Insider trading

Definition: The buying and selling of stocks and/or bonds (ie, securities) of a corporation by someone who is in possession of “material” (ie, important) “non public” information. This practice is generally illegal.

Example: An executive of BYE Corporation becomes aware that his company is about to announce an offer to buy the SL Corporation. SL’s share price is currently $40. BYE is about to offer to pay $55 per share of SL in order to get holders of its shares to sell them to BYE. The executive could make a quick and substantial profit by acting on this information and buying as many shares of SL as he can for $40 before the buyout offer is announced to the public.

Investeach explains: It’s not illegal to be an insider. In fact, every company has insiders! A team of executives knows things about the business before anyone else does. What is illegal is to act on the information before it becomes public in an attempt to profit!

Not only is it illegal to attempt to profit one’s self, it is also illegal to give someone, such as a relative or good friend, a “tip” containing the non-public information. Further, it is generally illegal for the person receiving the tip to act on it!

The term “material” simply means important. If a prescription drug company just received word from the government that the major new cancer drug it has applied for approval to sell has been rejected because the side effects are too severe, that news is very much material! However, if the company has decided to change from Hefty to Glad brand garbage bags, our response will be “who cares?” because it is immaterial.

Riddle me this:

1. Why is it not illegal to be an insider?
2. Explain what “material” information is.
3. Construct a scenario where a person can benefit from being in possession of material non-public information.