Much insider trading goes undetected.
Much insider trading goes undetected.

Insider trading can be legal or illegal. The illegal type is when investors buy or sell securities based on "inside" information about the company that isn't available to the public. The U.S. Securities and Exchange Commission makes a priority of catching insider traders; the agency filed 58 insider trading cases in 2012 alone. While the laws that prohibit insider trading are based on the belief that this practice hurts individual investors and the economy as a whole, not everyone agrees that ferreting out insider trading is worth the cost or even that insider trading is wrong.

Legal and Illegal Trading

Not all trading by insiders of a company -- its officers, directors and employees -- is wrong or illegal. Insiders are allowed to trade in company stock in many cases, and it’s common for a company to pay its people in the form of stock or options. Insider trading crosses the line when an insider uses material information that isn’t available to the public to make a trade, violating a duty of trust or confidence. For example, if an employee or corporate officer trades company stock after receiving a tip or otherwise learning confidential information about a positive or negative development for the company, this is considered illegal insider trading.

Purpose of Securities Laws

The U.S. securities laws require companies that offer securities -- including stock -- to the public to register those securities and to report information about their business. The purpose of these laws is to give investors access to information about the securities they are buying and to prevent fraud. When insiders trade on nonpublic information, they receive an unfair advantage at the expense of the public, which doesn’t have access to the same information.

Downsides of Illegal Trading

Illegal insider trading is thought to hurt the public in two major ways. First, it increases the wealth gap: Those who are at the top of a big company get richer, while the public misses out on the same opportunity. Second, rampant insider trading would undermine investors’ confidence that the markets are fair. The SEC rigorously enforces insider trading laws in large part because the commission's purpose is to maintain confidence in the integrity of the marketplace, which bolsters the stability of the economy as a whole.

Legalizing Insider Trading

Not everyone agrees that insider trading on nonpublic information is wrong or should be illegal. Some people believe that insider trading is valuable because it increases the available information about the company; if insiders had been allowed to sell their stock in Enron, for example, the stock price would have plummeted and the fraud at the company may have been discovered much earlier, they argue. Others argue that the cost and difficulty involved in detecting and prosecuting illegal insider trading are out of proportion to the small toll it takes on investors and the marketplace.