Many people who work with or adjacent to the stock market have heard the term “insider trading” before. Many may also know that insider trading nets a fairly hefty penalty in court.
But why is that the case?
What is insider trading?
Insider trading occurs when a person with inside information uses that advantage to make decisions in the stock market that other people cannot. For example, say an employee hears that their company will soon file for bankruptcy. If they choose to sell their stocks before this announcement goes public, this is insider trading.
It also applies in situations where a person on the inside shares or sells their information to other people on the outside.
The U.S. Securities and Exchange Commission takes a look at penalties associated with insider trading. A person convicted of insider trading can expect to see up to 20 or 30 years in jail, and fines ranging from $500,000 to $1 million or even higher in some situations.
Needless to say, these are enormous penalties for a single person to face.
Why is this an issue?
So why are the penalties so harsh, exactly? Essentially, it is to protect the entire stock market structure and integrity.
Investors make the stock market work. Without them, the entire system would collapse. Investors also trust in the transparency and fairness of the stock market.
Insider trading strips that fairness away. If investors do not feel like they can trust the market, they will stop investing, which can grind the entire thing to a halt and do enormous financial damage to countless people. Thus, penalties serve as a deterrent to anyone who may try.