Rogues of Wall Street

CHAPTER 4 Insider Trading

Insider trading has long been at the core of any definition of operational and trading risks against which an entity must defend itself. The rapid spread of hedge funds and the ultra‐competitiveness of their traders has only increased the need for vigilance in this area. Significant and widespread prosecution of the crime suggests that more can be done by the industry to manage the issue. But what can be done? To paraphrase Sigmund Freud, understanding the problem will go a long way toward solving it.

What Is Insider Trading

At its most basic, insider trading is just as it sounds: trading on “inside information.” In other words, it is trading in a company's stock on the basis of material information that only people inside the company should ideally be privy to. People inside the company are prohibited from trading on such information, as is anyone who happens to come into receipt of it. Such practice has been illegal since the Securities and Exchange Act of 1934. This Act defines corporate insiders as a company's officers, directors, and any beneficial owners of more than 10 percent of a class of the company's equity securities.¹

In the United States and many other jurisdictions, however, “insiders” are not just limited to corporate insiders where illegal insider trading is concerned but can include any individual who trades shares based on material nonpublic information (MNPI)² in violation of a duty of trust. This duty may be imputed; for ...