What it means
In securities law, the word usually covers company officers, directors and large shareholders, along with employees and advisers who learn confidential information through their work. In the United States, a person who owns more than 10% of a company's shares is generally treated as an insider for reporting purposes.
Other countries have similar tests with their own thresholds. Being an insider is not illegal and insiders trade their own company's shares all the time.
The law cares about two things: whether the trade is based on material information that has not been made public, and whether required disclosures are made. Material means information that a reasonable investor would consider important when deciding whether to buy or sell.
Insiders are normally required to report their trades promptly to the regulator, and those reports are public. Investors read them closely, because a cluster of purchases by executives can suggest confidence, while heavy selling may raise questions.
The signal is imperfect, as executives sell shares for many ordinary reasons such as tax bills or buying a house. Many companies add their own controls.
These often include trading windows, which are fixed periods after results are published when insiders may trade, and blackout periods before results when they may not. Pre-arranged trading plans let insiders sell on a set schedule decided in advance.
The nuance for non-finance staff is that you can become an insider without a senior title. A marketing manager who learns of an unannounced takeover is treated as having inside knowledge, and the same trading restrictions can apply to that person.
Outside the United States, similar ideas appear under different names. In the European Union and the United Kingdom, for instance, senior managers and their closely connected persons must notify their own dealings in the company's shares.
The details of who counts and how quickly reports are due vary, so a global company usually writes one policy that follows the strictest rule.
In practice
Real-world examples.
Example
A chief executive buys $200,000 of her company's shares on the open market two days after results are published. The purchase is reported to the regulator and analysts note it as a sign of confidence.
Example
A finance analyst at a listed retailer learns during budgeting that profits will fall far short of forecasts. Company policy bars him from trading in the shares until the results are public.
Example
A shareholder who holds just over 10% of a manufacturing company sells part of the stake. Because of her insider status she files a report so that the market can see the sale. The filing also tells other investors that a major holder has reduced exposure, which can influence market sentiment. She also consults the company's legal team in advance, since the rules on timing and reporting are strict and mistakes are costly.
Case study
Seen in the real world.
Calder Freight is an illustrative, fictional listed logistics company. Its compliance officer kept a list of everyone with access to the quarterly numbers, which included directors, the finance team and two outside auditors.
Before each results date the list was updated and every person on it was reminded that trading was forbidden until the announcement. One manager forgot and asked to sell shares to fund a house purchase, but the request was routed through compliance and refused.
The manager was frustrated, but in this illustrative story the policy protected both the person and the company. Had the sale gone ahead just before weak results, it would have looked like trading on inside knowledge whatever the manager's intent. The compliance officer used the episode as a training example the following year, with names removed, to show that the rules apply equally to junior and senior staff. The episode also led the board to extend the training to contractors, since temporary staff and advisers had been given access to the same documents without receiving the same warnings.
Watch out
Common mistakes.
- Assuming only senior executives count as insiders, when anyone with confidential knowledge can be treated as one.
- Believing that insider trading is any trade by an insider, when the offence is trading on material information not yet public.
- Reading every insider sale as a warning sign, when many sales are for personal reasons unrelated to the company's prospects.
Questions
People also ask.
Is it legal for insiders to buy and sell company shares?
Yes, provided they do not trade on material non-public information and they follow disclosure and company policy requirements.
Where can investors see insider trades?
Regulators publish the reports that insiders must file, and financial data services collect them in searchable form.
Can family members be affected?
Yes, passing information to relatives or friends who then trade can create liability for both the person who passed it on and the person who traded.
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