Legal Definitions - classical theory of insider trading

The classical theory of insider trading describes a specific type of illegal securities fraud. It occurs when a person considered a "corporate insider" trades in the securities (like stocks or bonds) of their own company, using important, confidential information that has not yet been made public. The key element is that this insider has a special legal obligation, known as a fiduciary duty, to the company's shareholders. By trading on this secret information for personal gain, they are breaching that duty.

In simpler terms, it's about someone within a company using privileged information about that company to make a profit (or avoid a loss) in the stock market, betraying the trust placed in them by the company and its investors.

Here are some examples to illustrate the classical theory of insider trading:

• Example 1: CEO Buys Shares Before Major Announcement

  Imagine the CEO of "Quantum Innovations Inc." learns in a confidential board meeting that their company is about to announce a groundbreaking technological breakthrough that will revolutionize its industry. This news is expected to significantly boost the company's stock price. Before the public announcement is made, the CEO uses this secret information to purchase a large number of additional shares in Quantum Innovations Inc. for their personal portfolio.

  How it illustrates the term: The CEO is a corporate insider with a fiduciary duty to Quantum Innovations' shareholders. The information about the technological breakthrough is material (important) and non-public. By buying shares based on this confidential knowledge, the CEO is trading in their own company's securities and breaching their duty to treat all shareholders fairly, thus engaging in classical insider trading.

• Example 2: CFO Sells Shares Before Negative Earnings Report

  Consider the Chief Financial Officer (CFO) of "Global Logistics Corp." While preparing the quarterly financial reports, the CFO discovers that the company's profits are significantly lower than market analysts' expectations, and this news will likely cause the stock price to drop sharply when announced. To avoid personal losses, the CFO sells a substantial portion of their Global Logistics Corp. stock holdings before the official earnings report is released to the public.

  How it illustrates the term: The CFO is a corporate insider with a fiduciary duty to the company and its investors. The information about the unexpectedly poor financial performance is material and non-public. By selling shares to prevent losses based on this privileged information, the CFO is trading in their own company's securities and violating their fiduciary duty, which constitutes classical insider trading.

• Example 3: Board Member Tips a Friend for Personal Benefit

  A member of the Board of Directors for "BioPharma Solutions" learns that a crucial drug trial has unexpectedly failed, which will cause the company's stock to plummet once the news is public. Instead of trading themselves, the board member secretly tells a close friend about the failed trial, knowing the friend will sell their BioPharma Solutions shares immediately. In return for this tip, the board member expects a significant "favor" or a share of the friend's avoided losses.

  How it illustrates the term: The board member is a corporate insider with a fiduciary duty. The information about the failed drug trial is material and non-public. By "tipping" their friend with this confidential information for a personal benefit (the expected favor or share of avoided losses), the board member breaches their fiduciary duty. Both the board member (for the tip) and the friend (for trading on the assumed breach) could be held liable under the classical theory of insider trading.