Many people have heard the term “insider trading” before, and many also know the definition. However, not a huge number understand why insider trading proves so problematic.
This is the primary driving force behind the rather large penalties associated with insider trading. But why exactly is it such an issue?
What is insider trading?
The U.S. Securities and Exchange Commission dives into insider trading in the market. First: what is it?
In essence, insider trading occurs when someone on the “inside” uses their knowledge to gain an unfair advantage in the stock market against those on the “outside”.
For example, if someone in a company knows in advance that the company will soon declare bankruptcy and sells their stocks before the news breaks to the public, this counts as insider trading. This is someone using their unique position and information to make decisions that others do not have the ability to make.
Why is it a problem?
This poses an issue because the stock market essentially runs on a trust system. Individuals who break the trust by using inside information to their advantage could risk disrupting the entire system.
The less trust that investors have in the stock market, the less likely they are to participate, too. This hesitance can actually cause the entire fragile system to begin crumbling, putting everyone else at risk, too.
For this reason, those who engage in insider trading often face extreme penalties when caught, such as 20 years in jail and up to $500,000 in fines and fees.