The term insider trading refers to transactions involving the purchase or sale of securities of a company by individuals with access to material, nonpublic information about the company. The laws of many countries, including the United States, prohibit the trading of securities while in possession of inside information.
Inside information refers to material, nonpublic information, which is considered private and, if disclosed, could affect the decision of a reasonable investor to buy or sell a security. Examples of inside information include earnings projections, the purchase or sale of a business, the outcome of a legal proceeding, or the award of a large contract.
In the United States, insiders are typically defined as company officers, directors, beneficial owners of more than 10% of a company’s stock, as well as individuals in possession of material, non-public information. Trading of a public company’s stocks or bonds by individuals with inside information is illegal in many countries. Generally, individuals in possession of inside information are prohibited from:
- Trading the securities of the company.
- Making recommendations to others regarding the company’s securities.
- Passing inside information on to others who could then use it to trade in the securities of the company.
In the United States, insiders are permitted to conduct trades as long as the transaction does not rely on nonpublic, material information. Transactions by corporate officers, significant shareholders, and key employees need to be reported to the Securities and Exchange Commission using Forms 3, 4, and 5:
- Form 3: an initial filing, used to register equity securities for the first time by an insider. If the issuer is registering for the first time, this form must be filed no later than the effective date of the registration statement. If the issuer has previously registered with the SEC, the insider must file this form within ten days of becoming an officer, director, or beneficial owner.
- Form 4: used to report changes in ownership; this form must be submitted to the SEC within two days of a transaction.
- Form 5: used by insiders to report transactions that should have been reported on a Form 4, or were eligible for deferred reporting.