the announcement is made, the world will know, but until it is made, only corporate insiders know. They also know, or can reliably guess, that once the announcement is made, Company X's stock will drop. The temptation is strong for these insiders to sell their own stock before the announcement, to escape the losses that they alone know are coming.
The temptation may be strong, but it is also illegal. Such an action constitutes "insider trading," and it has been against the law ever since the modern system of stock market regulation was put in place in the wake of the Great Crash of 1929 (Stevens, 1987, pp. 12-13). Insider trading was made illegal because of the belief that it fundamentally undermines the proper operation of a free market. To sell a stock on the basis of inside information is the equivalent of selling a car while lying about its condition. If such behavior is pervasive, the market cannot function at all, because no one can trust the information they are being given.
In the late 1970s and through much of the 1980s, insider trading became a problem of crisis proportions on Wall Street. Some of the most prominent figures on Wall Street, notably Ivan Boesky and Michael Milken, wound up in federal prison as a result of their insider-trading activities, and were also slapped with fines in the hundreds of millions of dollars--Ivan Boesky would be hit with $100 million in forfeitures and penalties, while Michael Milken would be fined a staggering $600 million (Stewart, 1991, p. 16).
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