HomeTradingHow Does Insider Trading Work: An Illegal Process Explained

How Does Insider Trading Work: An Illegal Process Explained

Insider trading is a financial activity that has been making headlines around the world for decades. It is an illegal but highly profitable practice that involves buying and selling stocks and other securities with information that is not available to the public. While it may seem like a lucrative opportunity, insider trading carries significant risks and consequences.

In this article, we’ll look at what insider trading is, how it works, and the penalties associated with this practice. 

What is Insider Trading?

Insider trading is the illegal practice of using information not available to the general public to purchase or sell stocks and other securities. It is a form of market manipulation and fraud and can result in significant fines and even prison time for those involved.

Insider trading is prohibited by the Securities Exchange Commission (SEC) and many other regulatory bodies around the world. To understand how insider trading work, it is important to understand the different types of information that can be used to trade securities. Generally, insiders use material nonpublic information, meaning information not yet disclosed to the public, to their advantage when trading securities.

This could include knowledge of an impending corporate merger, a change in management, or any other news that could affect the stock price. Insiders may also use non-public information about customer demands, sales forecasts, financial performance, etc. to make profitable trades.

How Does Insider Trading Work?

The ‘insider’ is typically someone who has access to confidential and material non-public information which can influence the security’s price. For example, an executive of a company may have access to information that could affect the stock price of his/her own company and use this information to make a profit through trading.

Insiders must avoid the temptation to use the information they have to gain an unfair advantage in the market, as it is illegal. Insider trading is a federal crime and is monitored by the U.S. Securities and Exchange Commission (SEC).

The SEC will investigate if insider trading is suspected to determine if someone has violated insider trading laws. If the investigation reveals that someone has committed insider trading, they will be subject to civil penalties including monetary fines and possible jail time.

Who can be charged with Insider Trading?

Insider trading is illegal and it can be charged to any person who has access to confidential information not available to the public. This could be corporate executives, board members, advisors, or even friends and family members who have been given access to such information.

It is important to note that trading based on information obtained through other people such as journalists or industry experts is also illegal. A person who trades without any knowledge of the information may also be liable for ‘tipping’ another person about the non-public information and profiting from the trade.

By using confidential information to make investments or trades for personal gain, a person can be charged with insider trading regardless of whether they knew the information was not available to the public. 

What are the Penalties for Insider Trading?

If convicted of insider trading, the penalties can be severe. Under federal law, those found guilty of insider trading can face up to 20 years in prison and a $5 million fine. Additionally, the Securities and Exchange Commission (SEC) can bring civil charges against those accused of illegal insider trading.

Those convicted may be required to pay up to three times the profit they earned or loss they avoided as a result of their insider trading activities. This means that investors may have to pay a fine or disgorge the profits they made from illegal activity.

It is also possible that the SEC may bar investors from participating in the securities markets for a certain period. It is important to note that any criminal penalties associated with how insider trading works will depend on the nature of the offense and the amount of money involved.

Is There a Defense to Insider Trading Charges?

When it comes to the question of how insider trading work, it’s important to understand that the alleged perpetrator may have a defense available. While insider trading is illegal, there are various ways to defend oneself if charged with such a crime. It is important to consult an experienced attorney to determine the best course of action.

The most common defense is the misappropriation theory. This means that the accused did not have confidential information when they acted or that they acted upon publicly available information. Another defense is known as the family member defense, which states that the person accused did not know that the information they used was confidential.

The most successful defense tactic is claiming that there was no intent to commit insider trading. This means that the defendant was unaware of the potential for their actions to be considered insider trading. For a court to accept this defense, the accused must provide convincing evidence that they had no intention of making a profit from using confidential information.

Additionally, the defendant can claim that they were not aware of the illegality of their actions. This is a difficult defense to prove, however, as prosecutors often argue that everyone should be expected to understand the rules and regulations surrounding insider trading.

Finally, a defendant can claim that the information used did not impact the company’s stock price or another financial gain. This means that even if there was insider trading, it did not affect the market or benefit anyone financially.


Insider trading is an illegal but potentially lucrative process that can lead to serious penalties if caught. It involves individuals using confidential information for their benefit and as such is illegal in many countries. Knowing how insider trading work is key to understanding the risks of engaging in this activity and the potential consequences should you be charged with insider trading.

Ajeet Sharma, the founder of Financegab and a well-known name in the field of financial blogging. Blogging since 2017, he has the expertise and excellent knowledge about personal finance. Financegab is all about personal finance which aims to create awareness among people about personal finance and help them to make smart, well-informed financial decisions.


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