In short, an insider is an individual that is privy (i.e. with knowledge of) to certain information not generally known to the public. When communicating corporate information, an insider generally refers to the following types of individuals:

When a corporate insider accepts employment as an officer or director or becomes a controlling shareholder he or she automatically makes a legal contract with the corporation to put the shareholders’ best interests ahead of his or her personal interests. This is a basic tenant of corporate law, which has grown over time.

In the early 20th century, the U.S. Supreme Court determined that a corporation’s directors could not act on information that was otherwise not known to the shareholders. The court determined in multiple cases that directors have fiduciary duties to protect the interests of their shareholders. Then, President Franklin Roosevelt helped to pass the Securities Act of 1933 and Securities Act of 1934, which established the foundation for prohibitions against insider trading that we still use today. The Securities Act of 1934 also created the United States Securities and Exchange Commission, called the SEC, which monitors illegal insider trading.

With that brief bit of history, what is considered to be "inside" or "secret" information? Well, this is generally determined on a case-by-case basis depending on the specific facts. But, in general, "inside" information is generally considered to be material information that an insider could use for his or her benefit that the public (or that corporation’s shareholders) does not have access to. Let’s go over a brief example to clarify.

Assume Billy is director at ABC, Inc., a corporation that sells prescription drugs. One day, Billy and the directors are in a board meeting and hear from an expert at a drug company that ABC, Inc. just received a very poor review for one of its new drugs, and the drug company will release that information to the public in a few days. Billy, after hearing the bad news, decides to sell a million dollars of his ABC, Inc. stock before the drug company’s press conference because he knows the bad news will likely hurt the price of the stock. If Billy sells his stock before the press conference, he’ll have committed illegal insider trading because the public did not know about the bad information from the drug company. If the public did know, it’s likely that many of them would also sell their ABC, Inc. stock and Billy would be in the same position as them – for which Billy would not have committed illegal insider trading.

This is a very simplified example, but as you can see the purpose behind laws against insider trading is to keep the "playing field" as fair as possible for everyone who trades in securities. Insider trading is not generally easy to monitor by the SEC or others, and many times insiders get away with their acts.

Next, we’ll go over the differences between legal and illegal insider trading.