Question: Is insider trading illegal? No, it is not always illegal, and that answer may surprise some people. Insider trading, meaning the buying and selling of shares and the exercise of options among corporate “insiders” is perfectly legal as long as the insider follows the requirements set by the Securities and Exchange Commission and most likely trades during an open “window” established by the company. Illegal inside trading occurs when the SEC rules aren’t followed – usually because the trading occurs by someone who is not an insider and who is in possession of “inside information” that only insiders should know and who likely trades outside of the corporate window.
Insider trading gets a bad reputation because of those who don’t follow the rules and ended up in prison, but it is an important part of corporate governance. Without the ability to buy or sell their corporate stock, corporate officers and directors would not have a way to raise money and diversify their holdings. Instead, they would be stuck owning their stock until such time they are no longer corporate insiders. Not being able to sell stock would be demotivational for management and thus bad for business.
Any corporate insider who wants to buy or sell their own company’s stock must file a Form 4 with the SEC. By doing so, their filing becomes public information that is tracked by any number of services. The tracking website that I look at is through Finviz.com, but there are many others that you can use Google to discover. Tracking is done on a daily or even real-time basis so this is public information that you can use to do your own trading.
What Does It Mean?
You might think at first that an insider who is buying is bullish for the future of that company and hence that stock and an insider selling is bearish. In my experience, that is not entirely the case. Insider buying is more bullish than insider selling is bearish. Corporate officers and directors sell their stock for all sorts of reasons: desire to buy something else like a house; needing to pay taxes; the stock has hit a pre-determined target in a 10b5-1 plan, which is a pre-approved plan for orderly stock sales; or just plain portfolio diversification. These sellers need money for some reason and they sell stock to raise it.
On the other hand, an insider filing to buy additional stock or to exercise existing stock options can be viewed as a re-commitment or a “doubling down” on the company and could be a bullish signal in the broadest sense about the future of the company. Insiders of companies whose stock has been beaten down may stake their future on buying the stock at a low point so as to steady the stock’s fall and try to get the ship pointed in a different direction. In my opinion, if you as an investor spot this type of corporate insider buying at a low point, you may want to consider buying into that company as well. It may be an opportunity for a deep value play that will make you big money – or maybe it won’t. In any event, you need to have a keen eye for this type of play, and perhaps you want to “paper trade” or pretend to invest a few times before you actually put any real money into it, just to see if your instincts were correct.
Insider trading is perfectly legal as long as the rules are followed. If you are so inclined and if you are diligent in tracking these transactions, it might be a way to pick out a plum value play if you are astute enough. Also, don’t sell your stock if you see that an insider is selling, because they may have good reasons unrelated to the future of the company to be selling.