Why Is Insider Trading Illegal? A Look at Market Fairness, Law, and Investor Confidence
When investors ask why insider trading is illegal, the answer goes beyond simple rule-breaking. In reality, insider trading laws exist to protect trust, fairness, and equal access in markets that depend on public confidence.
When trades are made using material information that has not yet reached the public, prices can shift before most investors have a chance to react. That imbalance damages transparency and weakens belief in the system itself.
Below, we will break down how insider trading works, why regulators treat it so seriously, and what the data shows about its impact on markets and investors.
What Does Insider Trading Mean?
Insider trading occurs when someone buys or sells stock based on important confidential information that is not available to other investors. The key legal idea is that this information is material and nonpublic.
Something is material when a reasonable investor would consider it important to a buying or selling decision, such as earnings figures, mergers, or regulatory decisions.
A CEO who learns about a pending merger and buys shares before that information is public has committed insider trading. Regulators also pursue situations where someone outside the company gets privileged information (like overhearing calls or tips from insiders) and uses it to make trades.
How Often Does Insider Trading Occur?
Most financial markets have laws against trading on insider knowledge, and enforcement actions give us clues about how often it happens.
| Insight Category | Statistic / Trend |
|---|---|
| Estimated insider trading prevalence (US) | Occurs in roughly 1 in 5 major announcements |
| SEC enforcement actions per year (approx.) | ~50 cases filed annually |
| Recent major enforcement scalp | Terren Peizer charged for insider trading under Rule 10b5-1 |
What this suggests: the number of detected and prosecuted cases is just the tip of the iceberg. Economists estimate illegal trading happens more often than regulators catch.
So, Why Is Insider Trading Illegal?
To answer why insider trading is illegal, we must look at how markets operate. Financial markets rely on confidence and equal access to information.
| Reason Insider Trading is Banned | How It Affects the Market |
|---|---|
| Unfair advantage | Private info lets insiders profit over average investors |
| Lower trust | Investors feel markets are rigged |
| Price distortion | Securities do not reflect true public expectations |
| Reduced participation | Retail investors may avoid markets |
Insider trading hurts fairness and trust in markets, affecting not just active traders but pension holders and everyday investors.
A Brief History of the Legal Ban
In the United States, before the Great Depression, trading on private knowledge was common. The Securities Exchange Act of 1934 and Rule 10b-5 made trading based on confidential information a violation. Important precedents like United States v. O’Hagan gave regulators stronger enforcement tools.
Real Enforcement Examples and Penalties
| Case / Penalty | Details |
|---|---|
| Terren Peizer (2023) | Charged for insider trading using a Rule 10b5-1 plan. |
| Australian case (2026) | Six-year sentence for misusing private takeover info. |
| Anthony Viggiano (2024) | 28 months for tipping friends. |
| U.S. Annual Actions | ~50 SEC cases filed yearly. |
Insider Trading and Market Integrity
Market integrity depends on prices being shaped by shared information rather than private advantage.
Signal Distortion in Prices
When insiders trade ahead of public news, prices reflect nonpublic knowledge, distorting true supply and demand.
Impact on Ordinary Investors
Everyday investors relying on public research stand at a disadvantage when others have advanced knowledge.
Global Regulatory Efforts
Regulators worldwide view insider trading as a crime, not just a civil violation.
How Investors Can Trade Lawfully
Lawful investors focus on public data. Tools like a Financial Calendar and Stock Screener help discover opportunities within legal boundaries.
Conclusion
Why is insider trading illegal? Because it weakens core market principles. Laws and enforcement exist to protect transparency and ensure no participant gains an unfair edge.
LambdaFin supports this by bringing clarity to market activity through structured data, disclosures, and analytical context.