What Insider Trading Can Teach Investors About Investing

It is no coincidence that corporate executives always seem to buy and sell at the most advantageous times. In the end, the CEOs and CFOs of the world have access to every piece of company information that you could possibly desire. However, just because company executives have unique insights does not imply that individual investors are always in the dark about their investments. Insider trading data is available to anyone who wishes to make use of it.

This article will discuss what insider trading is, how we can understand insider trading, and where we can find relevant data on insider trading in general.

What Is Insider Trading and How Does It Work?

Insider trading can be classified into two categories: legal and illegal. First and foremost, let us consider the illegal variety. Insider trading is defined as the purchase or sale of a security by insiders who have access to information that is not yet publicly available. Insiders are in breach of their fiduciary duty as a result of the act. As you can imagine, engaging in illegal insider trading is a major no-no for anyone who is closely associated with a corporation.

The Most Important Takeaways

  • Illegal insider trading occurs when an employee of a company takes advantage of nonpublic information to make a profit by purchasing or selling investment securities.
  • However, not all buying and selling by insiders (including CEOs, CFOs, and other executives) is prohibited by law, and many of these transactions are disclosed in regulatory filings.
  • Insider trading is not limited to directors and upper management; anyone who has access to material nonpublic information and uses that information to make illegal profits can be found guilty of insider trading.
  • When it comes to large corporations, there can be hundreds of insiders, which makes analyzing their buying and selling decisions more difficult.

Insider trading is a criminal act that can be committed by anyone who has access to material and nonpublic information. This means that virtually anyone, including brokers, family members, friends, and coworkers, can be considered an insider in the financial industry.

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Insider trading is a crime that must be punished.

The following are some examples of insider trading that is prohibited by law:

  • In response to learning that his organization will be losing a government contract next month, the CEO of a company sells stock in the company.
  • In response to hearing from his father that the company will be losing the government contract, the CEO’s son liquidates his parent company’s stock.
  • The stock is sold by a government official who realizes that the company will lose the government contract and therefore wants to make a profit.
  • The Securities and Exchange Commission (SEC) is extremely strict when it comes to those who engage in unfair trading practices and thereby undermine investor confidence and the integrity of financial markets. Don’t assume that those who place the trades are the only ones who are at fault. A person who is caught “tipping” an outsider with material nonpublic information may be held liable as well, depending on the circumstances.

Insider Trading That Is Compliant with the Law

The fact that insiders do not always have their hands tied is an important point to emphasize. Unlike outsiders, who can (and do) buy and sell stock in their own company at any time, insiders are only restricted and deemed illegal to do so at specific times and under specific conditions.

Many people believe that only directors and upper management are subject to insider trading prosecution. This is not the case.

Corporate insiders, according to the SEC, include company directors, officials, and any individual who owns a 10 percent or greater stake in the company in question. Within two business days of the date the transaction took place, corporate insiders are required to report their insider transactions to the Securities and Exchange Commission (before the 2002 Sarbanes-Oxley Act, the time frame was the tenth day of the following month).

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An insider who sells 10,000 shares on Monday, June 12, must file a report with the SEC by Wednesday, June 14 to avoid being fined. A Form 4, which details a company’s insider trades or loans, is used to report changes in insider holdings to the Securities and Exchange Commission (SEC). An additional Form 14a, filed by the company, lists all of the directors and officers as well as the common interests in which they are involved.

Individual investors find a great deal of value in the type of information contained in regulatory filings. For example, if insiders are purchasing shares in their own companies, it is possible that they are privy to information that ordinary investors are not aware of. The insider may purchase because they believe their company has great potential, or because they believe there is a possibility of a merger or acquisition in the near future, or simply because they believe their stock is undervalued.

Peter Lynch, one of the greatest investors of all time, is credited with saying that “insiders may sell their shares for any number of reasons, but they buy them for only one: they believe the price will rise.” As a result, insiders are only permitted to buy and sell their company stock once every six months; as a result, insiders buy stock when they believe the company will perform well in the long run.

Insider trading is determined by the SEC using the Dirks Test, which states that if a tipster breaches their trust with the company and is aware of the breach, that person may be held liable for insider trading under the Securities and Exchange Act.

According to Nejat Seyhun, an internationally renowned professor and researcher in the field of insider trading at the University of Michigan who is also the author of the book Investment Intelligence from Insider Trading, executives purchasing shares in their own companies outperformed the overall market by 8.9 percent over the following 12 months. When they sold their shares, the stock underperformed the market by 5.4 percent, according to the data.

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Where to Look for Insider Trading Information

Access to information is unquestionably one of the ways in which the Internet has transformed the world of investing. Anyone can obtain the most recent insider-trading statistics for virtually any publicly traded company by simply clicking on the company’s name. Here are a couple of websites that provide free access to insider trading information:

Yahoo! Finance: On Yahoo! Finance, you can look up any quote and then click on “Insiders” to see a list of the most recent trades. Despite the fact that some insider trading filings don’t appear in databases for up to a month after they’ve been made, Yahoo! appears to have one of the most up-to-date data feeds.

Although not visually appealing, the SEC’s EDGAR database is the first point of contact for trading data sent to the SEC. It is necessary to search for the “central index key” (CIK) for the company on the SEC website in order to locate the filings. Corporate and individual people who have filed a disclosure with the SEC are identified using the CIK, which is stored electronically on the SEC’s computer systems. Once you have obtained the CIK, you can conduct a search for specific filings.

What’s the bottom line?

Insider trading information is not a new concept. For decades, investors have made investment decisions based on the actions of insiders in the companies in which they invest. Remember that while the data is important, large corporations may have hundreds of insiders, making it difficult to identify patterns. Continue to conduct your due diligence on a company in the manner in which you would normally do so, but keep an eye out for any insider activity. They are almost certainly more knowledgeable than the rest of us.

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