Insider dealing: What is it? Who does it? Why do they do it? What happens if they get caught? And what is being done to stop it? David Bowen offers a layman's guide

Q. What is insider dealing and why is it wrong?

A. Retailers are fond of saying that the three secrets of success are 'location, location and location'. Those who make their money on the stock market can adapt that to 'information, information and information'. In theory, a company's share price is related to the profit it is making now, and will make in the future. In reality, other factors, most notably its prospects as a takeover target, are at least as important.

Share price jumps and slumps are caused by unexpected news. If everyone knows a company is doing badly or is likely to be taken over, its share price will be gradually marked down or up until the news is 'built in' to the price. But when a formal announcement is made - especially of a bid - there can be spectacular movements. A bid will push the share price up because the bidders will have to offer a high price to persuade the target's owners to hand over control.

There are obviously people in the company who know in advance about these announcements. If one of these mentions to a friend that the company is about to receive a takeover bid, the friend can make money simply by buying shares, waiting for the price to leap, and selling out. That is insider dealing.

The stock market is supposed to be a pure market, where everybody has the same information. The London Stock Exchange says an announcement must be made through it, so that every shareholder has access to the information at the same time. In reality, the City professional with a computer screen will always get it before the old lady in the country, but the principle is clear. A. A. Does that mean it has always been illegal?

A. Far from it. Until 1980, it did not occur to City folk that they were cheating. 'My uncle and grandfather, who were Stock Exchange operators for nearly a century to the late Seventies, never knowingly committed an outsider trade,' says one City expert. The whole point of City lunches was to swap gossip and titbits of information: it was a perk of the job.

The Americans were the first to decide that insider dealing was a bad thing. The Securities and Exchange Commission was given armies of investigators to hound transgressors. The British followed in 1980, though at first half-heartedly. It was only in 1985 that the Companies Securities (Insider Dealing) Act gave teeth to the law. It declared that insider dealing occurs 'when an insider privy to the affairs of a company passes on price-sensitive information to a third party, either to produce profit or to avoid loss'. A. The Criminal Justice Act 1993, which has just come into force, says the 'insider' no longer has to have anything to do with the company involved. The City is squealing, saying the new rules could throttle the legitimate workings of the market. Worse, they could spell the end of the City lunch.

There are still those who believe that there is little wrong with insider dealing. Sir Martin Jacomb, a top banker, has said it is a 'victimless crime', while the Swiss are only reluctantly - under fierce American pressure - making it illegal.

Q. Who is responsible for investigating it and for bringing prosecutions?

A. It is a painstaking process. The Stock Exchange keeps a close watch on unusual share movements before a big announcement, and will make preliminary inquiries before telling the DTI's investigations division. This digs a little and decides whether the Secretary of State should appoint inspectors - an accountant and a lawyer who act independently and have considerable powers to cross-examine and demand documents. They produce a report, at which point the Secretary of State decides whether to bring a prosecution, which is conducted by DTI lawyers. A. A. How many prosecutions have there been, with what results?A. A. There have been 29 trials for insider dealing since 1985, involving 46 people. Of these 19 were found guilty, 27 not guilty. Although the maximum penalty is seven years and/or an unlimited fine, no one has been sent to jail. The only case this year, involving shares in Aaronson Brothers, led to two people being fined pounds 1,500 each.

Q. Doesn't it still happen all the time?

A. It happens, but nowhere near as much as before. For a start, most people do not want to break the law. Second, the stock market and Department of Trade and Industry try quite hard to catch people - although they are rarely successful. So people who engage in insider dealing have to cover their tracks - using public phone boxes (most City lines are now tape-recorded) and perhaps false names, or they tell their friends and split the profit. Celebrated US cases (such as those fictionalised in the film Wall Street) involved numbered accounts in the Cayman Islands and Switzerland. They can also use nominee accounts, held by banks, which do not name the ultimate shareholders.

Q. But there must be grey areas?

A. Indeed there are, which is why insider dealing is so difficult to prove and lawyers love it. In 1991 Thorold Mackie, an analyst for a Scottish stockbroker, told his client to sell its shares in Shanks & McEwan after he had had a conversation with the company's chairman. The chairman said he had told Mr Mackie there would be a 'profits warning' - that the profit would be below what was expected - while Mr Mackie said he had just been told it would not be a vintage year. If the chairman was right, Mackie was passing on inside information (because it was specific); if he was not, it was a general comment. He was convicted, then let off on appeal. A. A. If you are the insider handing over the tip, are you guilty?

A. Yes.

Q. Should you just not buy and sell relevant shares at all if you have information that isn't public knowledge?

A. Perhaps, but what would you do if you overheard two people in a bar talking about a takeover bid? (This may or may not be insider dealing, depending on whether the people were insiders or not, or whether you believed they were: line up a good lawyer.)

If a friend gives you a tip, and you have no reason to believe he has any special information, you should be safe: it is just like betting on a tip on the 2.30 at Kempton Park. You would be an insider then only if you knew that a horse was going to be nobbled.

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