Insider traders have a crucial advantage: they possess material non-public information (MNPI).
This is information about a company that hasn’t been shared with the general public, but if it were, it would significantly influence an investor’s decision to buy, sell, or hold a company’s stock.
What Do Insider Traders Know?
Here’s what they know that you don’t:
- Confidential Company Secrets: They have access to information that is meant to be kept private within the company until it’s officially announced. This can include:
- Upcoming Mergers, Acquisitions, or Takeovers: Imagine knowing a company is about to be bought out at a much higher price per share. An insider could buy shares before the announcement and sell them for a quick, substantial profit.
- Major Earnings Surprises: If an insider knows the company is about to announce much better (or much worse) earnings than expected, they can buy (or sell) stock before the market reacts.
- New Product Launches or Regulatory Approvals: Knowing a pharmaceutical company is about to get FDA approval for a groundbreaking drug, or that a tech company is launching a revolutionary product, could lead to significant stock price increases.
- Changes in Management: Information about a CEO’s resignation or a major shake-up in leadership can have a strong impact on investor confidence and stock price.
- Significant Legal or Regulatory Developments: Awareness of a pending lawsuit settlement, a major fine, or a new regulation that will heavily impact a company’s business.
- New Contracts or Canceled Deals: A large, lucrative contract can send a stock soaring, while a major client pulling out can cause it to plummet.
- The “Non-Public” Aspect: The key is that this information is not available to the average investor through public channels like press releases, SEC filings, news articles, or analyst reports. It’s confidential and known only to a select few.
- The “Material” Aspect: It’s not just any secret; it has to be “material.” This means it’s information that a reasonable investor would consider important when making an investment decision because it’s likely to affect the company’s stock price. For example, knowing a janitor’s hours are being cut wouldn’t be material, but knowing the company is facing bankruptcy certainly would be.
How Do Insider Traders Make Money (illegally)?
Insider traders use this MNPI to make trades (buying or selling stock, options, etc.) before the information becomes public. Once the news does become public and the market reacts, they profit from the difference in price.
- If the news is good: They buy shares before the announcement, and then sell them after the stock price jumps.
- If the news is bad: They sell shares (or “short” them) before the announcement, and then profit when the stock price drops.
This is illegal because it creates an unfair advantage, undermining the fairness and integrity of the financial markets. It’s like having a sneak peek at the test answers before everyone else.
