Why Is Insider Trading Heavily Penalized?

You do not have to be directly involved in trading to know the term “insider trading”. After all, it gets lobbied around in news often enough that plenty of people have a passing familiarity with it.

But what exactly is insider trading? How much of an impact does it actually have on trading? And why are the penalties for it so high?

What are the penalties?

The U.S. Securities and Exchange Commission discusses the potential penalties of insider trading. Not many people realize exactly how high the costs are if you end up convicted. You can face a maximum prison sentence of up to 20 years, which is already bad enough. But it is the potential fine that most people find shocking. For individuals convicted of insider trading, the maximum fine is up to $5 million.

Of course, whether or not a convicted person ends up facing the maximum penalty depends on a number of factors. But millions of dollars is nothing to sneeze at, whether it is $1 million or $5 million.

Risks to the entire market

But why is the fine so high? For many, it acts as a deterrent, and this is important to the overall health of the trading system. The stock market – and most trade systems in general – run by honor and trust. In other words, the investors put their money in with the expectation that the market runs fairly.

Insider trading is, by nature, extremely unfair. Thus, if insider trading is rampant within a market, investors lose that faith. They will likely stop investing, which can cause the entire market to suffer or even risk collapsing. Needless to say, this is a huge risk that no one wants, and thus insider trading ends up with massive penalties.