchange Commission.

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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 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.

Insider Information