Many people have at least heard the term “insider trading” before, and may have mixed opinions on it. Some do not understand why the penalties are so harsh.
Understanding the main risk of insider trading may make some of these points make more sense.
What is insider trading?
The U.S. Securities and Exchange Commission discusses insider trading as an issue. Insider trading occurs when a person on the “inside” uses their information to make unfair decisions in the stock market.
For example, employees of a company will typically know before the rest of the world if that company plans on filing for bankruptcy. If an employee used that information to sell their share of company stocks before news broke, this counts as insider trading.
Insider trading may also occur if an insider shares this information with an outsider and that outsider then uses it to make stock market decisions.
What is the big risk?
So what is the big deal, exactly? In short, it can put the entire stock market system at risk. This is due to the power of investors.
Investors typically believe the market to be a fair place to do business. If the investors do not have faith in the clean record of the stock market, they tend to invest less money or less often.
The more uncertain investors feel, the more likely they are to withdraw from the market – sometimes entirely. And the more investors do that, the less of a leg the market has to stand on. It is a trickle-down effect that could impact everyone, which is why insider trading gets treated so harshly.