Insider trading is a very contentious subject. The mere mention of it conjures up images of white collar criminals being dragged away in handcuffs. For all its negative connotations, insider trading isn’t always a black and white issue. The following article will help you differentiate legal vs. illegal insider trading.
Legal insider trading
Insider trading is legal when corporate insiders – directors, officers, analysts and other employees – buy and sell company stock using publicly available information. After all, there is nothing wrong with owning and selling your own company. These sorts of trades happen all the time, especially in management positions. In fact, many managers receive stock options in their own company, allowing them to trade the stock at a certain and for a particular price.
To keep their activities legal, company employees must report their trades to a regulatory authority, such as the Securities and Exchange Commission (SEC) in the United States, within a certain time period.
While insiders may have access to privileged information not yet available to the general public, they are unable to buy and sell a company stock until that information is made public through a press release, news conference or any other announcement.
Technically, anyone who owns 10% of a stock is also considered an insider. They are subject to the same rules and regulations as corporate insiders.
Illegal insider trading
Buying and selling your own company is still considered “insider trading” because you may have access to information not available to the general public. Knowledge about upcoming products, a merger or acquisition, or a new CEO can send stock prices higher or lower. This is when insider trading can become illegal – when insiders use information not known to the general public to execute trades. Insider trading is deemed illegal when an insider has direct advantage over other investors.
How you may benefit from legal insider trading
We mentioned earlier that insiders usually have more knowledge about their company than the general public. This should be obvious to most readers. While they may not buy or sell the company stock until private information is made public, they generally have a better sense of where the company is headed.
If corporate insiders are buying their company stock for the first time, you should also consider buying. This is especially true if non-management employees do the buying. Since they usually don’t receive the same stock options as management, their willingness to buy company stock means they are confident about the company’s business and growth prospects. It’s not terribly uncommon to see company employees buy company shares for the first time.
Keeping an eye on the General Counsel – the company’s top lawyer – can also help you get an insider edge. If the company’s General Counsel is buying shares, that’s usually a strong signal the company is headed in the right direction, even if it’s not entirely apparent yet.
Keeping an eye on the behavior of corporate insiders can reveal interesting insights about a company. While not foolproof, it may give you the extra boost of confidence you need to buy or increase your holdings of a particular company.
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