Insight on Insider Trading

Opher Joseph  This article: “Insight on Insider Trading” was written by Opher Joseph – Financial Analyst, I Know First.

  • According to the study conducted by New York University and McGill University professors, “a quarter of all public company deals may involve in some kind of insider trading”.
  • Legal regulations allow key personnel of the company to trade in the stock only during a certain allowable window period and such trading is prohibited around the date of declaration of financial results by the company.
  • I Know First provides a solution for Insider Trading based on an Artificial Intelligence algorithm.

What is Insider Trading?

Insider Trading

The U.S. Securities and Exchange Commission (SEC) defines illegal insider trading as: “The buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, non-public information about the security.” By definition, illegal insider trading has two components, it is carried out by an “insider” and the trade is carried out based on material information not available in the public domain at the time of the transaction. This renders the transaction to be illegal.

Insider trading can be legal or illegal depending on the material facts and circumstances relating to the transaction. Therefore, not all insider trading is deemed to be illegal. For example, legal insider trading happens when insiders like directors of the company purchase or sell shares, but they disclose their transactions legally per the requirements of the Securities and Exchange Commission (SEC) in the required company filings.

An insider can be any key personnel like employees, executives, or directors who have access to the strategic information about the company and use the same for trading in the company’s stocks or securities before such information becomes public knowledge. Insider trading is not limited to company management, directors, and employees. Outside investors, brokers, and fund managers can also violate insider trading laws if they gain access to non-public information. These insider personnel can provide such discreet information to their friends and relatives to gain from forthcoming market fluctuations. Such information is generally known as tips. The Securities and Exchange Commission has rules to protect investors from the effects of insider trading. It does not matter how the material non-public information was received or if the person is employed by the company. It also applies to any key person who shares non-public material information to a family member who further shares it with a friend, and if the friend uses this insider information to profit in the stock market, then all three people involved could be prosecuted.

Thus, Insider trading is an unfair practice, wherein the other stockholders are at a great disadvantage due to the lack of important insider non-public information. To remove this bias, implement fair trade practices, and also avoid large windfall financial gains to only a few privileged traders, stock exchange regulators have legal provisions imposing severe legal actions and punishment to those found violating the insider trading regulations

Some common examples of illegal insider trading are:

  • A lawyer representing the CEO of a company learns in a confidential meeting that the CEO is going to be indicted for accounting fraud the next day. The lawyer shorts 1,000 shares of the company because he knows that the stock price is going to go way down on the news of the indictment.
  • A board member of a company knows that a merger is going to be announced within the next day or so and that the company stock is likely to go way up. He buys 1,000 shares of the company stock in his mother’s name so he can make a profit using his insider knowledge without reporting the trade to the Securities and Exchange Commission and without news of the purchase going public.
  • A high-level employee of a company overhears a meeting where the CFO is talking about how the company is going to be driven into bankruptcy as a result of severe financial problems. The employee knows that his friend owns shares of the company. The employee warns his friend that he needs to sell his shares right away.
  • A government employee is aware that a new regulation is going to be passed that will significantly benefit an electricity company. The government employee secretly buys shares of the electricity company and then pushes for the regulation to go through as quickly as possible.
  • A corporate officer learns of a confidential merger between his company and another lucrative business. Knowing that the merger will require the purchase of shares at a high price, the corporate officer buys the stock the day before the merger is going to go through.

The Need for Regulation of Insider Trading

Insider Trading

The Securities and Exchange Commission (SEC) prosecutes over 50 cases each year, with many being settled administratively out of court. The SEC and several stock exchanges actively monitor trading, looking for suspicious activity. The SEC does not have criminal enforcement authority but can refer serious matters to the U.S. Attorney’s Office for further investigation and prosecution.

Market fluctuations due to insider trading can cause a substantial financial effect in a very short time. Hence one negative move from the key insider investor can lead to erosion of the financial wealth of retail investors. More and more new aspirant traders have started trading in the stock market during the pandemic, and relevant steps are necessary by both the regulator and also the investor to be aware of such insider trading activities. According to the study conducted by New York University and McGill University professors, “a quarter of all public company deals may involve some kind of insider trading.” This conclusion was reached after carefully examining “hundreds of transactions from 1996 through the end of 2012”.

Some of the negative effects of insider trading are:

  • Damage can be caused to a corporation’s public image and reputation.
  • Damage to market efficiency by affecting the normal trend and behavior by affecting the general perception of the stock.
  • Affects general market reputation.

As insider trading increases, law enforcement efforts to fight and control it are weakened due to a lack of prosecutorial resources. When this illegal behavior multiplies, some companies and individuals start feeling empowered to keep on coordinating insider trades because they come to believe their chances of being caught are very low.


Each country has its own laws and regulations that govern insider trading activities which are monitored by the stock exchanges across the globe. Until the 21st century and the European Union’s market abuse laws, the United States was the leading country in prohibiting insider trading made on the basis of material non-public information. Insider trading has a base offense level of 8, which puts it in Zone A under the U.S. Sentencing Guidelines. This means that first-time offenders are eligible to receive probation rather than incarceration. SEC regulation FD (“Fair Disclosure”) requires that if a company intentionally discloses material non-public information to one person, it must simultaneously disclose that information to the public at large. In the case of unintentional disclosure of material non-public information to one person, the company must make a public disclosure “promptly”. Insider trading, or similar practices, are also regulated by the SEC under its rules on takeovers and tender offers under the Williams Act. Generally, these legal regulations allow key personnel of the company to trade in the stock only during a certain allowable window period and such trading is prohibited around the date of declaration of financial results by the company.

How do Insider Trading Disclosures Help Investors?

Several financial information and stock market sites contain information on SEC filings by the company and provide detailed information on the history and past trends of the stocks purchased and sold by key internal personnel. In terms of market perception, when insiders buy stock of the company in substantial quantities, it is generally followed by a bullish market trend in the market as the market anticipates this move expecting favorable business growth by the company. While on the contrary, the inverse situation is also true when the insiders sell the stock of the company. Thus, when there is a substantial sale of shares by the key personnel of the company, a nervous sentiment is depicted by the stock market and represents bearish trends in the stock.

In order to monitor pan market insider trading activity, one can always use Artificial Intelligence enabled services, from the one like I Know First Algorithmic Services to help monitor and keep track of the insider trades, which helps to stay ahead of the market competition. There is a special Insider Stocks package designed by I Know First Algorithmic Services that helps monitor Insider Trading. I Know First has used algorithmic outputs from the Insider Trading package to provide an investment strategy for institutional investors.

The Investment Result for the period from 1st January 2021 to 20th February 2022

The investment strategy that was recommended to institutional investors by I Know First accumulated a return of 99.54% that exceeded the S&P 500 return by 85.83%.


Insider trading is an essential element of the stock market. Knowledge of insider information can provide additional benefits, but at the same time, such trading is prosecuted by the state. I Know First is able to provide an efficient solution for Insider Trading based on an Artificial Intelligence algorithm. I Know First has used AI outputs to provide an investment strategy for institutional investors that generated a return of 99.54% and exceeded the S&P 500 return by 85.83% for the analyzed period.

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