By Ee Hsin Kok. Edited by Arjun Chandrasekar.
Overview
If you’ve ever seen stories of insider trading on the news, you probably think it’s unfair and illegal. For example, famous businesswoman Martha Stewart was sentenced to five months in prison for illegal insider trading in the early 2000s. However, not all forms of insider trading are actually illegal. In this article, we cover what separates legal and illegal insider trading, and how you can draw insights from legal insider trading.
The Legality Of Insider Trading
Insiders are considered people with non-public information about a publicly-traded company. This generally applies to executives and higher-ups of the company, as they are the first to be informed on the financial and business dealings of their company before it is released as public information.
Insider trading is considered illegal when a person acts on non-public information in order to get an edge up on the market. For instance, if an executive working for a biotech company hears that the FDA has rejected an important drug they created, and he shorts the stock before that news is announced, that is considered a form of illegal insider trading.
It is also important to note that illegal insider trading is not just applicable to employees of the company being traded, but to anyone who gains access to that non-public information. If for example, that same executive told his mom about the FDA’s rejection, and his mom told her friend, and that friend shorted the stock, it would still be illegal.
Insider trading can be perfectly legal, but it must conform to the SEC’s guidelines. Firstly, insiders are required to disclose all transactions of that company’s stock to the public. That includes buy and sell orders, the quantity of those orders, and the prices at which they are executed. Additionally, insiders are only allowed to trade their stocks within certain time periods where there is no non-public information that might affect their decisions.
How to see Insider Activity
As mentioned above, Insider Transactions must be declared to the public. This means that you can see what insiders are doing with their shares. A quick google search with the format “{company name} insider activity” will get you a host of results.
In the picture above, we have the most recent insider transactions for Alphabet. As we can see, Sundar Pichai (Alphabet’s CEO) sold $8 million worth of Alphabet stock on February 16th, and Sergey Brin (Co-founder and Director of Alphabet) sold $41 million worth of Alphabet stock on the 9th of February.
What Insider Activity Means
From the image above on Alphabet’s insider activity, you might consider it concerning that the CEO and a Director are selling tens of millions worth of shares. However, you shouldn’t be. Insiders sell for any number of reasons: maybe they’re buying a new house or yacht, maybe they want to diversify their wealth outside of a single company, maybe they have to pay their kid’s college tuition, or maybe they’re going through a divorce. Whatever it is, it is probably irrelevant to the success of a business, and coming to conclusions from insider selling is just not a good idea.
On the contrary, insider buying is actually a positive sign. While there is any number of reasons for an insider to sell their shares, there is only one reason for them to buy more: they believe in the business. Don’t just take my word for it, in the words of famous investor Peter Lynch: “insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.”
