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In one week a few years ago, six top financial investors, including a billionaire, were arrested and charged with fraud and conspiracy for having illegal information before making their trades, bringing them riches that they didn’t deserve. They were accused of making millions of dollars from this information over the course of 3 years.

Trader of the Apocalypse
Creative Commons License David Blackwell. via Compfight

Most people don’t understand this kind of crime at all, or why it’s a crime. The idea that most people have is that everyone looks for information on something to try to get ahead of the game; that’s what I’ve always thought anyway.

In a way it’s like the NFL, which wants every team to disclose when players are injured and what kind of injuries they have. This is ward off certain gamblers having knowledge that no one else has to make more money.

In general terms, there are two laws against insider trading, and both are federal laws. The first is the Securities Exchange Act of 1934 and the second is the Insider Trading Sanctions Act of 1984. The purpose of these laws was to restrict the ability of people from making money, or losing money, based on information that wasn’t being shared with everyone else.

The initial purpose of these laws were to prevent workers at companies traded on the market from doing things that would bring them profits at the determent of the company or the company’s investors. It’s also to stop others from learning this information and then acting upon it. It’s this law that sent Martha Stewart to prison some years ago.

A portion of a quote from the 1984 act tells us why they believe this is unfair: insider trading threatens “markets by undermining the public’s expectations of honest and fair securities markets where all participants play by the same rules.” In other words, those with this information get a benefit and have more opportunity to game the system than those of us without it.

The thing that’s confusing about this law is that most people think it’s just business as usual. In other words, any of us who are investing in a company could just pick up the phone, call a company, and start asking questions. Where the problem comes in is that not everyone knows everything that’s going on in a company. If you get to talk to either the CEO or CFO and they tell you something that they’re not going to tell anyone else, you now have an advantage that could make you a lot of money that no one could have made. And, it’s possible that either of these people could be convinced to share this information with you for a percentage of the profits that are made. The acts were meant to eliminate these possibilities.

Obviously it’s still happening, and it’s my belief that those doing it are getting more savvy. No more email or other records to show what they’re doing, and, well, let’s face the fact that there are many people who can earn lots of money in one day of trading who don’t have any more knowledge than the general populace. At least now you know why it’s illegal and that it’s not a legally accepted practice anywhere in the country.
 

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