Insider trading: Is it worth it?

Insider trading is the act of trading stock or other securities based on information that has not yet been released to the public.  This non-public information can allow individuals to either profit or avoid a potential loss. For example, if a publicly traded pharmaceutical company has given early warning to a hedge fund that a drug trial has failed and the fund sells all their shares, that's insider trading.

The United States is generally viewed as the country with the strictest laws on insider trading in order insure that every American has a fair shot at making profits. Depending on the severity of the case, punishments usually result in a monetary penalty and jail time.

In 2001, according to the SEC (Securities and Exchange Commission, not the overrated football conference), Martha Stewart avoided a loss of a little under $50,000 by selling all 3,928 shares of her ImClone Systems stock, after receiving material, nonpublic information from Peter Bacanovic, who was Stewart's broker.  The day following Martha's trades, the stock plummeted 16%.

In 2003, Stewart was indicted by the government on nine counts, including charges of securities fraud and obstruction of justice. She was sentenced to serve a five-month term in a federal correctional facility and a two-year period of supervised release.

Others, such as Jess Skilling, the former president of Enron, served longer imprisonments. In 2006, Jeff was convicted of multiple federal felony charges relating to Enron's financial collapse, and is now serving a 24-year prison sentence. 

Just how common is insider trading?

"Insider trading has been increasing in recent years, in part because of the aggressiveness of hedge funds seeking out opportunities," says Robert Prentice, professor of business law and ethics at McCombs School of Business.

The problem with insider trading is that it hurts people's confidence in the markets and hurts economic growth. However, with the recent conviction of Raj Rajaratnam, founder of the Galleon Group hedge fund management firm, it appears that this problem is finally getting under control (even though some may argue that the punishments do not fit the crime).

Hook 'em