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Lawmakers are considering yet another bill to ban insider trading. But the term "insider trading" seems open to interpretation. Senior Producer Paddy Hirsch helps us understand what it is and why it's a big deal. Angela Kim/Marketplace
Marketplace Whiteboard®

SAC insider trading charges, explained

Paddy Hirsch Jul 25, 2013
Lawmakers are considering yet another bill to ban insider trading. But the term "insider trading" seems open to interpretation. Senior Producer Paddy Hirsch helps us understand what it is and why it's a big deal. Angela Kim/Marketplace

SAC Capital was indicted today, charged “with criminal responsibility for insider trading offenses committed by numerous employees and made possible by institutional practises that encouraged the widespread solicitation and use of illegal inside information.”

So what does all that mean?

If the charges are true, it means that the company allowed and even encouraged its employees to cheat. They are alleged to have cheated by squirreling out what’s called “material non-public information.” That’s information about companies that no one outside of the company knew — and then the company used that information to make money. 

If you want a quick-and-dirty explanation of insider trading, this Whiteboard video works. But if you’ve got a couple of hours, and want to enjoy a Hollywood classic, then you could do worse than watch “Wall Street,” the classic Charlie Sheen/Michael Douglas movie from the 1980s about the rise and fall of a young investment banker.

Sheen’s character, Bud Fox, breaks the law by using that all-important material non-public information at three points in the film:

  1. When Fox meets Gordon Gekko, in his office on his birthday, Fox presents him with some cigars, but Gekko remains unmoved. So Fox gives him something else — a little secret about Blue Star, an airline that employs his father. Gekko uses the tip to make a bundle, and breaks the law in the process. By providing that information, and profiting from it himself (Gekko gives him a job), Fox also breaks the law. 
  2. A little later in the film we see Fox dressing up as a janitorial supervisor, and stealing secrets from an office drawer. I’m no lawyer, but this looks like breaking the law, whether he made money from the information or not.
  3. And finally, in a bid to take Gekko down, Fox convenes a secret meeting between Blue Star union leaders and Gekko’s nemesis, Sir Lawrence Wildman. Fox makes money through his knowledge of the deal that gets done in the meeting, as does Wildman. If the union bosses decided to make a few bucks in the market, they too would have broken the law.

Like those three moments in the film, there are three key components to information related to insider trading:

  1. The information has to be non-public: No one outside the company and its vendors or its lawyers and accountants (and their spouses), know about it.
  2. The information has to be material, i.e., it has to be a big deal. No one outside the company knows I have a pink plastic piggy bank on my desk, but so what? 
  3. You have to make money. As soon as you spy the memo about the pending acquisition of Placebook on the Boogle Inc. CEO’s desk, you are in possession of insider information. But so long as you don’t do anything with that information, you’re safe. If you go out and buy a bucketload of Placebook stock, and then sell it for a huge profit after the deal closes, that’s breaking the law.

The gray area lies in talking about inside information. If you go to the bar and tell your BFF about the Boogle/Placebook deal and your pal uses that information to make money, are you breaking the law? Well, maybe.

Best to keep your mouth shut, I’d say.

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