What is Insider Trading?

What is Insider Trading?

The words “insider trading” are one of the more exciting financial phrases to be uttered in the news. It brings to mind images of elite stock market traders in suits and ties, engaged in shady backroom meetings to make millions, if not billions of dollars. But behind the sensationalized narrative, what exactly is insider trading?

7 Infamous Insider Trading Cases and Scandals

  • Martha Stewart
  • Nancy Pelosi
  • Donald Trump
  • Phil Mickelson
  • Albert H. Wiggin
  • Ivan Boesky
  • R. Foster Winans

What is Insider Trading?

As you may very well know, publicly traded companies sell shares of ownership in their company on the stock market. This allows both institutional investors (like big banks and investment firms) and consumers to buy and sell stocks.

There are a number of ways to make money on stocks, and one of them includes collecting dividends. Dividends are a small share of company profits paid to each shareholder based on the number of stocks they own in that company. Though, the most glamorous stock investment method is to capitalize on market movements through buying low and selling high.

How do investors know if and when a particular security is about to take off? Nobody has a crystal ball to make such predictions, but there are a few tools and strategies that can be used to make an educated guess.

Serious investors conduct market research and perform fundamental analysis of the companies they invest in.

For example, when the Coronavirus pandemic started, certain financial analysts predicted that healthcare stocks would be a solid purchase. An investor conducting their market research might then turn to more specific market research of a security, such as looking at a company that manufactures hospital equipment and examining its debt to equity ratio and other metrics to see if it’s a good buy. Some traders have even created elaborate analytical programs or software that crunch numbers and deliver statistically backed predictions about what to buy and what to sell.


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These are all perfectly legal methods of deciding what to buy and sell on the stock market, but what about investors who gain an unfair edge over others through non-public material information about a company? In other words, what about individuals with access to “inside information”?

These individuals learn what others on the market cannot, giving them an unfair advantage that they can then abuse for their own financial gain. This is called insider trading.

Why is Insider Trading Illegal?

By now you may be wondering what is so bad about one person having insider information. What is unfair about someone having material information that will help them decide whether to buy or sell shares of a particular stock?

Let’s take a step back to look at the stock market at large. These markets rely on a fair playing field to function, where anyone with the ability to pay can come and purchase a share or shares within a company or companies of their choice. Oftentimes, the price of these stocks will be influenced by how many people are buying or selling the stock. For example, if investors rush to purchase shares of a company, that can drive up the price. If people are rushing to sell off their shares, that can drastically lower the price.

Someone with insider knowledge who then acts on that knowledge to buy or sell large quantities of a stock can influence the market, artificially manipulating the value of the stock and creating a financially inaccurate representation of its true worth. This, in turn, can create a bubble that, when it pops, leaves many investors at a loss. All due to self-serving investment choices made with non-public insider information.

This chain of events can erode consumer investor confidence in the market and impede its overall health. One of the main goals of the stock market is for businesses to raise capital by selling stock. If investors don’t have confidence in the veracity of their investment, they won’t buy stocks, and companies won’t get the funding they had hoped for.

Another reason that insider trading is illegal is because it involves the inside trader placing their own interests above others to whom they might own a fiduciary duty. These could be other investors in their company or even financial clients if the perpetrator manages others’ investment portfolios.  

It’s important to keep in mind that some forms of insider trading are legal. When corporate insiders of the company issuing stock buy and sell those stocks, that is perfectly acceptable. The only requirement to legitimize these trades is that certain forms must be filled out with the Securities and Exchange Commission (SEC) within two days of the transaction. According to the SEC, in these instances, anyone with 10 percent stake or more in a company is considered an insider.

How is Insider Trading Proven?

As you might guess, insider trading involves an inside tip; not one broadcast to the public. This tip might come in the form of a verbal conversation over lunch, a phone call, text, or email. But how exactly can you prove, beyond a reasonable doubt, that someone was involved in insider trading?

Written tips carry the danger of becoming evidence, should an investigation result from the suspicion of insider trading. The SEC is not able to read people’s private text messages or a company’s internal communications arbitrarily. Instead, they conduct market surveillance activities using sophisticated software to flag suspicious looking trades. Such trades might occur around momentous events, like a corporate development or earnings report. The trades themselves are usually indicative of a hope to strike it big, such as a trade placed before a massive price fluctuation.

Another way the SEC tracks insider trading is through tips and complaints from unhappy investors who got the short end of the stick on a trade. In most cases, these angry calls will come from irate option writers.

Options involve trading contracts to buy or sell stocks. If these option writers are out of the loop on what is actually going to happen to a stock price, they can suffer a loss. Moreover, inside traders sometimes make more money on options contracts than they would buying or selling shares of the stock in question. If option writers suspect foul play, they will report it to the SEC.

The SEC also gets insider trading tips from whistleblowers. If a whistleblower provides useful information that leads to a conviction, they can be rewarded between 10-30 percent of the money seized from insider traders. Typically, though, insider trading arrangements involve a very limited number of people and occur as a one-off, isolated event. Whistleblowing is more common in terms of revealing widespread securities fraud. A whistleblower may be someone at the company, like an employee, or even client who becomes aware of insider trading. Though they might be intimated to share what they’ve learned, they are protected from professional retaliation by the SEC through the Occupational Safety and Health Administration (OSHA).

Other alerts to insider trading can come from regulatory organizations, like the Financial Industry Regulation Authority (FINRA), or even media speculation. In these cases, insider trading can only be prosecuted when followed by an investigation from the SEC, FINRA, or a comparable organization.

Once the SEC decides to pursue an investigation based on pertinent facts, the Division of Enforcement will examine trading records, subpoena witnesses to interview, and even obtain electronic records, like phone calls and emails. In some cases, insider trading may be tied to a larger enterprise operating fraudulently. If this is the case, the SEC may use more serious investigation techniques, such as wiretapping, to implicate and expose inside traders.

Despite these technological tools and regulatory powers, the SEC will still need to conduct an investigation. Unless the perpetrators of insider trading willingly step forward to explain what happened, the SEC will need to gather evidence for their case, just like any other type of criminal investigation.

Evidence can include anything, including seemingly innocuous lunch reservations where the perpetrators meet shortly before an astonishingly advantageous trade. It can also include more noteworthy red flags, such as large ATM withdrawals. Keep in mind that since the SEC is conducting the investigation, they will have the power to subpoena any information they need for the case.

What Are the Penalties for Insider Trading?

Once the investigation is complete and the SEC is ready to present their findings, they may elect to bring the case to administrative action or federal court.

In administrative action, an administrative law judge will take legal considerations and facts into account and render a decision accordingly, such as a cease and desist order, monetary penalties, suspension or even revocation of financial industry accreditations and registrations. These penalties can also include disgorgement; the legally mandated repayment of all ill-gotten gains made from insider trading.

If the SEC chooses to take the case to a US District Court, they may seek to impose all these penalties, as well as injunctions and sanctions limiting future financial activity.

Despite the fact that the SEC has a process in place for finding and prosecuting inside traders and their tipsters, inside trading still occurs. Money is a powerful motivator, and it can be hard to ignore a helpful tip that could lead to millions or billions in profit.

Believe it or not, insider trading in America goes back to the the Revolutionary War. William Duer, appointed by Alexander Hamilton to serve as the assistant secretary of the US Treasury, resigned from his position after it came to light that he was using his access to confidential information in order to speculate on securities.

Since then, there have been many other examples of insider trading. A few high-profile cases of insider trading include:

7 Infamous Insider Trading Cases and Scandals

1. Martha Stewart

The queen of homemaking and color-coordinated dinner parties has actually served time in prison because of insider trading.

It all began in 2001, when the FDA (Food and Drug Administration) would not approve a new cancer drug called Erbitux. The drug’s manufacturer, ImClone, realized its future plan for growth would be severely impacted by this news, and their stock began to plummet.

Many people who invested in this pharmaceutical company lost money as the stock dipped 16 percent on December 31st, 2001. The stock dropped to $46 per share, and over the following months it continued to fall until it hit $10 per share.

Martha Stewart avoided a loss of $45,000 by selling 4,000 shares of Erbitux a few days prior, netting her gains of a quarter of a million dollars.

That amount may seem like small change for a celebrity of Martha Stewart’s status. After all, her net worth is estimated to be $628 million as of 2020. But Martha Stewart didn’t even make the bulk of the profits from this insider trading scheme.

Erbitux CEO Samuel Waksal, as well as his close friends and family, made off with much more.  They sold their shares in the company before its stock plummeted. This includes Waksal’s daughter, Aliza Waksal ($2.5 million); his father, Jack Waksal ($8.1 million); general counsel for the company, John B. Landes ($2.5 million); and the VP of marketing and sales, Ronald A Martell ($21 million). Their stock broker, Peter Bacanovic, also worked with Martha Stewart and tipped her off, resulting in the sale that netted her $250,000.

That amount may not have been enough to attract the attention of the SEC. It was actually a tip from Bacanovic’s assistant, Doug Faneuil, that brought Stewart’s involvement in the scheme to light.

Waksal was sentenced to seven years in prison and fined $43 million. Both Stewart and Bacanovic staunchly asserted that Stewart had already made the decision to sell her shares of ImClone if it dipped to less than $60 per share, but the court found Stewart guilty and sentenced her to five months in prison, five months of home arrest, two years of probation, and a fine of $30,000.

Due to the scandal, Martha Stewart also resigned as CEO from her namesake company, Martha Stewart Living.

2. Nancy Pelosi

Nancy Pelosi, a Democratic representative in the US Congress from the San Francisco Bay Area, is also Speaker of the House of Representatives. She is currently at the epicenter of insider trading speculations relating to the recent COVID-19 pandemic.

On January 17, 2020, Senator Pelosi’s husband, Paul, bought 3,000 shares of Amazon and 5,000 shares of Facebook for a total of $5.2 million. Tangentially, he actually purchased the stocks using a call option that was set to expire the following day. This allowed him to purchase these stocks below their market value.

In any case, internet message boards and social media platforms exploded with debate about whether or not Pelosi’s stock purchase constituted insider trading. The basis for suggesting the possibility of insider trading comes from the fact that reports about COVID-19 were just coming to the attention of the government. Did Senator Pelosi know that almost every state would issue stay-at-home orders and mandated quarantines, thus increasing reliance on online shopping venues, such as Amazon? Or was it simply a stock buying decision executed because the call option was set to expire the next day? In the absence of an investigation, it would be difficult to prove one way or the other, but it has certainly provided internet-based food for though (and let’s not forget the memes).

Remember, insider trading involves possession of material information about the company. This is a bit different, because Senator Pelosi, as Speaker of the House, is in a unique position to capitalize on information about the economy as a whole. Whatever the case may be, Paul Pelosi’s purchase has netted the couple $2 million in profits since January. This is particularly infuriating to Americans who have lost their jobs and seen their retirement savings wiped out by the economic fallout of the pandemic.

Incidentally, it was actually Paul Pelosi who inspired Congress to pass the Stop Trading on Congressional Knowledge Act (ironically named STOCK). This act prevents members of Congress from using their non-public knowledge to make decisions around the buying and selling of securities.

Nancy Pelosi was also at the center of questions regarding the intersection of governance and money making when VISA went public in 2008. Pelosi bought shares of VISA for $44 per share, spending more than $200,000 on the company, right before shares jumped to $60.

It’s impossible to know whether Pelosi’s decision was simply a long-term investment decision or if the payment processing company unethically gave the senator favorable treatment. Either way, Pelosi’s investment transactions have raised more than a few eyebrows.

3. Donald Trump

Insider trading is by no means confined to one side of the political aisle. In addition to Senator Pelosi, other senators have raised suspicions of insider trading, including Democrats Dianne Feinstein and Susan Davis (both from California), and Republicans Richard Burr (North Carolina) and Kelly Loeffler (Georgia). Insider trading accusations or speculation have also been leveled at the White House, spearheaded by Senator Elizabeth Warren.

The Massachusetts senator was (and perhaps still is) set on a federal investigation looking into whether or not President Donald Trump provided a tip to select traders about the airstrike that killed Irani general Qasem Soleimani. Her ire is fueled by a Daily Beast report that President Trump told guests at his Floridian estate of Mar-a-Lago that a major response to Iran’s globally destabilizing presence the day of the strike. Senator Warren believes this information may have provided confidential, non-public, market-moving information, giving investors a tipoff to buy defense industry stocks.

Incidentally, defense stocks did see positive movement in the 24-hour period after Soleimani’s airstrike: Northrop Grumman (5 percent), Lockheed Martin (3.6 percent), and Raytheon (1.5 percent).

It would be difficult to prove that Mar-o-Lago guests profited from these market movements, not to mention the controversy of building a case against a sitting president for making references to geopolitical events that he is responsible for orchestrating. Moreover, it is hard to determine if Senator Warren’s call for a federal investigation is fueled by genuine ethical concern, or if it is part of an ongoing four-year campaign to remove President Trump from office, which included a lengthy impeachment trial.

Senator Warren hasn’t called it quits yet. She is now calling for investigations into Kodak. The film and photo-printing company was tapped by the Trump administration to start manufacturing generic pharmaceutical drugs as part of a series of policy changes to make healthcare more affordable. The selection of Kodak in particular might seem odd, but it was purported that they had the infrastructure in place to pivot their production focus and begin manufacturing and delivering pharmaceuticals.

The deal fell through when Congress called for an investigation into insider trading and excessive gifting of stock options. At the time of this article, the claims of insider trading have yet to be proven and were not discovered in an internal review by the company. Kodak still plans to push forward as generic drug manufacturer, despite losing the $765 million loan they were set to receive for the deal.

In any case, the investigation transpired after Kodak stock soared from $2 per share to more than $33 per share at the end of July—a whopping 1650% increase. Though the Trump Administration was involved in granting Kodak the requisite government loan to make a comeback, it is unlikely that anyone was involved in insider trading.  

4. Phil Mickelson

You might recognize the name Phil Mickelson if you’re a fan of golf. Mickelson has won 44 events on the PGA, including three Masters Tournaments and five major championships. Like most world-famous professional athletes, Mickelson has extra cash to invest, and his investment choices have landed him in hot water.

The three-way insider trading narrative that incriminated Mickelson reads somewhat along the lines of a movie like Ocean’s Eleven.

It begins with professional gambler, Billy Walters. Walters partnered with a pair of computer analysts to evaluate point spreads set by Las Vegas casinos. Their goal was to find system flaws and place bets accordingly. Walters was the face of the operation, using his charm and connections to spread bets around town.

In the 1980s, this trio raked in tens of millions of dollars. It wasn’t long before the FBI caught wind of what was going on and shut it down.

Walters remained a legendary figure around town, opening businesses and mingling with celebrities like Phil Mickelson. While the two seem like an unlikely pair, Mickelson had cash, and Walters had the know-how when it came to betting. When the 2008 recession slowed Las Vegas down, the pair set their sights on something else: insider trading.

This is where yet another figure enters the story: Tom Davis. Davis was a board member of mega-sized dairy producer, Dean Foods. He was also a compulsive gambler.

Walters and Davis began to discuss the investment potential of Dean Foods, using veiled codes about “meeting for coffee” and “The Bat Phone.” They also referred to Davis’s company as “The Dallas Cowboys.”

Davis would provide Walters with inside tips about what was happening at Dean Foods. By 2012, Walters had raked in $42 million by buying and selling Dean stock at the right times.

It was Walters who introduced Davis to Mickelson, and the golfer began buying and selling Dean Foods stock based on tips from Davis, through Walters.

For example, when Dean Foods made the decision to spin off part of its operations as a brand called WhiteWave, stock prices jumped 40 percent and Mickelson made almost $1 million dollars on the sale. Incidentally, these gross profits also allowed Mickelson to repay his gambling debts to Walters.

It all fell apart when the FBI cornered Davis at his home in Dallas. Davis acknowledged that he knew Walters, but lied about everything else, even during the SEC investigation, until 2015. Finally, declining health pushed Davis to cooperate in order to reduce a 190-year prison sentence.

Davis, Walters, and Mickelson all went to trial, and the trial was a dramatic tour-de-force replete with thorough questioning about decades of insider trading, gambling, and unethical financial abuse (mostly on the part of Walters and Davis). Walters never fully cooperated when it came to implicating Mickelson, who got off the hook—sort of, and just barely.

Mickelson had to repay his trading profits of almost $1 million dollars, plus a whopping six figures in interest. He avoided jail time with this settlement, but that was mostly because of the timing of the trial.

The US Circuit Court had recently reviewed a similar case and decided that while an informer and informee are guilty of insider trading, a third party receiving a tip from the informer cannot necessarily be considered part of an insider trading scheme.

The rules around insider trading were not set in stone by the founding fathers. This means insider trading law needs to be clarified on a case-by-case basis by the courts. Just a short while after Mickelson struck a settlement, the Supreme Court examined yet another similar case and decided that a third party receiving a tip from the informer can indeed be implicated. If Mickelson had reached the point of needing to make a settlement just a little before or after he did, he might have been watching the PGA Tour from a cell in white collar prison.

5. Albert H. Wiggin

The case of Albert H. Wiggin occurred after the Wall Street Crash of 1929.

Throughout the 1920s, the US saw a decade of incredible prosperity, but several factors—low wages, proliferating debt, struggling agricultural yields, and rising unemployment—came together with unfortunate timing to lower the true value of stocks far below their actual price. This caused financial crash of 1929 and created panic, resulting in self-perpetuating cycle that almost imploded the economy.

Albert H. Wiggins, then head of Chase National Bank, was in a position to see the lay of the land and make moves accordingly, even before stock market financial signals became public knowledge.

Wiggins used his vantage point to short 40,000 shares of his own company, selling out before the crash and raking in a cash profit of $4 million. Wiggins then repurchased the stock at a much lower price, presumably to hold on to it and watch it grow again.

As it turns out, Wiggins really did not do anything illegal. In order to obfuscate the sale of his stocks, he used a different company in Canada as a “shell company” for the purchase. Some have argued that Wiggins intentionally made moves to run Chase into the ground before making his short sale, but this is debatable. In fact, Wiggins went on to advise President Hoover during the Great Depression with suggestions that have retroactively received accolades from historians.

In any case, the short sale made Wiggins an unpopular figure for a long time. He later declined a six-figure pension from Chase due to the public outcry against him.

The Securities and Exchange Act of 1934, which created the SEC, was formed with figures like Wiggins in mind. The fraud and market manipulation that had plagued the stock market, especially around the stock market crash, prompted the government to create a new regulatory agency that would increase transparency and foster a sense of consumer confidence in the markets.

6. Ivan Boesky

There were a number of high-profile mergers and acquisitions deals in the 1980s. A merger or acquisition is a major financial event that triggers massive market movements, creating cash windfalls for investors who make moves at the right time, especially if those individuals have insider knowledge. Ivan Boesky was one such trader with insider access who profited from these market movements in the 1980s.

Boesky was a stock trader with his own brokerage company, fittingly named Ivan F. Boesky & Company. Since the inception of the company in 1975, Boesky was making sizable amounts of cash profit by speculating on corporate mergers and acquisitions.

As it turns out, these trades were often not done by speculation. Rather, they were moves made based on insider trading tips. This all came to light when some of Boesky’s corporate partners sued him for an unrelated matter around misleading statements regarding the nature of their legal partnership.

An ensuing SEC investigation ultimately revealed that Boesky’s speculations were actually calculated moves made with insider information provided by corporate informers. The material facts they gave Boesky included non-public information about impending mergers and acquisitions. This allowed Boesky to capitalize on momentous seminal events in the world of finance, and made Boesky look like an investing rock star.

Boesky’s insight was also formed in large part by consistent payments to employees of the mergers and acquisitions branch of investment banking firm Drexel Burnham Lambert (DBL). DBL fueled many of the corporate takeovers in the 1980s, so these financiers were privy to non-public information about upcoming mergers and acquisitions. Incidentally, DBL was forced into bankruptcy in 1990 because of its illegal activity around junk bonds.

Boesky decided to cooperate with the SEC as an informant, which helped them prosecute Michael Milken, the senior executive driving the unethical actions round junk bonds at DBL.

In 1986, Boesky’s conviction of insider trading was handed down, landing him a reduced penalty of three and a half years in white collar prison with a whopping $100 million dollar fine. Though he was released early, he was permanently banned from working with securities ever again.

Incidentally, Boesky’s fall from power also brought down many of the biggest corrupt players on Wall Street, whose junk financing and greed epitomized the negative stereotype of Wall Street excess. Boesky inspired passage of the Insider Trading Act of 1988, which further increased the penalties of insider trading.

7. R. Foster Winans

By now you’ve seen that a government employee, investor, or company officer can all fall into some serious insider trading liability. As it turns out, insider trading allegations can also be lodged against members of the press who write and comment on the securities market.

R. Foster Winans was not a corporate insider, but he was prosecuted, fined, and jailed for insider trading violations. Yet, the particulars of his case rested on the blurry line that lies between material non public information and public information. Even the Supreme Court was deadlocked about the nature of this particular insider trading scheme, but the 4-4 vote was enough to uphold the insider trading charge after he was indicted by Rudolph Giuliani.

R. Foster Winans was a journalist with The Wall Street Journal who co-wrote a column called (fittingly) Heard on the Street from 1982 to 1984. Over the course of those two brief years, there were arguably multiple insider transactions made in connection to nonpublic information. To complicate matters, the information was just about to become public information because the entire premise of Heard on the Street involved profiling a company’s stock and then making predictions about how that company stock would fare accordingly.

Winans did not avoid an insider trading conviction because of his actions. It was suspicious enough that the company stock he profiled would often follow his predictions, for good or bad, but additionally, Winans would share information about company securities with a stockbroker named Peter N. Brant of the firm Kidder, Peabody & Co. Brant himself had already been labeled by insider trading enforcement as a recidivist—someone who repeatedly breaks a law, even after experiencing the negative consequences of breaking it.

Brant would pass the information he received from Winans to multiple insiders of his own so that each of them could place a securities transaction to their pecuniary benefit. In return for making the insider trade, these brokers gave Winans a slice of the financial pie.

If Winans was telling the truth during his SEC trial, he didn’t make much more than $31,000 from the scheme, a fairly small amount considering the overall profits these brokers made from insider purchases.

Winans insisted that while his behavior was unethical, it was not a criminal form of securities trading. The court disagreed and sentenced him to a year in prison. The First Amendment Lobby, championing free speech, took up his cause and criticized the government for overstepping their bounds in terms of securities law.

To this day, when misappropriation theory and insider trading activity is discussed in law school, the Winans case is an important case study. Winans has continued to argue that he did nothing illegal, even after serving time for SEC insider trading violations. Winans has famously said, “The only reason to invest in the market is because you think you know something others don’t.”

Insider Trading Isn’t Just a Wall Street Problem

Movies like The Wolf of Wall Street (2013) and Wall Street (1987) portray a world of high-power financiers living lives of unbelievable wealth. It has become the epitome of the negative stereotypes associated with Wall Street. Moreover, the financiers portrayed in these movies are at the epicenter of unethical financial moves based on insider information.

But are the movies really accurate? Are traders on Wall Street really using non-public information to buy and sell stocks to their advantage?

The answer is complicated. Not every stock trader is a greedy inside trader. Many are well-intentioned, hardworking individuals who research and study the markets every day, leveraging personal experience to buy and sell stocks accordingly. There are certainly some individuals that cannot resist the investment potential of acting on inside information, but these individuals aren’t just relegated to the world of Wall Street alone. As we have seen, politicians, athletes, businessmen, and even homemaking personalities have all benefited from insider knowledge to make a profit on buying and selling stocks.

The number of times this has happened (legal insider trading and illegal insider trading) has prompted the government, time and again, to create acts and laws prohibiting this kind of behavior. These laws and regulations, enforced by agencies like the SEC, keep the markets operating ethically in order to foster consumer confidence.

Insider trading will always be an issue that we as a society will have to contend with, but by highlighting these infamous insider trading scandals, we can learn more about the stock markets and continue to improve the system to make stock trading as fair as possible.   

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