What is 'insider trading'?
Insider trading generally refers to the purchasing or selling of securities of a company while in possession of material information that has not been generally disclosed in the marketplace.
For example, suppose a company makes an important discovery of a valuable mining asset, as Texas Gulf Sulfur did in the 1960's, or invents a new drug that is likely to have a major impact on the bottom line, as Pfizer did with its impotence drug in 1998, or announces that it is making an important acquisition, is being acquired, or merging, as Citicorp and Travelers did in 1998. Such news would likely cause the price of the company's shares to increase. If insiders who have that knowledge buy, they win, while the person selling his or her shares who did not have that knowledge will lose.
Similarly, if a company hides bad news that would be likely to cause the market price of its shares to drop, while members of corporate management who knew the bad news sold the shares, that likely would be insider trading. For example, in April 1998 Cendant announced that it had discovered accounting irregularities. Its financial statements had significantly overstated its income. When the news was released Cendant's shares dropped from the $35 per share level to about $18 per share (46%) in just one day. In a recently filed Class Action lawsuit, it was alleged several members of Cendant's top management sold 2 million shares at the high price before the bad news was released.
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