What is Material Insider Information?
Material insider information is material, nonpublic information about a security or its issuer. Information is material if it might reasonably influence the users of the issuer’s financial statements.
How Does Material Insider Information Work?
Let's assume you are vice president of finance for Company XYZ, and you know the company missed its profit goal for the quarter by three cents per share. However, the company will not issue its press release regarding quarterly financial performance until tomorrow. You have material insider information. The information is material, in that it would affect the buy or sell decision of a reasonable investor, and it is nonpublic.
Insider information could include things such as:
- events regarding the issuer’s securities (e.g., defaults, calls for redemption, repurchase plans, stock splits, changes in dividends, changes to the rights of security holders, public or private sales of additional securities, and changes in credit ratings)
- bankruptcies
- significant legal disputes
- government reports of economic trends
- orders for large trades before they are executed
The reliability of the source is important when determining whether something is material insider information. It is also important to note that disclosing information to analysts does not necessarily make the information public.
Financial institutions and other companies commonly have 'fire walls' to prevent the communication of material nonpublic information among departments of the same company. This may mean controlling interdepartmental communication, creating lists of stocks that employees and their families are not permitted to buy or sell, and reviewing employees' trading activity.
Why Does Material Insider Information Matter?
Trading on material insider information is generally illegal. It erodes the public's confidence in financial markets by creating an unfair trading advantage. Punishment can include prison time, fines, restitution, damages and the loss of a number of professional licenses.
However, some insider information is OK -- as long as the trader follows SEC regulations, which include limiting the times during which insiders can trade company stock and requiring insiders to publicly disclose their trades.
It is important to note that traditional insiders -- employees, directors or officers of an issuer -- are not the only people who can be convicted of illegal insider trading. Anyone who purposely acts on material nonpublic information is committing the crime. This can be family members of the issuer's CEO, the friend of an employee who works for the issuer, a broker for one of the issuer's directors, government employees who become aware of unannounced contracts with an issuer, etc.
