Insider trading

If you’ve paid any attention to the finance industry, you’ve heard of insider trading. By definition, insider trading involves trading on material, non-public information. Material information is any information that can drive someone to make an investment decision. Non-public information is not widely available or disseminated.

Insiders of publicly traded companies have access to significant amounts of material non-public information. For example, the executives at a large biotechnology company will know about a new medical product prior to releasing it publicly. If the product was groundbreaking, the executives could buy a bunch of stock prior to its release. Once the product is announced publicly, the demand and price of the stock would increase, creating a significant profit for the insiders.

This would be a big problem if the SEC found out. Insiders can discuss and obtain insider information, but cannot trade on it. As soon as a trade occurs, the person providing the insider information (the tipper) and the person receiving and trading on the insider information (the tippee) are subject to serious consequences.

Regardless of the size of the profit made or the loss avoided, the SEC takes insider trading very seriously. In civil court, perpetrators can be sued for up to three times the profit achieved or loss avoided. Known as “treble damages,” any investor in the security at the time of the trade (known as contemporaneous traders) can sue those responsible for insider trading for up to this amount.

Criminal charges and fines can also be levied against those found guilty of insider trading. If a person is caught, they could be fined up to $5 million and sent to jail for up to 20 years. When the problem is widespread across a financial firm, the firm can be fined up to $25 million. Collected fines are typically distributed to the SEC’s Fair Fund, which holds and distributes money to victims of financial fraud.

If a registered representative receives what they believe is inside information from a customer, they should inform a supervisor promptly. Additionally, it is imperative the representative avoid using the information for their own personal gain, as they could be liable for some of the penalties mentioned above. Remember, both the tipper and tippee can get in trouble!