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But I thought “Insider Trading” is illegal…

2010-11-12 2 comments

The term “Insider Trading” is fairly well known from it’s somewhat ubiquitous presence in film and TV. In brief, Insider Trading is when someone with “inside knowledge” of a company (aka the “Insider”) profits from that knowledge by buying/selling shares in a company.

An example would be a scientist working for a pharmaceutical company that has developed a cure for AIDS. Obviously, the price of the company’s stock is going to go up once their cure is made available to the world. If this scientist knows about the cure but that knowledge has not been made public, the scientist is prohibited by law from buying a lot of shares in the company and thus profiting greatly once the information is released and the stock price soars. This would be an example of illegal insider trading. But in fact it is possible for insiders to trade stocks legally. In fact, it is common. Read on…

Legal Insider Trading

Many employees have stock in the companies that employ them. Those employees are free to trade that stock. This is perfectly legal and fairly common: As you read these words, somewhere in the world shares of some company have been bought or sold by employees of that company. Nothing wrong with that. These employees may be called “Insiders,” depending on who you ask. Typically, the officers and directors of a company are considered insiders.

Illegal Insider Trading

So what makes it illegal for insiders to trade stock in the company they work for? The key is Material Nonpublic Information. What the hell is that? Good question. As of this writing (2010-11-12), Wikipedia does not have an entry for Material Nonpublic Information, so it was necessary to look elsewhere (gasp!). According to LSU Law Center’s Medical and Public Health Law Site, Material Information is any information that would influence an investor’s decision to buy or sell securities. Nonpublic Information is information that is not available to members of the general investing public. Put the two together and what do you got? Any information (not available to the public) that would influence an investor’s decision to buy or sell securities. In this case, “public” essentially means “shareholders.”

So in our example above, the scientist who knows about the new AIDS cure would have to wait until the news was made available to the shareholders or to the public in general via a widely-read publication such as The Wall Street Journal. Only then could he legally trade the stock based on his inside knowledge.

Now you know: And knowing is half the battle. GI Jooooooeee…..

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