Mike Swanson's picture

Why Is Insider Trading Illegal - Mike Swanson (WallStreetWindow)

I know you might be wondering why is insider trading illegal? It wasn't always illegal. First though you have to realize there is legal insider trading. This is when a CEO or a company insider buys or sells stock in their own company. The SEC requires that they report these trading so that you can know when they are going on.

Illegal insider trading is when someone buy or sells a stock, because they learned about information not known to the public. They have been privy to nonpublic information and are taking advantage of it. Even a tip about upcoming earnings passed along by a company officer is illegal to act on.

It does seem to happen though, because you can see stocks that have sudden surges in volume and then come out with news. It looks as if people knew about the information and acted on it. If they did they broke the law.

But why? Why is this illegal? Why can't you but stock picks based on insider info?

Back after the 1929 stock market crash there were cries that the stock market was rigged and that insiders made money while everyone else suffered. There were active "pools" of traders that included big powerful bank insiders that would run stocks up - basically manipulate there share price - and then come out with news that excited the public. They would sell into their manipulations and then the stock would drop and the public would lose.

The SEC adopted insider trading laws with the goal of making the stock market more fair. They claim that without insider trading laws the stock market would not be accurate and be like a big fraud game for the regular investor.

The courts say that insider trading is illegal, because the officers of the company have a duty the shareholders and the company to not take advantage of them with inside information. Insider trading may make it so CEO's and management have incentives to play sneaky stock games instead of just try to run their company the best they can.

In the end their is a fear that if the stock market is not seen as a level playing field then thousands of investors will leave it or never enter it all. So insider trading laws are designed to the benefit of all who invest in the stock market and the SEC is the guardian angel that protects investors and keeps the market pure.

For more on the stock market and investment strategies I use to make money check out my free stock market beginners guide.