Insider Trading: Legal and Illegal

Understanding insider trading rules protects you legally and helps you interpret insider transactions as investment signals. [DEFINITION] Insider Trading: The buying or selling of a security by someone with access to material, non-public information about that security. Legal insider trading requires proper disclosure; illegal trading involves misusing private information. ### Legal vs Illegal Insider Trading **Legal insider trading:** - Executives buying/selling company stock - Reported to SEC within 2 business days (Form 4) - Publicly disclosed and tracked - Subject to trading windows and blackout periods **Illegal insider trading:** - Trading on material, non-public information - Tipping others to trade on such information - Includes friends, family, or anyone receiving the tip - Punishable by fines and imprisonment [EXAMPLE] Legal: CEO buys $500,000 of company stock and files Form 4. This is publicly disclosed and often signals confidence. Illegal: CEO's friend buys stock after CEO tells him about unannounced positive earnings. This is securities fraud. ### Who Is an Insider? Legal definition includes: - Officers (CEO, CFO, COO, etc.) - Directors (board members) - Employees with material information - Anyone with 10%+ ownership - Anyone who receives material non-public info [KEY] It's not just company employees. If your neighbor tells you his company is being acquired (non-public info) and you trade, you've committed insider trading. ### Tracking Legal Insider Transactions SEC Form 4 filings reveal: - Who bought or sold - How many shares - At what price - Type of transaction (open market, option exercise, gift) [TIP] Focus on open market purchases where insiders spend their own money. Option exercises and sales to cover taxes are less meaningful signals. ### What Insider Buying May Signal **Positive signals:** - Cluster buying: Multiple insiders buying together - Large dollar amounts relative to salary - Buying during market weakness - CEO/CFO purchases (they know most about financials) **Less meaningful:** - Automatic purchase plans (10b5-1 plans) - Buying through options or grants - Token purchases ($10,000 by a billionaire) ### What Insider Selling May Signal [WARNING] Insider selling is harder to interpret. Insiders sell for many reasons: - Diversification (their wealth is concentrated) - Life events (buying a house, paying taxes) - Scheduled sales (10b5-1 plans) - Genuine concerns about the company (rare) ### Researching Insider Activity Free resources: - SEC EDGAR (official filings) - OpenInsider.com - Finviz (insider tab on stock pages) - Yahoo Finance (holders tab) [EXERCISE] You see that a company's CEO, CFO, and two directors all bought stock in the open market last week totaling $2 million. The stock is down 20% from its high. What might this signal? |ANSWER| This is a strong bullish signal: 1) Multiple insiders buying (cluster), 2) Open market purchases (using their own money), 3) Significant dollar amount ($2M), 4) Buying during weakness (confidence the decline is overdone). While not guaranteed, this pattern often precedes positive developments. [SCENARIO] You work at a tech company and overhear executives discussing an unannounced acquisition. You tell your brother, who buys stock. What are the legal consequences? Both you and your brother could face SEC enforcement for insider trading. You "tipped" material non-public information; he traded on it. Penalties can include: civil fines up to 3x profits gained, criminal fines up to $5 million, and prison sentences up to 20 years. The SEC actively investigates unusual trading before announcements.