Insider Trading in the US
Insider trading is the buying and selling of a public organization’s stock and securities (for instance, bonds) by people who have the nonpublic details regarding the company. Several forms of trading anchored in insider details are deemed unlawful in some nations (Thompson, 2013). This practice is unfair to the company and to the investors lacking access to company’s secrets since the ones with such information can realize exceedingly high profits. Nonetheless, in most countries, trading through particular insiders, for example, workers, is allowed on condition that it is founded on details available in the public sphere. Some nations demand that the progress of insider trading be regularly reported to ensure that the transactions are effectively examined. In the US, trading carried out by organizational representatives, key workers, executives, and major stakeholders have to be unveiled publicly or to the regulator (Thompson, 2013). In this regard, insiders in the US have to fill a form with the United States Securities and Exchange Commission before selling or purchasing shares of their business. People who get access to nonpublic details of a company and trade based on that might be on the wrong side of the law.
Studies discuss numerous concerns in support of insider trading and affirm that its overall influence is positive (Thompson, 2013). Discussions in support of insider trading seek to show that it is not wrong. There is no ethical responsibility to tell a possible customer that the cost of the goods the company is selling is probably changing shortly. In this regard, in insider trading, there is no ethical obligation to reveal that an alteration in the price of a commodity is likely to happen thus disclosing nonpublic information (Thompson, 2013). On the same note, it is evident that insider trading is not fraudulent since it does not result in losses. There can be no fraud without of losing. Sellers gain the moment insiders are purchasing at a cost that is to some extent higher. Nevertheless, such does not consider the opportunity cost of price alterations in the future. Furthermore, the action is just because there are no rights infringed. The non-insiders obtain a higher cost for the stock so their rights are not breached.
In a case where a company considers its rights to have been violated, there are legal processes that it can pursue (Thompson, 2013). Research has established that whenever transactions are not deceptive, and the inside dealer is not infringing any individual’s property privileges in information; the progression does not hold anything unethical. One of the benefits of insider trading is that since the cost of the stock partly reveals the inside details, the prices become more sensible. Insider trading has also been found to promote aggressive takeovers, which could be the only means of eradicating deep-rooted poor management. On this note, aggressive takeovers and practices that enhance them are beneficial. Inside details permit companies to recompense insiders indirectly over and above the external players who are offered the information (Thompson, 2013). Though some individuals feel that the benefits of insider trading are unreal or weak, they ought to be taken into deliberation.
Despite having some advantages, some researchers maintain that insider trading is unethical and wrong (Thompson, 2013). One of such assertions is that the details employed by the insider could have been illegally acquired from a given company. The moment assets are employed for gain without the approval by the proprietor; all the benefits accrued belong to the owner, and the use of a company’s information for selfish gains is unfair. The players in a stock transaction cannot have equal knowledge since one ought to be more diligent in analysis or research. Nonetheless, insider trading is essentially different as the party that lacks inside details does not have a means of attaining them irrespective of the level of analysis or research it undertakes. The harmful impact of insider trading is that it decreases the magnitude of the market as the participants are reluctant to take part in markets that have considerable insider trading. When there are a few traders in a given market, it signifies that the market is less resourceful, poorly managed, and highly variable.
Studies assert that insider trading is unethical because it increases the outlay of capital for a security issuer hence lessening general economic development (Thompson, 2013). Evidently, economic models may be employed in analyzing the appropriateness of insider trading. Ideal competition carries numerous presuppositions: countless customers and traders, no hindrances to exit or entry into the market, and extensive understanding by most of the participants to mention a few. Though some suppositions are infrequently, if at all, satisfied, microeconomic theory affirms that strict existence of perfect competition in any market leads to an enviable occurrence where the resources that are inadequate within the community are utilized efficiently by the companies entailed, and commodities are supplied successfully. In such a situation, it would not be possible to make any of the participants better devoid of causing harm to others.
In keeping with the economic model, it is difficult or impossible to realize perfect competition due to the tremendous benefits of a faultlessly competitive market; however, all traders ought to strive to achieve this objective (Yadav, 2014). Endeavors that lead to a suitable competitive market ought to be promoted while the ones that decrease such competitiveness should be dejected. With its intrinsically uneven information, insider trading is evidently at odds with perfect competition (Yadav, 2014). An ideal outcome would necessitate making inside information accessible by all the participants in the market so that they have the same details regarding a company. This makes it apparent why insider trading is deemed unethical in a flawlessly competitive economic market.
The issue of whether insider trading is unethical remains debatable as while some people perceive it to be fraudulent others do not (Engle, 2008). Fraud may occur by a person illegally selling stocks that belong to a different person, issuing nonpublic information secretly with the aim of deceptively benefiting from it, or offering an incorrect quantity or quality. It entails intended deception that seeks to make an individual relinquish some legal rights or property. In insider trading, fraud may be perpetrated when a buyer who has inside information informs his stock broker to make substantial purchases while well aware that the stock prices have a high probability of increasing in a little while. In such a case, if the seller could have sold through the same broker while not having prior non-public information regarding the company, it would have been deemed ethical. This is because, if the inside trader had not known that the stock prices were about to rise, he would not have made significant purchases and hence other buyers could have benefitted from it. On this note, the buyers would not have intended to make unjust profits, even if any of them chose to buy a huge amount of stock. For sellers, there is no ethical responsibility of making the potential buyers aware that the price of the stock has a likelihood of increasing or decreasing after some time.
Regulations and Regulators
Although insider trading does not have a precise statutory definition as an offense, an individual or organization can be held liable following the judicial and administrative interpretation of the relevant laws under the Securities and Exchange Commission (SEC) and anti-fraud statutes. The first law concerning insider trading, the Securities Act, was passed in 1933 by the Congress, creating a homogenous set of rules that would shield investors against fraud while trading securities (Yadav, 2014). The law requires investors to be given significant information regarding public sale’s securities, for instance, financials. Besides, the law prohibited fraudulent nature of activities such as dishonesty. In 1934, the Congress passed Securities and Exchange Act to regulate the secondary market’s transactions of securities, thereby enhancing financial transparency as well as accuracy. The laws under this act aimed at reducing fraud in the trading of securities. Securities and Exchange Act also gave the go-ahead to the creation of the Securities Exchange Commission (SEC), a regulator of the secondary trading of securities.
The SEC is responsible for the creation of the rules that regulate the securities’ market and collaborates with the Department of Justice to enforce the regulations. The SEC is one of the most aggressive financial regulatory bodies when it comes to instituting legal proceedings against persons suspected to be involved in insider trading in addition to the creation of the relevant laws (Yadav, 2014). An insider trading offender can face either a criminal or civil penalty, depending on the evidence presented regarding the indication of intent. According to Rule 10b5-1 of the Securities Exchange Commission, company officers should not buy or sell the stock of their companies if they are in “knowing possession” of material information that is not in the public domain.
Rule 10b5-1 of the SEC indicates that an individual or organization that is in possession of nonpublic information and uses it for personal benefits such as to avoid making a loss or increase profits while trading securities can be charged with insider trading. Previously, the offense attracted a jail term not exceeding 20 years and a fine of up to 5 million dollars (Yadav, 2014). In 1988, the Insider Trading and Securities Fraud Enforcement Act was made a law with the aim of strengthening the insider trading penalties that were in place at the time. The law adds possible civil penalty fine of at most thrice the profit gained or evaded loss during the transaction. Nevertheless, Congress members are protected from penalties related to the offense.
In 2000, the CEC officially put Regulation Fair Disclosure to effect. The regulation requires an organization to reveal any significant details that they intend to disclose to a given individual but absent in the public domain. The disclosure of the information to the public and persons should be done simultaneously. However, if an individual gets access to such information without the company’s intent, the firm should disclose the information to the public promptly (Thompson, 2013). The U.S. federal securities laws also govern constructive insiders such as legal representatives, auditors, and investment bankers to mention a few. These individuals get non-public details regarding organizations in the course of their service delivery. On this note, these constructive insiders are held accountable for violating insider trading regulations if the company that they serve prohibits the dissemination of the nonpublic information to persons who are not privy to it.
The Securities Exchange Commission also regulates insider trading or related activities under the William’s Act, using the relevant takeover and tender offer rules. Williams Act, an amendment to 1934’s Securities and Exchange Act, aims at enhancing transparency in cash tender offers to all the involved parties, including the people who are offered, companies’ management, and stakeholders (Thompson, 2013). The rules under this act require anyone making a cash tender offer, 15-20% more than the current market price, to a company that needs registration under federal law to disclose to the Securities Exchange Commission where the funds used in the offer comes from, the purpose of the offer, and any contractual relationship or knowledge regarding the target organization. By having a base offense level, insider trading is placed in Zone A of the United States’ sentencing guidelines. Therefore, a person who has been proven guilty of the offense can receive probation instead of being put behind bars.
Strong v. Repide
Repide bought shares of Philippine Sugar Estates Development Company from Strong, a shareholder. Repide did not disclose to Strong that he was a director of the company (Wagner, 2010). Repide, the director, negotiated the trading of Strong’s stock at the time he was taking part in the sale of the land assets of the company to the Philippine government. However, Repide did not bring the information about the sale of the assets to the attention of Jones, the plaintiff’s agent, despite having a material impact on the price of the stock. Due to lack of the disclosure of the information to the agent, the director bought the stock at almost 10% of their total actual value.
Repide used the agent to conceal his identity from the seller. Upon learning that Repide had fraudulently hidden the information affecting the value of the shares, Strong filed a case against him to recover her sold stock. In the complaint, she added that her agent did not have the power to transfer the ownership of the shares. In 1909, the United States Supreme Court ruled in favor of Strong (Wagner, 2010). In the verdict, the judge stated that although generally directors are not obliged to reveal special information to the plaintiff before trading securities, companies should share information about material transactions that are likely to alter their prices to the public. Shareholders who intend to sell their securities should be informed about the transactions prior to selling them.
Dirks v. Securities
Ronald Secrist, an insider who was an employee of Equity Funding of America Company, informed Raymond Dirks, the defendant, that the value of the assets of the company was overstated as a result of fraudulent activities that were taking place in the organization. Secrist asked Dirks to confirm about the deceptive practices and disclose them to the public (Wagner, 2010). After investigating the claims, Dirks informed the company’s investors about the findings of his investigations after the Wall Street Journal turned down his request to publish his story. The information made some investors sell their stock, and as a result, the value of the company’s shares declined rapidly, from $26 to $15.
The deterioration of the stock’s value prompted the Securities Exchange Commission to start an investigation on the matter. Although the findings of the investigation indicated that there were fraudulent activities in the company, SEC also concluded that Dirks assisted the violations of the SEC Rule 10b-5 by informing the investors about the claims regarding the suspected fraud and possibly receiving commissions from the investors who benefited from the transactions (Wagner, 2010). Nevertheless, he was just censured by SEC since he had helped in the exposure of the fraud. However, the Supreme Court of the United States gave a verdict indicating that Dirks, in this case, the tippee, could not be held accountable for the improper use of the inside information since he got it from an insider who was not giving it for his benefits. As an insider who leaked out the non-public information of the company, Secrist had a constructive motive concerning the firm; to expose fraud, and so, he did not violate any federal securities law.
U.S. versus O’Hagan
A law firm, owned by James O’Hagan, was offering legal services to Grand Metropolitan Company at the time when the organization intended to tender an offer for Pillsbury Company’s common stock (Engle, 2008). Since O’Hagan was aware of the intended transaction, he purchased Pillsbury shares’ call options and eventually made over 4.3 million dollars upon the sale of the stock. The Securities and Exchange Commission conducted an investigation on the matter and concluded that he had misappropriated the confidential information of Pillsbury. However, the court verdict held that O’Hagan was not barred from buying or selling the shares under the SEC regulations since he did not have a direct involvement in the planned takeover.
Some forms of deals
founded on insider trading are deemed illegal in some nations due to the view
of injustice to the investors without access to company’s nonpublic information
as the ones with such details can realize extremely high profits. Individuals
who get access to nonpublic details regarding an organization and trade anchored
in that may be at fault. If a company finds that its rights have been violated,
there are legal courses that it can follow. In a case where transactions are
not deceiving, and the inside dealer is not violating any individual’s property
rights in information, the practice does not have anything unethical. One
benefit of insider trading is that because the cost of the stock somewhat tells
the inside details, the prices become more rational. Moreover, insider trading
has also been found to support aggressive takeovers, which could be the only
way of getting rid of deep-seated poor management. Despite some benefits,
numerous researchers affirm that insider trading is unethical and wrong with
some maintaining that the information used by the insider could have been
illegally obtained from the company. In insider trading cases, a person or
company could be held answerable in line with the applicable regulations under
the Securities and Exchange Commission (SEC) and anti-fraud laws.
Engle, E. (2008). Insider trading in US and EU law: A comparison. European Business Law Review, 26(1), 465-490. Retrieved from https://poseidon01.ssrn.com/delivery.php?ID=994020123000096109088070030065096010116045067060095028110097089103022118108023022101018063099111026042034107119030091081000030029066004033083011078119103009004002049091066099020016008109084028092124022016127002027083126009030114083113030122079100&EXT=pdf
Thompson, J. (2013). A global comparison of insider trading regulations. International Journal of Accounting and Financial Reporting, 3(1), 1-23. Retrieved from http://www.macrothink.org/journal/index.php/ijafr/article/viewFile/3269/2976
Wagner, R. E. (2010). Gordon Gekko to the rescue: Insider trading as a tool to combat accounting fraud. University of Cincinnati Law Review, 79(3), 973-1016. Retrieved fromhttp://scholarship.law.uc.edu/cgi/viewcontent.cgi?article=1016&context=uclr
Yadav, Y. (2014). Insider trading in derivatives markets. The Georgetown Law Journal, 103, 381-432. Retrieved fromhttps://georgetownlawjournal.org/articles/62/insider-trading-derivatives-markets/pdf