"I lost a fortune!” – Martha Stewart
What you probably do know about insider trading: It is the illegal act of buying and/or selling securities (stock, bonds, options) by someone who has access to material, non-public information about the company whose securities are being bought and/or sold. Governed primarily by the Securities and Exchange Commission, the United States government considers this a very big no-no due to its harmful effects on public confidence, temptations on officers and managers and its unfair allowance to, with certainty, profit off of good news and bad.
What you might not know about insider trading
It can be legal, sometimes. The “sometimes” is dependent on when the person with insider information actually acts upon that information by buying and/or selling securities. For example, if you are on the board of your buddy’s publicly traded bioengineering firm, and just received information that the firm has definitively created a medicine that kills cancer cells specifically, thereby negating the necessity of chemotherapy, and you go ahead and pour your entire retirement in his company’s stock before it publicly announces this medicine next week; then you and Martha Stewart will have similar stories to tell in jail. However, if you do the exact same thing one hour after the company’s public announcement, all is (most likely) well.
Who is an “insider?”
Is insider status reserved to only employees of a company? Not necessarily. In 1984, the Supreme Court, under Dirks v. SEC, established that a “tippee,” one who has received insider information and acts on such information, is usually a manager or other employee of a company, but can also be a friend or family member of the “tippor” if that person discloses insider information before it is publicly disseminated. So even if your brother recently informed you of something his company is about to announce, you would be considered a tippee and could be guilty of insider trading if you choose to invest before the public announcement.
To clarify, just because one has insider information does not mean one is guilty of insider trading. One must act upon the information for there to exist an illegal activity. In Dirks, the Supreme Court established a two-part test in order to determine whether someone who qualifies as a tippee is actually guilty of insider trading:
- Whether the individual breached the company’s trust.
- Whether the individual did so knowingly.
Which types of companies can get in trouble?
The rules governing insider trading are reserved for publicly traded companies because only publicly traded companies are governed by the SEC. As always, there are certain exceptions for non-publicly traded companies and their registration under the SEC (Regulation D, non-public offering exemption). Nevertheless, don’t be surprised to see or hear about a non-publicly traded company getting into trouble for something that is similar to insider trading. The principles will be the same: Someone acted upon material, non-public information, thereby breaching their fiduciary duty to the firm or commitment under the operating agreement.
Did you know “poop” is a colloquial term used to describe information that is considered non-public? Poop can also refer to people who have insider information.