What is insider trading and why is it illegal?

It's when you buy or sell stock based on private knowledge. Like if you're a finance guy at Widget Industries, and you knew that Widget Industries was going to report really bad financial results on Friday, so you sold all your stock on Tuesday.

It's illegal because it's massively unfair, it takes advantage of investors, and it leads to moral hazard because company executives could make a killing by tanking their own company. Think about it, it's easy to screw up a company, so why not sell short $100 million of stock and then rake in the cash once the market realizes what you've done? Ugh!!

Becoming a public corporation is a tradeoff. On the one hand, you get easy access to an enormous marketplace for funding. On the other hand, you have certain restrictions, like insider trading. If as a company owner you can't live with the insider trading rules, you stay privately funded. Of course, most private buyouts and contracts include the same sorts of terms (i.e. that if it is found that a company executive misrepresented the worth or value of the company, there are penalties that kick in).