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What is insider trading?

There's a fair bit of confusion on what insider trading is. That's not surprising because it refers to two different things. The difference is that one is legal and the other is not.

To better understand the distinction, think of one as trading legally as an insider and the illegal one as trading on inside information. A company insider is anyone who owns 10% or more of a company's shares or works at the company's senior levels. Senior positions include the board of directors, president, vice-presidents or general manager. It also includes people who may have a special relationship with the company. This includes a spouse or relative of insiders, or a lawyer or accountant who may work for the company. Insiders can buy and sell shares any time they want. But they must report their trading to the provincial securities commission within a set period, generally by the 10th day of the following month. The trading is legal as long as you do the required reporting. Insider trading is commonly reported in business newspapers each month. Trading on inside information, defined as undisclosed material information, on the other hand, is always illegal. Material refers to information that could affect the price of a company's stock, such as still-to-be-announced financial results or a big contract that's yet to be made public. The assumption is that if you're an insider, you could have access to this information. This is when you have to restrict your trading. You can't trade if you have this knowledge. It doesn't have to be proven that the information will definitely have an effect on the stock price -- only that it's reasonable to think it might have an effect. You don't have to be an insider to have access to inside information. But you can't trade on that inside information. Here's an example: You're a dentist and your patient, who is the general manager of a company, tells you the company had a profit or loss before the information is made public. You can't trade that stock. Authorities don't have to show that you took advantage of the inside information. They need only prove you had access to it and made a trade. The fact that you made the trade is considered proof enough that you were using that information to try to make a profit. Securities commissions and stock exchanges watch for evidence of trading on inside information by monitoring trading volumes for unusual activity. It's normal for heavy selling of a stock after poor earnings or a loss are reported. But if there's suddenly a lot of trading and nothing new has happened, authorities may take a look at who's doing the trading. The penalty for trading on inside information is up to two years in jail and the greater of $1 million or three times the profit made from the trade.