Why is insider trading a problem?

On Behalf of | Oct 26, 2022 | Criminal Defense

Insider trading is something that most people who work in a larger company have likely heard of at least in passing.

But what is it? Why do people generally speak of it as if it is a bad thing? What does it mean for the overall health of the stock market?

What is insider trading?

The U.S. Securities and Exchange Commission discusses insider trading and the problems it poses. First of all, what exactly is it?

Insider trading is an umbrella term that refers to any use of information not available to the public in someone’s decision to buy or sell stocks.

As an example, say a company is going bankrupt and will soon file for bankruptcy. Before they reveal this information to the public, they will reveal it to their employees. If an employee then takes this information and sells their stocks, knowing the company will soon go under, this is considered insider trading.

It also applies in situations where someone on the “inside” takes the information they learn and shares or even sells it to other people outside of the company if they use it to play the stock market.

How insider trading hurts the market

So why is this such a bad thing? In essence, the entire stock market functions on an honor system. Investors trust the market to be a relatively fair and unbiased place. If more and more people use unfair advantages to make their decisions, fewer investors will want to participate.

This could put the entire system at risk, which is why it is such a heavily punished offense.