Difference Between Legal & Illegal Insider Trading

A person can be guilty of illegal insider trading for providing an insider stock tip to another person.

A person can be guilty of illegal insider trading for providing an insider stock tip to another person.

You've done it -- landed that dream job you've wanted ever since college, and in addition to the window view that you get to enjoy each day you're also offered a stock options package that lets you buy shares of the company for a discount. You're going to be involved in key changes at the organization, which means you'll have a better gauge than most as to the financial health of the business. Now that you've got reason to be concerned, you may be surprised to learn of the fine line that exists between legal and illegal insider trading.

Overview

Insider trading rules are meant for corporate insiders, such as management officials and employees, in addition to anyone else with access to nonpublic information about a publicly traded company. Considering that insiders know more about a company than others, they must follow a protocol for trading shares so that they don't unfairly profit from their position. A securities law allows company officials to schedule their stock market trades in advance so as not to give the impression of improprieties. Blatant illegal insider trading occurs when someone uses news others aren't privy to as a means to profit in the stock market, or when someone helps a select group of others to make favorable trades in the stock market from the secret. Illegal insider trading isn't always so black and white, however.

Water Cooler Talk

You may be privy to information shared in private meetings or just pick up on scuttlebutt around the water cooler at work. You may be tempted to buy or sell shares of your company's stock based on that knowledge or even share the news with your sister, who can then profit form the information. If you or your sister profits from the news, you could both be in violation of securities laws. In 2013, individuals who were involved in similar scenarios were discovered by regulators and were not only forced to give up the profits they earned but also pay thousands of dollars in penalties, according to a 2013 article in "The New York Times."

Social Media

Your company just passed a major milestone and you had a role in the accomplishment. You're proud and you want to tell all of your friends about the success on your social media web page. Be careful, though. That's exactly what Reed Hastings, the chief executive officer of Internet streaming company Netflix decided to do in the summer of 2012 when, instead of making a public announcement he only shared news of a significant company development with his friends on Facebook. The stock price rose 13 percent shortly following the social-media update. Regulators caught wind of the incident and launched an investigation to determine whether or not Hastings was in violation of the law.

Consequences

Among the harshest consequences of legal insider trading is losing profits that could have otherwise been earned. For example, corporate executives who sold shares of their stock in the years preceding the Dow Jones Industrial Average's climb to the significant milestone of 14,000 in 2013 missed out on millions of dollars in profits as a result, according to a 2013 CNBC report. The consequences for illegal insider trading are even more life-altering. Illegal insider trading can cause financial professionals to lose their securities license, which means they cannot resume a career in financial services. Insider trading can also lead to criminal penalties. Participants in a 2011 high-profile hedge fund insider trading ring were sentenced to prison terms ranging from one to 11 years

About the Author

Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.

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