Insider ownership of a stock is expressed as a percentage of the company's outstanding shares owned by insiders. An "insider" is defined as a corporate officer, director, or any institutional investors who own at least 10% of the company's outstanding shares.
It is legal, and common, for a company's insiders to own its stock. A company's employees often own stock or stock options in the company. The trading of shares of a company's stock, by people with private knowledge of the company's business, is known as Insider Trading.
For insiders, short-swing profits, or profits realized from buying and selling a stock within six months, are prohibited. Furthermore, insiders are required to make their trades public through an SEC filing, generally a Form 4, and insiders have the ability to submit a written plan of action to demonstrate their intent to sell the stock independent of any private information they may obtain in the future. This is necessary if, for example, an employee who plans to retire has decided to sell their stock over time; and then that employee learns private information that may affect the stock price; under insider trading law, that employee would not be allowed to trade the stock, but given a documented plan to do so the scheduled trade would be legal.
It can be useful to evaluate the percentage of a company owned by corporate officers, directors and institutional investors, and to analyze whether these insiders have been buying or selling the stock in recent months. If, for example, several key executives are filing selling reports in close succession, this is a clue to look closely at a company's fundamentals to figure out what is causing the selling spree.
Not all insiders are created equal. C-level executives (CEO, COO, CFO, etc.) are generally the best-informed, followed by other key executives; the large institutional investors are the least informed.
Questions you should ask as you evaluate an insider trade include:
As above, it is legal for insiders to own, buy, or sell a company's stock, provided they comply with SEC regulations.
However, it is not legal for insiders to use information that has not been made public in making their trading decisions. Hence the prohibition on short-swing profits and the requirement to file an SEC form 4 documenting all trading decisions by insiders. Insiders cannot use any information that has not been made public in making a decision to buy or sell the security. Furthermore, "tipping" other investors with inside or non-public knowledge about a company that may affect its stock price is illegal.
For more, see Insider Trading.