Insider trading policies are formal practices established by publicly-owned companies to prevent the unfair exploitation of confidential or inside information for personal gain. In the United States, the Securities and Exchange Commission (SEC) monitors stock transactions, and the sophisticated software employed in that monitoring is capable of uncovering suspicious activity. When such activities are discovered, the SEC investigates not only the people involved in the trade, it also investigates the company whose securities were traded.
There is more to insider trading than internal parties trading in a company’s securities. The president, chair and other principal officers of a company aren’t prohibited from trading in their company’s stock offerings; quite the contrary, it would be unfair to prevent a company’s major decision makers from investing in it. Insider trading policies seek to define for all company employees the wide range of activities considered illegal insider trading. In most cases, buying or selling stock in a company based on information not generally available to the public is the target of insider trading policies.
Most companies have employees at all levels who might come into possession of confidential information before the general public. It’s critical to provide them with clear explanations of what’s expected of them, because there are many misconceptions about what constitutes insider trading. For instance, some people think that it’s acceptable to share inside information as long as they don’t personally benefit from it. In fact, whether one personally profits from the misuse of inside information or passes it to someone else who misuses it, a person who passes inside information has broken the law. Any insider trading policy will make that clear.
Publicly traded companies go to great lengths to define insider trading and make certain that their employees thoroughly understand it. Most require that all employees sign a statement to that effect. Insider trading policies go much further than simply prohibiting the practice, though. Most provide not only for the discharge of any employees caught at insider trading, but also for reporting them to the SEC for possible criminal charges.
A company’s employees aren't the only ones who might acquire and misuse confidential information. Attorneys, accountants, software designers and other third parties may become privy to inside information in the course of their duties. Companies that contract with such third parties must ensure that they also have solid insider trading policies that emphasize that clients’ information must be treated as confidential.
The SEC requires that certain insiders’ trades in the company’s stock are publicized within a specified period of time. These insiders are the principal officers and other top executives, and their trading activity is closely watched not only by the SEC but also by many investors both inside and outside the company. Without any allegation of illegal insider trading, the investments of a company’s top decision makers in that company are considered a general statement of its overall financial strength.
Other trading rules are also laid out in the company’s insider trading policy. For example, many companies categorically prohibit all employees from selling their stock short. Most also prohibit any trades in the stock at all for a certain length of time before earnings reports and other such activities.