Insider trading is the buying and selling of stocks by people who have inside information about a company where that material information is not known to the public and which will probably have a significant effect on the price of the stock when the information becomes generally known. Insiders include the corporation's directors, officers, managers, and other employees, and also any people with inside information because of their relationship with the company, such as technicians, auditors, and suppliers, and anyone who owns more than 10% of the outstanding stock, and any of the relatives of these people.
Insider trading is prohibited by the Securities Exchange Act of 1934 (SEA) to prevent unfair profits by corporate insiders at the expense of the public. It also requires that:
- corporate insiders must report any change in their holdings of company stock within 10 days after the end of the month in which there was a change;
- insiders are not permitted to sell short their company stock;
- stockholders are entitled to recover any speculative short-swing profits or losses avoided within a 6 month period because of insider trading.
The Insider Trading Sanctions Act of 1984 (ITSA) amended the SEA to give the Securities and Exchange Commission (SEC) the authority to ask the courts to impose penalties on inside traders and on those who passed material inside information to 3rd parties of up to 3 times the amount of gains or losses avoided because of the trades. The maximum criminal penalty was also increased from $10,000 to $100,000.
The Insider Trading and Securities Fraud Enforcement Act of 1988 extended ITSA to include punishment of controlling persons of the corporation who could have or should have prevented insider trading by the corporation's employees. It also expanded the SEC's authority to provide assistance to foreign regulators by allowing it to use its compulsory powers to compel testimony and production of documents to obtain information at the request of a foreign securities authority.