What is Insider Trading? A 2iQ Guide

To help investors make sound decisions when choosing to buy or sell on the stock market, the investment experts at 2iQ Research provide keen insight into insider trading. What is it? How does it help investors decide when to buy or sell? In this guide, we answer those questions and delve deep into the world of insider trading.

What is insider trading?

Insider trading is defined as:

The act of selling or purchasing a public company’s shares is based on non-public, material information about a company.

This investment activity is most often done by those within the company, such as employees, but others privy to non-public information are included within the insider trading sphere.

Is insider trading illegal?

The simple answer – insider trading can be both illegal and legal. It all depends on time and information availability and whether the investor adheres to the guidelines set forth by the market regulators around the world. The European Securities and Markets Authority (ESMA) caters to the European markets, but each country has its own regulators as well. For example, the Financial Supervisory Authority (FI) presides in Sweden and the Financial Conduct Authority (FCA) operates in the UK

Each country has its own set of laws for the stock market, and subsequently, for Insider trading as well. While 2iQ research possesses information about Insider trades across various continents and countries, this blog will primarily focus on Insider trading in the USA. In the USA, the SEC is the stock market governing body, regulating when and how investors can trade stocksand whether they’ve broken those rules. 

On insider trading, the SEC states:

If an investor sells or purchases stock based on insider knowledge of business activities and practices, that information must be public knowledge when the transaction occurs. Additionally, if shares are purchased, insiders must hold their shares for a period of six months.

What does this mean for investors?

Considering that insiders who purchase stock must hold that stock for a minimum of six months, it’s generally a safe bet that they expect the cost of the stock to rise within that time period.

When you see insiders selling company stocks, the reason behind the sale is usually less clear. In some cases, company quarterly or annual reports show a dip in company profitability, but other times these periods of insider stock selloffs can come from seemingly nowhere.

How are insider trades tracked, and where can investors find them?

Tracking insider trading as an investor may be more challenging than it seems. Thousands of stocks are bought and sold through the New York Stock Exchange (NYSE), S&P 500, and Nasdaq markets. Crawling through the sheer amount of data would be time-consuming, and finding a nugget amongst the norm would be a difficult task. This is made doubly hard when insider trades come from outside the C-suite, making them even more challenging to pinpoint.

Finding insider trades was made much easier with the Electronic Data Gather, Analysis, and Retrieval (EDGAR) database. Introduced in 1992, EDGAR collects, indexes, stores and validates the submission of insider trading activity by company employees or others required to file by the SEC. The EDGAR database provides investors and interested parties with information, such as:

  • Form 3 Filings
  • Form 4 Filings
  • Form 5 Filings
  • Form 144 Filings

What is SEC Form 3?

Form 3 is the Initial Statement of Beneficial Ownership of Securities. It must be filed by anyone considered to be a company insider or major shareholder who has a class of equity securities or those who hold ownership or stake within a business. Form 3 allows the SEC to track the investment activities of people who fall within the category of ‘insiders’ and ensures that trades they are doing are, in fact, legal.

This SEC form is designed to disclose the holdings of top-ranking company insiders and must be filed within ten days of someone becoming affiliated with a company.

What is SEC Form 4?

The SEC Form 4: Statement of Changes in Beneficial Ownership must be filed whenever someone defined as an insider buys or sells company stock. Form 4 filings are required within two days of a transaction, and if parties fail to disclose their trading, they could be subject or civil or criminal legal action.

What is SEC Form 5?

Like the SEC’s Form 4, Form 5 is an Annual Statement of Changes in Beneficial Ownership. Filing of this form is required when a corporate insider has bought or sold company stock within the last 12 months. Additionally, it’s a secondary level of oversight to ensure that insider trades follow the rules the SEC has set forward regarding trades resulting from non-public information.

What is SEC Form 144?

Unlike the previous three forms, there is one main difference with SEC Form 144 – filing time. Insiders must file SEC Forms 3, 4, and 5 within a specified period after selling or buying company shares. The SEC Form 144: Notice of Proposed Sale of Securities must be filed before restricted shares have been sold – and it must be filed if the insider is proposing the sale of 5,000 or more shares or shares worth over $50,000 within three months.

Restricted shares are required to be held for a period of one year. These include stocks that are awarded or received from the company as compensation or bought during employment.

Additionally, those who file Form 144 must make these trades within a set period and must adhere to any rules about these specific trades. Selling off such a large chunk of company shares requires a reason – and the SEC wants to know why. The primary purpose of this form is to inform the SEC about impending stock sales and allows it to ensure the decisions these transactions were based on aligning with regulations.

Insider trading examples

The reality is that insider trades happen far more often than you may think, and it’s 2iQ’s aim to provide insight into these trades to help investors make sound decisions. Recent examples include:

Upwork Inc (UPWK: US)

On May 12, a Director on the Board of Upwork Inc - Kevin Harvey - bought 65,828 shares of UPWK stock at a value of $16.32 per share. Eye-catching details about this trade include the fact that Mr. Harvey has over 20 years of experience in the entrepreneurial field to his name. Also, this marks his first purchase in the company since Upwork's IPO in 2019. To add to it, Upwork reported shiny new results in its Q1 2022 earnings disclosure. The company's revenue was up by 24% year on year, and the number of active clients has risen by 16% year on year.

HubSpot Inc (HUBS: US)

On 17 May, HubSpot CTO and Co-founder Dharmesh Shah purchased 10,000 company shares at $340.08 per share. This purchase increased his holding to 1.511 million shares. This insider purchase is interesting for several reasons.

Mr. Shah will have detailed information about the business, its revenue and future prospects. At the time of his purchase, the stock price was down approximately 50%, but after first-quarter results showing a 42% increase in profits year on year, it’s safe to say Mr. Shah expects a profitable 2022 financial year.

How can investors track insider trading activity?

In addition to the EDGAR database, which gives insights into all share transactions, there is a wide range of tools available for investors to help make sound stock market decisions. The way investors use insider trading data can vary, and ultimately, it’s up to you to find a strategy that fits your goals. Here are a few tools you can use to track insider trading:

Official databases

Per regulations, stock market transactions must be recorded. EDGAR, along with the New York Stock Exchange and Nasdaq’s database, the Trade and Quote Database (TAQ), and others like it provide detailed information on all stock market transactions.

Financial news publications

The Financial Times (FT), CNBC, and Bloomberg are just a few examples of media outlets that report on high-profile stock market transactions whilst also providing analysis into insider trading activity. 2iQ is regularly featured in these publications as a source for investment data.

Research firms

These institutions monitor the stock market activity of company insiders and provide their clients with reports to help them make sound financial decisions.

Investment data hubs

These companies collate and extract insider trading information from regulatory databases. They can help provide comprehensive, accurate, and up-to-date insider transaction activity to investment institutions.

Social media

Social media has become a prime medium for receiving information about insider trading. They can provide you with a starting place for researching investor activity. Check 2iQ's Twitter for reports on insider buying and selling.

Conclusion

Monitoring the stock activity of high-level company insiders is an important way to judge a company’s profitability and future growth. Whilst trolling through the data can be incredibly time-consuming, there are ways to streamline your insider trading analysis.

Though monitoring insiders’ stock market activity is a good indicator of a company’s performance, it is crucial to combine that with other investment analyses, reporting, and trends.

Follow 2iQ on Twitter for the latest news on insider trading, cluster buying, and short-selling.

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