Skip to headerSkip to main contentSkip to footer
Get our Free E-newslettersGet our Free E-newsletters
Kiplinger logoLink to homepage
Get our Free E-newslettersGet our Free E-newsletters
Subscribe to Kiplinger
Subscribe to Kiplinger
Save up to 76%
Subscribe
Subscribe to Kiplinger
  • Store
  • Home
  • Investing
  • Retirement
  • Taxes
  • Personal Finance
  • Your Business
  • Wealth Creation
    • Podcasts
    • Economic Outlooks
    • Tools
    • Kiplinger's Personal Finance Magazine
    • The Kiplinger Letter
    • The Kiplinger Tax Letter
    • Kiplinger's Investing for Income
    • Kiplinger's Retirement Report
    • Store
    • Manage My E-Newsletters
    • My Subscriptions
Skip advert
  • Home
  • investing
investing

10 Things You Must Know About Insider Trading

If you’re an active investor who occasionally buys or sells stocks based on tips, you need to know what's allowed -- and what can land you in jail.

by: Kathy Kristof, Dan Burrows
June 18, 2020
Skip advert

If you’re an active investor who occasionally buys or sells stocks based on tips, you need to know what's allowed -- and what can land you in jail.

After all, the headlines are rife these days with Washington, D.C. power brokers who have brought the wrath of the Securities and Exchange Commission down on their heads.

In the highest-profile case of alleged insider trading these days, the Department of Justice is investigating Sen. Richard Burr for a series of stock sales he made after attending private coronavirus briefings. A week later the stock market tanked.

The investigation of Burr came hard on the heels of the resolution of the Chris Collins scandal. In January, the former congressman received a 26-month prison sentence and a $200,000 fine.

While in office, Collins fed information he received as a board member of biotechnology company Innate Immunotherapeutics to help his son and others avoid thousands of dollars in losses after one of the firm's drugs failed a clinical trial.

Insider trading is a complicated subject where gray areas abound. In many cases, it is perfectly legal (although potentially unwise) to trade on tips that you hear or overhear. Illegal insider trading all comes down to the facts and circumstances.

Have a look at 10 scenarios that illustrate the dos and don'ts of using insider information.

  • Millionaires in America 2020: All 50 States Ranked
Skip advert
Skip advert
Skip advert

1 of 10

Scenario 1: You Overhear a Conversation in Public

Getty Images

Skip advert

You are standing in line at Starbucks, and a well-dressed couple in front of you is talking about retiring to Majorca after they sell their company. You recognize them as the founders of a publicly traded company and figure out that the deal hasn’t yet been announced. You snap up as many shares as you can afford and make a killing when the takeover is announced.

Is this insider trading?

If this couple bought or sold shares -- or called you and tipped you off in private -- it would be a violation. But illegal insider trading requires that you not only trade on the basis of important nonpublic information, but that you also have some sort of duty to keep the information confidential. Former football coach Barry Switzer was sued for insider trading following a similar scenario in 1981, but he won the case because he had no duty to ignore a conversation he overheard in a public place.

Bottom line: You're in the clear.

  • All 30 Dow Stocks Ranked: The Pros Weigh In
Skip advert
Skip advert
Skip advert

2 of 10

Scenario 2: You Eavesdrop on a Private Conversation

Getty Images

Skip advert

You’re a janitor at a major company. You hear members of the company’s board convening outside the room you’re cleaning and decide to hide in the closet. The board OKs a deal to sell the company for a fat premium to the current share price. You load up on the shares. Illegal insider trading?

Now you are definitely in hot water. This is not a public place, and "you’d be in a position to understand that confidential information was being disclosed, which changes the calculus," says Andrew Stoltmann, a Chicago-based securities lawyer.

  • 14 Best Tech Stocks That Aren't on Your Radar
Skip advert
Skip advert
Skip advert

3 of 10

Scenario 3: You Get a Hot Tip From a Chatty Cab Driver

Getty Images

Skip advert

You hop in a cab at the airport and are startled by the driver’s Armani suit and solid-gold pinky ring. You learn that the driver is merely taking this shift as a favor for a friend. The driver is now happily retired, living on his investment portfolio. When you whine about your own, he says: "Look, I’ll give you a break. Buy as much stock in Google as you can." You do. Is that insider trading?

It's probably unwise to take unsolicited financial advice from random people you don't know. The cab driver could be as clueless as you. But you have no reason to believe he’s telling you anything that’s not public information. There's nothing illegal about that.

  • 50 Top Stock Picks That Billionaires Love
Skip advert
Skip advert
Skip advert

4 of 10

Scenario 4: You Get a Hot Tip From a Chatty Cab Driver Who Has a Connection

Getty Images

Skip advert

Once again a cab driver is offering stock tips, but this time he mentions that his son is an attorney at Skadden, Arps, Slate, Meagher & Flom, a major law firm in the merger game. Insider trading?

This could qualify as insider trading. It will draw uncomfortable scrutiny from the SEC, but maybe not a prison term.

It’s all about whether you have reason to believe that you’re receiving important, nonpublic information from a person who has a duty to keep that information private. The cab driver’s trading would definitely be verboten. This scenario is in a hard-to-defend gray area, Stoltmann says.

  • 20 Best Stocks to Invest In During a Recession
Skip advert
Skip advert
Skip advert

5 of 10

Scenario 5: You Notice That Corporate Insiders Are Selling, So You Sell Too

Getty Images

Skip advert

You read a while back that executives at Countrywide Financial, the big mortgage lender, were unloading their stock. You decided that they must know something you didn’t, so you followed suit and sold your shares, too. Now you worry that the Feds are going to come after you. Are you guilty of insider trading?

You have nothing to worry about. The executives, however, could be in trouble.

Executives can sell their own company’s stock without running afoul of the rules as long as they’re not trading based on information they haven’t shared with the public. The SEC sued Countrywide’s CEO, Angelo Mozilo, and several other insiders in 2009 (after the company had been acquired by Bank of America), alleging that they had improperly traded on undisclosed information about the evil lurking inside the company’s loan portfolio.

Mozilo, who netted some $140 million selling Countrywide stock before the company collapsed, eventually settled the suit without admitting or denying guilt by paying $67.5 million in fines and disgorging profits.

As for you: Mozilo’s trades were disclosed in SEC filings and in numerous news stories. Trading based on publicly available information is perfectly legal.

  • 15 Great Retirement Stocks to Buy at Reasonable Prices
Skip advert
Skip advert
Skip advert

6 of 10

Scenario 6: You Put Two and Two Together and Make a Trade

Getty Images

Skip advert

A woman in your Bunco group says she’s about to quit her job because she can’t stand the strain of working in a medical office where all the patients are dying. Because of previous casual conversations, you know that patients in this office are involved in early trials of a new drug. You know what the drug is and who makes it. You sell short shares of the drug’s developer, betting that the stock will fall in value. Did you violate insider-trading rules?

This could draw the SEC's interest, but it probably won't be considered insider trading.

Your playing partner is sharing information that’s so general it can’t be used to gauge whether the clinical trial will result in failure. Thus, the tip fails the materiality test. It’s not significant enough to the company’s stock price. And because the woman is just sharing information about the status of the office’s patients and not the trial (including whether the ailing patients are taking the new drug or a placebo), no one appears to have a duty to keep quiet.

  • Warren Buffett Stocks Ranked: The Berkshire Hathaway Portfolio
Skip advert
Skip advert
Skip advert

7 of 10

Scenario 7: You Trade on Information You Receive in the Course of Your Job

Getty Images

Skip advert

You are entrusted with confidential information that the company you work for has suffered a massive data breach. You purchase options in your company's stock ahead of its public announcement of the breach in order to profit when shares fall on the news.

Now you've stepped in it.

Sudhakar Reddy Bonthu, a former manager at Equifax, pleaded guilty in July 2018 to a charge of insider trading based on his purchases of put options ahead of Equifax’s public announcement of its data breach.

"Bonthu used confidential information to determine that his company had suffered a massive data breach and then violated company policy to illegally profit from it," said Richard Best, Director of the Securities and Exchange Commission’s Atlanta Regional Office

Bonthu realized a profit of more than $75,000 when shares in Equifax tumbled after it publicly disclosed the data breach on September 7, 2017.

  • 11 Small-Cap Stocks Analysts Love the Most
Skip advert
Skip advert
Skip advert

8 of 10

Scenario 8: Your Stock Broker Tells You to Sell Based on Non-Public Knowledge

Getty Images

Skip advert

Your broker calls and says you need to get out of ImClone Systems now because the CEO, who is also his client, is selling all his shares. Insider trading?

This will draw SEC scrutiny, but maybe not a prison term.

If this scenario sounds familiar, it's because it happened to Martha Stewart. The SEC filed suit against homemaking personality in 2003 with these exact facts. Stewart did end up going to prison -- but not for insider trading. She was convicted of obstructing justice and lying to prosecutors.

Stewart settled the SEC’s insider-trading case, paying a fine and agreeing to never violate securities laws in the future. The settlement eliminated the need for a trial as well as a definitive answer about whether she had "a duty" to ignore the tip. But the case was complicated by the fact that Stewart had once been a stockbroker. The SEC contended that she should have known better.

  • Pros' Picks: The 15 Best Nasdaq Stocks You Can Buy
Skip advert
Skip advert
Skip advert

9 of 10

Scenario 9: You Pay People in the Know to Give You Secret Information

Getty Images

Skip advert

You’re a hedge fund manager, buying and selling stocks constantly. You pay a series of experts to feed you hush-hush information about pending mergers, and you earn millions in profits by buying shares of takeover targets before deals are announced. Insider trading?

Yes. And how. If you bribed or bought insider information and traded on it, you’re going to prison.

  • 10 Things You Must Know About Becoming a Millionaire
Skip advert
Skip advert
Skip advert

10 of 10

Scenario 10: You Pay People in the Know for Research, Analysis and Advice

Getty Images

Skip advert

You’re a hedge fund manager, and you pay dozens of analysts and consultants to provide seasoned advice about stocks to buy and sell. Some of those consultants may have access to secret information, but you trade based on a wide array of factors, including examination of public documents and detailed analysis about industries and companies operating within them. Insider trading?

This could get the SEC's attention, but it is probably not insider trading.

The key to the famous 2009 case against Galleon Group CEO Raj Rajaratnam, says Stoltmann, hinged on whether his lawyers were able to establish that his trading was based on assembling a "mosaic" of information or whether he paid "consultants" to feed him insider tips. The former, says Stoltmann, is perfectly legal.

Unfortunately for Rajaratnam, on May 11, 2011, he was found guilty of the latter -- specifically, nine counts of securities fraud and five of conspiracy to commit securities fraud.

  • Investing in Gold: 10 Facts You Need to Know
Skip advert
Skip advert
Skip advert
  • investing
Share via EmailShare on FacebookShare on TwitterShare on LinkedIn
Skip advert
Skip advert
Skip advert
Skip advert

Recommended

Is the Stock Market Closed for the Fourth of July in 2022?
Markets

Is the Stock Market Closed for the Fourth of July in 2022?

Independence Day falls on a Monday in 2022, so the bond and stock markets will enjoy a long holiday weekend. Here's a look at the markets' holiday hou…
July 1, 2022
Top Bear Market Tips from 10 Financial Advisers
investing

Top Bear Market Tips from 10 Financial Advisers

When a bull market turns into a bear market, it can be hard to know what to do. Take comfort in the guidance of 10 financial professionals.
June 30, 2022
Move Over ETFs: Direct Indexing Is an Investment Strategy Worth Paying Attention to
investing

Move Over ETFs: Direct Indexing Is an Investment Strategy Worth Paying Attention to

More flexibility, more control, the potential for higher returns and tax-reducing strategies: With pros like that, could direct indexing be right for …
June 25, 2022
Smart Investing in a Bear Market
investing

Smart Investing in a Bear Market

Here's how to make the most of today’s dicey market.
June 22, 2022

Most Popular

5 Best Dow Dividend Stocks to Buy Now
blue chip stocks

5 Best Dow Dividend Stocks to Buy Now

This mini-portfolio of blue-chip dividend payers is well-positioned to both generate income and hold up to headwinds for the rest of 2022.
June 27, 2022
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
Top Bear Market Tips from 10 Financial Advisers
investing

Top Bear Market Tips from 10 Financial Advisers

When a bull market turns into a bear market, it can be hard to know what to do. Take comfort in the guidance of 10 financial professionals.
June 30, 2022
  • Customer Service
  • About Us
  • Advertise With Us (PDF)
  • Privacy Policy
  • Cookie Policy
  • Kiplinger Careers
  • Accessibility
  • Privacy Preferences

Subscribe to Kiplinger's Personal Finance

Be a smarter, better informed investor.
Save up to 76%Subscribe to Kiplinger's Personal Finance
Do Not Sell My Information

Kiplinger is part of Future plc, an international media group and leading digital publisher. Visit our corporate site www.futureplc.com
© Future US LLC, 10th floor, 1100 13th Street NW, Washington, DC 20005. All rights reserved.

Follow us on InstagramFollow us on FacebookFollow us on TwitterConnect on LinkedInConnect on YouTube