Why is Insider Trading Illegal?

Insider trading is illegal because it is unfair to those who have no access to the inside information as it can lead to unethical manipulation of the market, and might lead company managers to become more interested in buying and selling company stock than in managing the company.

It is illegal for company officers, directors, and other insiders to trade their company shares based on information not available to the general public. Let’s say a company officer of XYZ Corporation learns that his company is going to report poor earnings for the quarter. The stock price will go down, so he sells his stock before the announcement and avoids that loss. Unfortunately, some other person bought this stock without the insider information, and this person loses money when the announcement is made public. This is unfair and illegal. What if the company officer doesn’t sell his shares, but informs his friends and relatives about the earnings report and they sell out? This is what happened in the famous Martha Stewart insider trading case, and it is illegal.

Of course, insiders are allowed to buy and sell shares in their own companies. This is legal when these corporate insiders report these trades to the U.S. Securities and Exchange Commission (SEC). That way the insider trading is not kept a secret and anyone can find out a corporate insider’s opinion of his company.