You would respond “of course insider trading is illegal” but in practice insider trading is more legal than illegal. When insiders are in possession of market-moving (material) non-public information and trade based on that information, then insider trading is illegal. However, when you look at the most insider trading cases that are brought to public’s attention, you will notice that the perpetrators are usually finance professionals or lawyers in possession of some imminent M&A information and they recruit friends and family to profit from it in stock and options markets. Can you remember any recent insider trading cases where an insider is prosecuted because they traded immediately before a significant corporate announcement?
Insider trading laws, regulations, and company policies restrict most insider trading to certain safe periods such that the transactions conducted during those time periods are less likely to be prosecuted. Most insiders are not idiots; they know that they are watched and they will be prosecuted if they tip someone off. As a result, we don’t see many “illegal” insider transactions conducted by inside insiders. Usually none of the more than 200,000 insider filings reported to SEC each year (see definition of insider trading?) has been deemed illegal by prosecutors.
In 2010 so far, there were only 5 insider trading cases brought by SEC. In the first case SEC charged a securities professional, meaning someone working for an investment bank, for tipping his friend and making around $1 million in at least 11 separate instances. Why did SEC say “at least” in their statement? Because it could be more, they just don’t know. They believe they could only prove 11 incidences. Did you also notice something else? SEC probably got the hint of illegal insider trading after the 11th incidence, I mean at least 11th. So if these guys stopped after the 10th insider trading case, they would not have been caught.
In the second case, a Walt Disney Company employee –no, not the CEO or CFO, just an administrative assistant- and her boyfriend tried to sell Disney’s earnings information to 20 different hedge funds before it is released. This is not an insider trading case, this is a dumb criminals case, perfect fit for Jay Leno’s show.
In the third case, a Microsoft employee –no not the CEO or CFO or other legal insiders, just a product manager at the MSN division- obtained earnings estimates and relayed the information to Art Samberg of Pequot, a hedge fund. These are not the insiders who are required to file their transactions. SEC was not successful initially in investigating this case and closed it in 2007. Only after Microsoft employee’s ex-wife brought new evidence into SEC’s attention, the case was a success 8 years after the initial illegal insider trading incident.
In the fourth case SEC charged billionaire Wyly brothers with using elaborate offshore trusts and subsidiary companies to conceal their transactions. Naturally Wyly brothers did not report their transactions on Form 4 either. SEC alleges that this has been going on for more than 13 years. 13 years? And they noticed this now!!
Finally in the fifth case SEC charged a former Deloitte and Touche LLP partner and his son with insider trading in the securities of several of the firm’s audit clients. This is similar to the first case we discussed. Usually lawyers, investment bankers, and accountants trade using insider information they obtained through their employment. SEC catches them only after several previously undetected insider transactions.
As you can see none of the insider trading cases brought by SEC this year involves legal insider transactions reported on Form 4.