What Is Legal Insider Trading?

Insider trading is the buying or selling of shares of a company by someone who has access to material, non-public information on the company. Legal insider trading is when company insiders - officers, directors, employees and 10% owners - buy or sell shares in their company in accordance with securities laws and regulations.

This kind of trading is fairly frequent since employees of publicly traded companies as well as their top management often hold stock in their firms or have stock options granting them the right to purchase a certain number of shares of the company's stock at a preset price.

This is considered to be a form of insider trading because these people - insiders in the company - might have special knowledge concerning the business not known to the public, which could give them unfair advantage over other investors.

This information can be about anything that could have influence on the company's stock price. For example information about a pending merger, a change of a CEO, information about a new product, announcement of a tender offer, a positive earnings report, etc.

To keep insider trading legal, insiders must register their trading with the Securities and Exchange Commission (SEC), which requires that trading is reported within a certain period. For example changes in ownership must be reported to the SEC within two business days (on Form 4).

Nonetheless, the most important thing is that insider trading is only legal when the material information has been made public and the insider has no direct advantage over other investors. The information is usually made public by the company by means of a press release or some other type of general announcement.

Bottom Line

So, as insiders have an insight into the workings of their company, it may be advisable for an investor to have a look at how insiders are legally trading their stock.