The trading of a corporation’s stock or other securities, which include bonds or stock options, by people who have significant inside information about a company. Such an insider trading is considered to be legal by most countries, but only in the case that it does not harm the company and its profit making in any way. The insider traders are mostly the officers, key employees, directors and other shareholders who may gain such authentic information. But this very term, insider trading, also has negative connotations. In the United States, it is incumbent upon the inside traders to publically declare their trade transactions to the regulatory authority within the given time of business days. However, when the same thing is done based on material non-public information while an insider is carrying a duty, it becomes a fraud and a breach of trust. This is illegal insider trading, which as a result raises the cost of capital for securities issuers that leads to a decline in economic growth largely.
There are ethics officers, who are commonly known as business conduct officers, are hired officials by organizations to protect their interests. This practice has started since the mid-1980s due to constant series of financial frauds, corruption and many abuse scandals which surrounded the US defense industry. To protect and promote the ethical business practices the Defense Industry Initiative (DII) was formed, which set an initial standard for ethics management in companies.
One such very famous or rather notorious case of an insider trading scandal is that of the Wall Street insider trading scandal of the mid-1980s. Its primary player was Dennis Levine who was a managing director at Drexel Burnham Lambert. (Newsweek, “Greed on Wall Street”, 1986) The initial charge was filed by the US Attorney Rudy Giuliani which finally led the investigators to arrest Ivan Boesky.
Levine built a whole network of professional at many Wall Street firms who were engaged in insider trading. He maintained an account with a fake name in the Swiss banks subsidiaries in Bahamas because it has some of the hardest bank secrecy laws as compared to anywhere in the world. He did this to be safe from detection. He later moved his business to Bank Leu in May 1980 which earned him around $10.6 million. (Stewart, James B. Den of Thieves, New York, Simon & Schuster, 1991) But at Bank Leu, the officials there realized Levine’s insider trading activities and banked on it themselves. But they did their piggybacking though Merrill Lynch, which detected a suspicion about trading activities in two other brokers’ personal accounts in May 1985. This started an internal investigation which reached Bank Leu, where due to the bank’s secrecy they had to forward the matter to the U.S. Securities and Exchange Commission (SEC). The Bank officials decided that Levine should give his reasons for such an insider trading, but due to their destroying most of the documents relevant to Levine’s activity, they were charged with the obstruction of justice.
The Bank Leu officials decided to cooperate with the SEC because they noticed a huge gap between the actual managed accounts’ statements and the omnibus records. The stock trading was taken to be distinct from normal banking transactions and hence the bank revealed Levine’s name and he was soon arrested for his frauds. There was tremendous amount of evidence against Levine of securities fraud, obstructing justice, tax evasion and a charge of perjury as well. Levine decided to coordinate with the government in order to disclose the names of others who were involved alongside him. (Levine, Dennis & Hofer, William, Inside Out, New York, G.P. Putnam’s Sons, 1991) This coordination with the government helped him to have a reduced sentence of two years in prison with a $362,000 fine. (Time Magazine, “From Pinstripes to Prison Stripes”, 1987) He also agreed to pay the penalty for these illegal profits as well as accept a lifetime ban from the securities industry.
The SEC investigations into this case led to the whole network of such fraudulent insider trading activities involving Wall Street professionals who revealed such information as the parking of stock, the accumulation of stock to pressure firms’ management, and stock price manipulation. This whole uncovering of the Wall Street financial fraud led to more people being caught including Michael Milken, who was efficient in the junk bond market, Ivan Boesky, who was a arbitrageur, and others who included Martin Siegel of Kidder Peabody, and Robert Freeman of Goldman Sachs. Now, Levine is a president of ADASAR Group, which is a financial consulting firm and he also deliver lectures at many universities and organizations around the world on many issues related to business ethics. He has also written a book about his experiences entitled, Inside Out. However, some people consider that his book is not something to advise people away from it, but many students of Business Ethics have rather written him letters asking him to give further tips on how to reach there on the top.
The staff of the SEC issued a complete report on what limits and nature of sanctions should be enforced about insider trading in 1984. It took its own civil enforcement activity as a remedy and not as a punishment. The Department of Justice dealt with any cases that warranted punitive measures. But the Congress was not satisfied with the Insider Trading Sanctions Act (ITSA) which was enacted in the same year because of the division of functions, which is why the ITSA asked SEC authority to seek damages in cases related to insider trading.
As a result of this whole Wall Street insider trading scandal of the mid-1980s, the Congress passed the Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA) which extends civil penalty liability to controlling persons. This act also holds liability for supervisors of employees dealing in insider trading, which has developed the systems of internal controls. The maximum criminal penalty for insider trading was up to $1 million for natural persons and $2.5 million for organizations and also increased the imprisonment from five years to 10 years.
Along with this a private right of action was also created which said that if a person buys stock on material non-public insider information, then he is liable for damages to anyone who sells that stock without the same information. ITSFEA also included section 204A to the Investment Advisers Act of 1940 which asked supervisors within asset management firms to enforce by creating written policies and procedures for avoiding any insider trading. The SEC also holds authority to carry out civil actions on failure to maintain such policies and to take rules it feels that are required to make internal control more particular. The law provides that no person be held liable for any violation solely because he has been employed by another one who is actually liable indeed. (Ralph C. Ferrara, Ferrara on Insider Trading and the Wall, 2006)
There is also a bounty provision in the ITSFEA which is present for the whistleblowers that allows SEC to give reward to anyone who informs about insider trading. This rewards goes up to 10 per cent of the evaluated penalties. Then there is the Financial Institutions Reform, Recovery and Enforcement Act of 1989 which grants more bounty to informants in the banking industry specially. These are rewards are considered small by some scholars.
There are different scholars who hold different opinions. But in all cases healthy markets requires investor confidence and that comes from the assurance they are protected against any improper use of inside information. (Thomas Newkirk, 1998) From the ethical aspect, such cases as that of the Wall Street insider trading scandal of the mid-1980s, many believe that teaching this case is not an end. But today because of the need to understand such cases more business schools have begun to teach business ethics.
But somehow, many countries go their own way and they allow insider trading without much supervision. Recently Japan has begun to regulate insider trading and its rules are not enforced. In India, it appears to be the same case and in Hong Kong the laws are not that strict on it allowing liquid stock markets. (Macey, 1991, p. 44)
However, this might come as a shock but the ethical aspect of insider trading is very simple that could be defined easily by ethical norms. This is because insider trading is something which is not a usual activity that will come under normal practices of every day. Many scholars have justified their position on the importance of having open information markets when there is no activity in the customary sense. (Manne, Henry G., Insider Trading and the Stock Market, The Free Press, New York, 1966)
For anything to be fraudulent it requires many proofs and in the case insider trading it should involve things like intentional misrepresentation of facts and to falsely rely on incorrect statements about loss and damage. If one views the situation practically, then any kind of full disclosure of all essential material matters will open an unlimited numbers of odd possibilities. The biggest question that comes with such a limitation is actually what material is or what could be essential. This question then arises that how much disclosure should be made and what if the disclosure goes beyond the financial matters without the informer knowing or intentionally doing so. Hence, those who are for the insider trading rest their case on some level of fundamental fairness. But unfortunately not many lawmakers are interested in essential analysis and they are not willing to answer tough questions and involve themselves in unjustifiable assumptions. When one regulation passes into a law then the enforcement system establishes its own position to expand its jurisdiction.
There is a TSYS Code of Business Conduct and Ethics which covers a lot of business issues, its procedures and practices. There are certain basic ethical principles that guide all employees and officers of a company and its majority-owned subsidiaries. Today, Americans are willing to spend more and are investing in the stock market and there is twice as much money invested in the stocks than in commercial banks. This goes on to show the trust that American stock markets hold because the people believe that the government maintains fairness in the stock markets. The important part of the regulation in the securities market is the thorough application of the laws against insider trading, which has both civil and criminal prosecution for insider trading. When an investor does not have money to spend or the confidence to spend it, he will not. This lacking of confidence in the market has financial consequences.
Those who judge insider trading through utilitarian ethics say that it is the same for buyers to purchase stocks from an insider as they might have otherwise. (McGee, 2008, p.59) At least a person should not be accused according to utilitarianism for purchasing the same stock at the price that the insider would have paid. The benefit of such information is that it provides for market information flow that makes markets more efficient. By what the insiders are doing one can also analyze the patterns and move their stocks to a better and truer value.
To be on the safe side, one should know what insider trading exactly mean and what things can be unethical while one is at insider trading. The U.S. Supreme Court has defined that a fact would be taken as material when it would take any significance in an investor’s deliberations. The following is material non-public information when it is with the insider: a company that was to receive a tender offer for a purchase, a company that will announce its merger, a favorable earnings announcement, any disclosure of valuable mineral finding, or an announcement that will be made about dividend payment.
Since the term insider trading is really confusing, hence many people don’t know what might it consist. But for sure, not all insiders trading are unlawful. The Rule 10b-2 of the Exchange Act presents a compliance program that can safeguard an insider transaction provided that there is a written plan for the acquisition of such. The SEC has adopted a strict stand on public investors about going through a certain waiting period to react to the information. The American Exchange recommends a waiting period of 24 to 48 hours after there has been a publication of the information.
There have been even cases where U.S. congressmen have been trading stocks on information of future legislation beforehand. They get an unfair advantage over regular citizens because they have information regarding which industries will be regulated, and which stocks will do better, and so they sell based on this private information. But SEC has been found to go after high –profile insider trading cases instead of also looking what the congressmen are doing by not following the same laws. In fact, the SEC law enforcement agents themselves go with the law firms that protect companies from such lawsuits from the government. (Wall Street Journal Article; "Several US Law Makers Bet on Firms They Oversaw," by Jason Zweig, Brody Mullins, and Tom McGinty, June 17, 2010) (Wall Street Journal Article; "SEC - Revolving Door Under Review - Staffers Who Join Companies They Once Regulated Draw Lawmaker's Ire; Ms. King and Getco," by Tom McGinty) This unfair use by the congressman is as unethical as using an insider trading information in a corporate.