Who Is An Insider?
When the U.S. Congress of 1934 legislated the Securities Exchange Commission (SEC) into existence to protect individual investors, it realized that corporate executives had an unfair advantage when trading their own companies' shares. But these politicians also realized that they could not ban such transactions. Even then, shares were used as incentives for employees, and who would start a public company if they couldn't participate in its success?
In lieu of banning insider transactions, the U.S Congress dictated disclosure. If insiders did trade, they would have to fill out a form and tell the world about it.
Of course, Congress needed to define who an "insider" is. The SEC obviously had to know who to police, and the people being watched over needed to know that they were now expected to play by new rules.
According to the Securities Exchange Act of 1934 (the 1934 Act), an insider is an officer or director of a public company, or an individual or entity owning 10% or more of any class of a company's shares.
The definition in all its legal speak is given in Section 16 of the 1934 Act. There are further words spared on how more specifically to define an "officer" and "beneficial owner" in
Rule 16a-1 of the Code of Federal Regulations.
While both passages are lovely pieces of prose, most investors should be content with the knowledge that the definition of an insider is intended to cover the people who have the most knowledge of the inner workings and future prospects of a publicly traded company.
Once pegged as an insider, the SEC becomes very interested in how you may be benefiting from the unfair advantage you have when trading your own company's shares. The concept of "disclosure" mandated in the 1934 Act was put into practice by Section 16(a) of the 1934 Act, which requires insiders to report their stock holdings and trading activity on
Forms 3, 4, and 5.