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What is the problem with insider trading?

On Behalf of | Mar 26, 2021 | White Collar Crimes

Dealing with the world of trading can often feel overwhelming at first. There are the laws that guide the entire affair, and there are unwritten rules that people follow, too.

One of the most important is to avoid insider trading. Maybe you have heard of the term before. But do you know what insider trading is? Why is it so bad in the first place?

Insider trading

The U.S. Securities and Exchange Commission explains insider trading as a negative market phenomenon. Insider trading is an action in which someone takes exclusive information and uses it to make a trade decision before the public has access to that same knowledge.

As an example, a business employee may hear that their parent company will soon file for bankruptcy. Needless to say, this will cause stocks to plummet. Before the knowledge goes public, they decide to sell their stocks in the company. This prevents them from taking the same loss other stockholders will inevitably suffer from.

Insider trading may be self-applied, but it can also apply to other individuals. For example, a family member might supply their relative with information from the inside of the company, allowing that person to make stock decisions.

Why is it a problem?

This is a huge issue because the stock market depends on trust and transparency. Investors will invest because they feel secure in the fairness of the market. If they believe odds stack against them or people play dirty, they are less likely to invest. This can eventually begin corroding the entire market. Needless to say, this is a huge danger and every participant should avoid it.