Insider Trading

In a broad sense, insider trading is obtaining information from nonpublic sources and using it for purposes of enhancing one's financial advantage. In a narrower sense, it refers to the purchase or sale of securities of a company, to the benefit of the seller or a third party, using inside information, understood as nonpublic information that the seller possesses as a result of having a fiduciary relationship with the company in question.

Inside information tends to be about something that may have an impact on the expected return or risk of a company: investment projects, appointments to the management team, plans for (or results of) research on new products, and so forth. For example, the purchase of shares of a pharmaceutical company by one of its managers hours before the public announcement of the results of research into a new drug that is likely to make the share price rise sharply would be classified as insider trading.

The person possessing inside information may be a manager or employee of the company who has a relationship of loyalty with the company; or a person or organization (legal counsel, advertising agency, auditor, consultant firm, or bank) that has dealings with the company, under a similar relationship of trust; or a person (a relative or friend, an employee of the bank) who has received information from one of the above. Inside information does not include public information or information made available to the public (to a journalist who is writing an article about the company, for example) or any information a person may obtain by his own effort and ingenuity, using licit means (such as the information obtained by a financial analyst by studying press reports and published accounting records of the company). Obviously, the legal and moral problem is about how inside information is used, not the mere fact of possessing it.

Close to insider trading are conflicts of interest, which can arise in any situation in which an interest interferes, or has the potential to interfere, with a person, organization, or institution's ability to act in accordance with the interest of another party, assuming that the person, organization, or institution has a legal, conventional, or fiduciary obligation to do so. An example might be an investment bank that uses the information it has about one customer to benefit another.

Often, insider trading is said to be a victimless crime, the suggestion being that it does not in fact have any moral consequences because the extent of the damage (which often takes the form of lost income) is unknown or because we cannot say exactly who suffers the damage or because the supposed damage is shared among large numbers of people in very small amounts, whereas the benefit tends to be highly concentrated. Yet it poses some interesting ethical problems, deriving from the fact that the person who carries out the insider trading has an informational advantage that outsiders lack—although that does not make every insider trading transaction immoral.