Why is insider trading problematic?

Many people who work in bigger businesses have likely heard the term insider trading before. They have also likely heard that it is an illegal practice and bad for everyone.

But what about it is such a problem? What makes insider trading a risk not only for the individual, but for entire businesses?

What is insider trading?

The U.S. Securities and Exchange Commission discusses insider trading and the damage it may cause. Insider trading occurs when someone uses their “inside information” in order to make decisions with their stocks.

For example, say someone works for a big retail store that is about to file for bankruptcy. The worker will know before the general public that the company is planning on filing for bankruptcy. Thus, if they take this knowledge and sell their share in the company before it officially announces its plans, this is considered insider trading.

Loss of faith in the stock market

So why is it a bad thing? Because the stock market exists on trust. Investors trust in the fact that people are playing the market fair and square, not using any unfair advantages in order to get a leg up over the competition.

When people engage in insider trading, they diminish investor security and damage the belief that the stock market is functioning fairly. This can in turn cause investors to invest in fewer companies, which can hurt the entire market on a whole.

This is why insider trading has such severe penalties, such as $500,000 in fines and potential jail sentences that can last years.