Although the term insider trading has a bad connotation, it is legal when SEC rules are followed and transactions are displayed on the company’s website and submitted electronically in a timely basis. One example of legal insider trading is Michele Buck, the CEO of Hershey’s, who openly discloses all insider trading activities per SEC guidelines. As a director and major stock owner, she openly discloses all her stakes, transactions, and change of ownership of company stock.
Shareholders of the company should understand insider trading to protect themselves and their interests. To the average investor, insider trading invokes images of shady board members and directors who jump the sinking ship without alerting all the passengers and crew on board. Such an action results in the loss of funds for everyone that didn’t know the current condition of the company.
Although insider trading has been used in this manner which is illegal, there are still legal ways to trade as long the directors conform to the SEC rules and regulations.
What is insider trading?
Insider trading is the buying and selling of company stock by a person who has information about that stock. This person is a non-public person such as a CEO or Director within the company.
How can it be illegal?
It’s illegal for the non-public person to trade company stocks based on information that the company hasn’t made public to their investors. This information refers to any information that could greatly impact the stock price. This gives them an unfair advantage and usually results in terrible outcomes for the public and investors.
If proved, the individual faces fines and jail time.
How can it be legal?
The SEC aims to maintain a fair marketplace and created these rules to ensure that all participants are protected and no one has an unfair advantage over others. As a result, stocks are legally traded every week.
In order to maintain legal insider trading, company executives have to report their trades to the SEC on a weekly basis or in a timely manner. These reports disclose transactions of the company stock. All directors and major shareholders have to disclose their transactions, ownership, and change of ownership in the company stock to remain compliant.
Illegal insider trading as defined by the U.S. Securities and Exchange Commission (SEC) is defined as, “The buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material nonpublic information about the security.”
How does a company executive remain compliant? By not acting on material that could impact an investor’s decision to buy or sell the stock based on their access to non-public information, which is information not legally available to the public.
Company executives should not be privy to stock information and should not be tipping others of this non-public material information resulting in buying or selling of stock by a few individuals.
To remain compliant, company executives should maintain good sportsmanship and an ethical code of fair play. They should follow the rules and act within the bounds set forth by the SEC and not outplay the system. Trading isn’t about beating opponents, it’s about driving the growth of your company.
Company executives should understand that their positions place them at an advantage to having access to insider information. Using this information that is not legal to the public is akin to fixing a sports match. It erodes trust between the public and the company executives, placing the company at a disadvantage and eventually other companies as well because investors will be wary to invest their money which affects economic growth and innovation in society.
Remaining compliant means that company executives should exercise restraint and confidentiality about non-public company information. This information should not be shared with anyone if it is not legal to make it public. A company executive could be prosecuted if they shared the information with a friend who had no interests in the company but the friend shared the information with other friends with interests which resulted in a stock transaction. Everyone connected will be prosecuted.
The SEC rules aim to create a fair and trustful marketplace to protect the interests of the economy and maintain economic stability, which is pertinent to growth.