Insider trading is not always a crime. The term refers to two relatively common practices: that of when people inside a company buy or sell shares of a stock from their own company--and report that trade after execution--or when someone trades a security based on nonpublic information about that company. The former practice is completely legal, although controversial, while the latter is a crime punishable by fines or prison.
Hundreds of suits are filed every year about insider trading--on occasion, snagging high profile business leaders and investors. Criminal insider trading is illegal because publicly traded companies are supposed to keep most of the relevant information about the company accessible to the public. Such privileged information is regarded by regulators to be something that should not be used to gain an advantage over other investors. The legal theory posited by lawmakers and regulators is that without insider trading regulations, public stock trading would become a race for insider knowledge rather than something based at least partially on the publicly acknowledged fundamentals of various companies.
It can be extraordinarily difficult for regulators to discover or prove insider trading in most of the instances that it happens. For example, corporate officers or other executives are not allowed to trade shares after learning about confidential corporate information. They are required to report the information after they make the trade--but as the information that they might be trading on would be confidential by definition, the only way that anyone could discover it would be, in most cases, long after the crime occurred.
Another common kind of insider trading is that of "tipping" from friends, lawyers, financial professionals or others that results in an illicit trade based on insider knowledge. The laws also apply to stock options and shares contained within a company 401(k) plan. Penalties can rise to triple the amount of at least the profits earned from the trade or more. Employees that own company shares can inadvertently run afoul of insider trading laws simply by boasting about their company--if someone trades based on that information.
The most important definition in regards to insider trading is that of an "insider." An insider has a broader definition than most people realise. Insiders include corporate directors, employees, contractors and their friends, family and extended professional network. Also, banks, lawyers and others that have access to privileged information at the company along with their associates are considered insiders. Government officials that may for whatever reason have access to priviledged information about a company are also considered insiders for the purposes of the law.
Understanding the rules surrounding insider trading can protect a company or an investor from massive penalties and a seriously damaged reputation. The SEC pays out bounties for anyone providing information that could lead to the prosecution of someone for insider trading. This makes it even more dangerous to allow insider trading to go on within a company than it would be otherwise.