Insider trading is the trading of a public company's stock or other securities (such as bonds or stock options) by individuals with access to non-public information about the company.
"Corporate insiders" are defined as a company's officers, directors or any beneficial owners of more than 10% of a class of the company's equity securities. By accepting employment these insiders have undertaken the legal obligation to put the shareholders' interests before their own in matters related to the corporation. This means that any trades in the company's own stock made by these insiders, if based on material non-public information, are considered fraudulent since the insiders are violating the fiduciary duty that they owe to the shareholders.
In addition, this duty may be imputed; for example, when a corporate insider "tips" a friend about non-public information likely to have an effect on the company's share price, the duty that insider owes the company may now be imputed to their friend. When allegations of a potential inside deal occur, all parties that may have been involved are at risk of being found guilty.
The Securities and Exchange Commission prosecutes over 50 cases of Insider Trading each year, with many being settled administratively out of court. The SEC and several stock exchanges actively monitor trading and can refer serious matters to the U.S. Attorney's Office for further investigation and prosecution.
US insider trading prohibitions are based on English and American common law prohibitions against fraud: as early as 1909 the United States Supreme Court ruled that a corporate director who bought company stock knowing it was about to jump in price committed fraud by not disclosing his inside information.
The Securities Exchange Act of 1934 was enacted after the stock market crash of 1929 to prohibit short-swing profits (from any purchases and sales within any six-month period) made by corporate directors, officers, or stockholders and to prohibit fraud related to securities trading. The Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 provide for penalties as high as three times the profit gained or the loss avoided from the illegal trading.
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