20

I know that insider trading is illegal. However, is it true that the CEO of a listed company can still buy/sell their own stock? If he/she does so, isn't that technically insider trading? Or why is it different?

Even if people directly working for the company did not engage in insider trading, they will surely give "investment advice" to their friends and family.

Imagine that you are good friends with a few Fortune 500 company CEOs, and you own the stock of those companies. Every time you have coffee or dinner with one of your friend-CEOs, they might say something like "you know, I don't think our company is doing too well right now...", or "hey, we have something big coming up in the near future...".

Based on this indirect information, you could adjust your position in the stock and make profit when the news becomes public information and the stock price reacts. This kind of stuff must be going on all the time, right? Isn't this insider trading, and how can you ever prevent this?

  • 2
    I worked for a public company and regulation required that all employee freeze any trades on some dates (for example, a few weeks before end of fiscal year) unless they spoke to the financial officer or a delegate. – the_lotus Oct 30 '15 at 14:17
  • 3
    Possible duplicate of What constitutes illegal insider trading? – Nathan L Oct 30 '15 at 15:25
  • 6
    This is, of course, setting aside the fact that Fortune 500 CEOs would not say things like that because they don't like prison. – corsiKa Oct 30 '15 at 16:54
  • I was in a company meeting once where someone asked the CEO a very specific question, and the answer was "if you want to know, you can come to my office after the meeting and I will tell you, but I'll have to take your name down and you won't be allowed to trade. " – gnasher729 May 5 at 18:11
33

Insider trading is any trading done on material non-public information relating to an instrument.

If my sister, who works for a drugs testing company, tells me that stage 3 trials of a drug look like they will fail and I trade on that information (probably by shorting a company's stock) that is insider trading. If an employee of that firm trades on that same stock knowing that the trials are likely to fail that is too. If an employee of that company trades on the stock without knowing that information that is NOT insider trading.

If I know from an insider I met at the pub that a large orange producer has seen a fall in production due to a blight and I trade on oranges futures, even though I am not directly trading in the stock it is still insider trading.

I mentioned that the information must be material, that means that it must have the potential to move the market; if I know that a firm is going to increase profits by 10% this year it is not material if analyst expectations are for a similar rise.

You are right that small scale insider trading, such as by employees and their families, is relatively unregulated and unchecked but directors and C-level employees of a firm are required to publish all and any dealings that they have in the stock and several have been caught and penalized for insider trading.

edit: http://www.sec.gov/spotlight/insidertrading/cases.shtml details some cases, many involving director and C-level employees, that the SEC has prosecuted recently.

Incidentally I work in financial fraud monitoring and we use an analytic based on previous days' trades and today's news (i.e. when the information becomes public) to identify traders who might either be indulging in or receiving orders to trade on insider information. Essentially this works by looking for large changes in position against an instrument that later has material information releases relevant to it.

One final thing to think about: given that being caught will generally cause perpetrators to go to prison and be banned from director level jobs and/or trading for life as well as a large, life-changing fine and a massive loss of reputation not many people with insider information want to risk trading on it, myself included.

  • 1
    +1 but the OP was also interested in how directors and C-level employees are able to trade their company's stock legally. – Eric Oct 30 '15 at 13:27
  • 1
    By not trading on material information that may move the price that isn't public. That usually means trading after material information becomes public or receiving stock as part of remuneration which is awarded by shareholders at the AGM. Basically by not doing anything detailed above – MD-Tech Oct 30 '15 at 13:30
  • 2
    @Eric several companies have a silent/quiet period enforcement for self-regulated public (those with access to insider information), usually before quarterly reports are published. During this period, all self-regulated employees and executives are barred from trading the own company papers. – Mindwin Oct 30 '15 at 13:47
  • @Mindwin I'll consider adding that to the answer. – MD-Tech Oct 30 '15 at 13:48
  • 4
    Don't forget that it is perfectly fine for congress people to trade on anticipated regulations that aren't yet public. For example if it is likely that a new bill would impose great cost to some industry they can short that industry without running afoul of any law. Why can they do this? Because they're the people that make the laws and they've chosen not to make that activity illegal. – Dean MacGregor Oct 30 '15 at 15:32
4

The CEO of a public company can, and often does, buy (and sell) the stock of his company. In fact, frequently the stock of the company is part of the compensation for the CEO. What makes this legal and fair is that the CEO files with the SEC an announcement before he buys (or sells) the stock. These announcements allow us 'in the dark' people enough warning ahead of time. See, for example, the trades of UTX stock by their public officers.

As for trading on information about other companies, if I am not mistaken... that is why Martha Stewart wound up in prison. So, yeah, it does happen. I hope it is caught more often than not.

On a related note, have you seen the movie 'Wall Street' with Charlie Sheen and Michael Douglas?

  • 1
    Another movie where insider trading is central to the plot is 'Trading Places' with Dan Aykroyd, Eddie Murphy and Jamie Lee Curtis. (yeah, I like movies about the stock market). – Jack Swayze Sr Oct 30 '15 at 9:46
  • 7
    Note that Martha Stewart was convicted of obstruction of justice, not insider trading itself. – wrschneider Oct 30 '15 at 14:22
  • Your link doesnt work. – JonH Oct 30 '15 at 19:10
  • #1 I did not add the link,someone else did, but I approved their edit. #2 I just tried it (on my phone) and it does work. Try again? – Jack Swayze Sr Oct 30 '15 at 21:22
  • In one of the Tom Clancy books, the directors of a company try to get around insider trading laws by publishing some very good news in a really, really, obscure publication. Which the hero of the book reads and the trades, making tons of money. – gnasher729 May 5 at 18:23
2

One scenario described in the original question -- a non-insider who trades after informal conversations with friends, where no insiders directly benefit from any such disclosure -- might not be illegal. (IANAL -- this is just my personal interpretation of articles in the news recently.)

http://www.bloomberg.com/news/articles/2015-10-05/insider-trading-cases-imperiled-as-top-u-s-court-spurns-appeal

the appeals court said prosecutors needed to show that the person disclosing the information received a clear benefit -- something more than the nurturing of a friendship ... In a 1980 case the Supreme Court rejected the idea of “a general duty between all participants in market transactions to forgo actions based on material, nonpublic information."

2

I believe executives place stock on auto-sell, meaning it's sold on a regular pre-specified schedule. I've seen executives usually only relinquish larger positions when an all-time high is reached (eg., positive results on trial of lead drug candidate), at time of retirement, or when leaving the company for another position. This otherwise sends a negative signal to investors, and they'll hear about it from investment banking analysts that cover the company.

At the small and mid-cap biotech companies in which I've worked as low level manager, selling stock felt like issuing a no-confidence vote or suggested some failure to manage my personal finances. I usually had to attest in writing that I was not in possession of material, non-public information. This would then need to be approved by our GC and CFO. Other depts were placed on a blackout period before earnings or major news.

The SEC will scrutinize holdings that are changed before major news or movement. I'm not sure of how this plays out, but they company will be presented with a list to see if anyone with the material information knows those stock holders. And yes, they once connected the dots between some middling employee and his college roommate who secured a large position with questionable timing.

Not sure if the days of getting a hot stock tip on the chair lift at Vail are totally over, but I'd be afraid of having to explain those trades, even if I bought and sold stocks daily.

-1

Using inside sensitive information about corporate and using the same to deal in securities, before the exchanges are made aware of the information.

Its mostly used in derivatives to get maximum returns on investmens, but Its illegal in all the exchanges

  • actually it doesn't matter whether the exchange knows about the information so long as it is "public" - definitions of public differ but they include times when the exchange itself wouldn't be involved. information does not need to be sensitive either; it must be material but in many cases it will be data that is about to be released such as company reports. – MD-Tech Oct 30 '15 at 15:08

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.