Insider trading

Insider trading occurs when employees have knowledge of information that is not yet available to the public, and use this information to buy or sell company securities at advantageous prices. For example, the CFO of a public company knows that reported sales levels will decline in the next quarterly financial statements, so he sells his company shares in advance of the information release. The CFO avoids a loss in the market value of his shares by timing the sale of the shares. The concept extends to giving confidential information to others, who then use the information to engage in trading activities.

Insider trading does not harm the company, but most definitely harms its investors, since they may be buying securities from or selling securities to people who have better knowledge of what those securities are really worth.

There are significant insider trading legal penalties, which are classified as felonies; all insiders who hold company stock should be regularly advised of the penalties associated with insider trading. It is possible for employees to avoid insider trading allegations by setting up a Rule 10b5-1 trading plan in advance with a brokerage house, or by only engaging in trades during brief trading windows, such as immediately after the release of periodic financial statements to the investment community. These trades should be reported to the SEC on the Form 4.

Related Courses

Public Company Accounting & Finance