What are the pros and cons of insider trading?

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kipling2448 eNotes educator| Certified Educator

The advantages of insider trading, defined as buying and selling stocks on the basis of information originating within the relevant organization or business and that is not publicly available, are clear:  those engaged in insider trading are partaking in a low-risk, high-reward practice that can reap considerable financial rewards.  Insider trading is commonly assumed to be entirely illegal, but there is a legal means of trading in stocks with inside information.  Employees and corporate officers are legally entitled to trade in the stocks of their own company.  As long as those transactions are properly reported to the U.S. Securities and Exchange Commission (SEC), then the transactions are perfectly legal, and highly profitable.

Insider trading is illegal, and has landed many investors in legal trouble, including spending years in prison, when it involves individuals outside of the corporation in question who buy or sell stock in that corporation on the basis of information provided from individuals inside the corporation who are privy to sensitive, proprietary information not accessible to the general public.  Illegal insider trading includes buying and selling stocks the change in value of which can logically be inferred from information an individual possesses about a particular corporation based on his or her association with that corporation.  An example could include employees or officers of financial services companies doing business with the corporation whose stock in which they are trading.

In the case of illegal insider trading, the disadvantages are clear:  prosecution by the U.S. Department of Justice and civil suits filed on behalf of shareholders by private and government agencies.  A very good breakdown of the laws pertaining to insider training is available on the SEC’s website at www.sec.gov/about/laws.shtml.  Violations of laws restricting insider trading carry significant financial penalties and can, as noted, involve prison sentences.  Among prominent individuals convicted of insider trading are R. Foster Winans, a former reporter for The Wall Street Journal who was convicted of providing information attained in the performance of his duties as a reporter for the financial benefit of friends; Ivan Boesky, one of the faces of the massive insider trading scandal of the late 1980s who was fined $100 million and sentenced to three-and-a-half years in prison; television personality Martha Stewart, who was fined and sentenced to ten months in prison; and Jeffrey Skilling, the former CEO of Enron, the company at the center of the enormous accounting scandal that resulted in his being fined $45 million and sentenced to two years in jail.

The advantage of insider trading – the reason it is commonly practiced – is the potentially enormous financial gains it can provide.  The disadvantage is, when conducted illegally, it can lead to public exposure, heavy financial penalties, and a prison sentence.