Insider Trading Laws and Penalties

Corporate insiders (often company executives, officers, or directors), who gain important inside knowledge about the company, must keep that information confidential until it's released publicly. They also must abide by government rules prohibiting them from using insider knowledge before it's public for their financial advantage. A violation of these duties can lead to criminal or civil penalties for insider trading—a type of securities fraud.

What Is Insider Trading?

Federal law makes it a crime for a corporate insider who becomes aware of "material, non-public information" about the company to:

• make stock or securities trades based on this information, or
• tip off others with this information.

Material information is anything that could substantially affect an investor's trading decisions. Examples include knowledge of confidential company earnings reports, a major acquisition, or regulatory changes. Non-public means the information has not been made available to the general public through Security and Exchange Commission (SEC) filings, media reports, or other public outlets.

To be convicted, the investor must knowingly violate the law. This knowledge requirement protects the average person who might dabble in securities and not understand SEC regulations.

(15 U.S.C. §§ 78j(b); 78ff (2024).)

Why Is Insider Trading Illegal?

Insider trading laws are in place to level the playing field and maintain a fair marketplace. Without these laws, insiders have an unfair advantage over public investors. The insiders could potentially make huge profits off the losses (and backs) of other investors, which not only hurts those investors but also undermines public confidence in the stock market.

Is Insider Trading Always a Crime?

No. Most corporate insiders will buy, sell, and trade their company stocks and securities. It's only illegal if they knowingly possess material, non-public information and use it to inform their investments unfairly. Insiders are allowed to make legal trades that follow SEC rules and reporting requirements.

Insiders can't get around these rules by tipping off others. The insider has a fiduciary duty to maintain the confidentiality of their inside information. The insider and the individual receiving the tip (the "tippee") can both face criminal charges if the tippee uses the information knowing the insider illegally shared non-public information.

What Are the Penalties for Insider Trading?

A person convicted of insider trading faces up to 20 years in federal prison and a $5,000,000 fine. Criminal prosecutions are brought by federal prosecutors (U.S. attorneys).

The SEC can also bring a civil action against the defendant. This civil action may result in civil penalties of up to $1,000,000 or three times the profits gained or losses avoided in the unlawful transaction.

(15 U.S.C. §§ 78u-1; 78ff (2024).)

What Are Some Examples of Insider Trading?

Insider trading can involve anything from massive corporate schemes to information shared over a business lunch or stolen from someone's computer. For instance, corporate officers who dump their stocks after gaining confidential information regarding the company's financial woes have engaged in insider trading. Insider trading can also involve a spouse, relative, or friend who steals or learns about company secrets from an inside employee and uses that knowledge to their benefit.

Below are some well-known insider trading scandals brought to light.

Martha Stewart and ImClone

Martha Stewart (known for her brand Martha Stewart Living) went to prison for five months due, in part, to her role in selling hundreds of shares of ImClone stock just before the FDA released its decision refusing to approve the company's new cancer drug. An insider had tipped her off. While, ultimately, she did not go to prison for insider trading charges, she (and the tipster) settled with the SEC in its civil action against her for insider trading.

Viky Bohra: Husband of an Amazon Employee

The husband of an Amazon employee admitted to using his wife's confidential company information to make 11 trades, resulting in a profit of $1.4 million. His wife worked as a senior manager in Amazon's tax department. As part of a deal, the husband pleaded guilty to insider trading and was sentenced to just over two years in prison. The SEC also brought a civil action against the husband and wife, in which the defendants agreed to pay back the $1.4 million, plus penalties totaling more than $1.1 million.

Jeffrey Skilling: Enron CEO

Jeffrey Skilling, former Enron CEO, was convicted of insider trading (among other counts) for his role in the Enron scandal. He inflated the value of Enron and defrauded investors. The insider trading charges stemmed from his actions in dumping around $60 million in Enron shares—shortly after which, the company declared bankruptcy. He was eventually sentenced to 24 years in prison (later reduced to 14 years) and paid more than $40 million in restitution payments to victims.