Insider Information: Definition, Importance, and Legal Framework

What is insider information?

Insider information is material, non-public information about a publicly traded company that could influence an investor’s decision to buy or sell the company’s securities. Examples include a pending merger, a major product recall, unexpected earnings shortfalls, or an imminent financial scandal.

Why it matters

When insiders or others act on material non-public information, they gain an unfair advantage over ordinary investors. This undermines confidence in market fairness and can distort price discovery and capital allocation.

Insider trading: when it’s illegal

Insider trading is illegal when someone:
* trades securities based on material, non-public information, or
* tips others who then trade on that information.

Illicit insider trading is prosecuted as securities fraud. Penalties can include fines, disgorgement of profits, and imprisonment.

Who counts as an insider — and what’s allowed

Insiders typically include company executives, directors, employees, and anyone else with privileged access (such as advisers, consultants, or major shareholders). Owning or trading company stock as an insider is not automatically illegal, but such trades are regulated and must comply with disclosure and timing rules.

Legal forms of insider trading often follow processes designed to prevent misuse, for example:
* Public disclosures of trades by company officers and directors (e.g., SEC reporting requirements).
* Preplanned trading arrangements (Rule 10b5-1 trading plans) that specify trades in advance so they are not based on current inside information.

Key regulations

• Securities Exchange Act of 1934: Provides core regulatory framework for trading and disclosure by public companies and their insiders.
• Regulation FD (Fair Disclosure, 2000): Requires that when a company discloses material non-public information to certain individuals, it must make that information public broadly to avoid selective disclosure.

The U.S. Securities and Exchange Commission (SEC) enforces these rules and pursues cases of insider trading and selective disclosure.

Example of enforcement

High-profile prosecutions illustrate the seriousness of enforcement. In 2003, Martha Stewart was convicted on charges related to trading based on privileged information; she served time in prison and paid civil penalties and disgorgement.

Key takeaways

• Insider information = material, non-public facts about a public company.
• Trading on such information or tipping others to trade is illegal and harms market integrity.
• Not all trades by insiders are unlawful; legal insider trading is regulated and often requires disclosure or adherence to prearranged plans.
• The SEC enforces insider trading laws and uses rules like the Securities Exchange Act and Regulation FD to curb selective disclosure.