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Why is insider trading a problem?

On Behalf of | Nov 2, 2022 | White Collar Crimes

Insider trading is an issue that has plagued stock markets and industries for as long as trading and stocks have existed.

But what exactly is insider trading? Why is it so highly punished and such a major offense in the business world?

Defining insider trading

The U.S. Securities and Exchange Commission discusses insider trading. This is an act of using any sort of inside information in order to make decisions regarding the stock market.

As an example, say there is an employee of a big business. This business announces to its employees that they will soon file for bankruptcy due to ongoing financial issues that they cannot overcome. This employee, knowing that the business will soon go bankrupt, decides to sell their stocks in it.

This is use of information that is not available to the general public. Thus, it serves as an unfair advantage for the employee, who can get an edge on the competition with no idea of what is to come.

Risking the entire stock market

So why is this such a big deal? In essence, it upsets the very basis of the stock market. This market exists on a foundation of trust. Investors trust that participants in the market are not using unfair advantages to make gains that other people have no chance of making.

If investors lose their faith in the market, they may stop investing. This could eventually lead to the collapse of the entire stock market system. Though this is an extreme example, it is a possibility nonetheless, and is why penalties for insider trading are so harsh.