Insider Trading – What is it and Who is Involved?
Insider trading is essentially trading of the stock or securities of a publicly traded company based on inside information, typically non-public information about the business. In many countries, however, some forms of trading based on inside information is deemed illegal. These include the futures and options markets, forex trading and commodity trading. In the United States, laws do not currently prevent persons from engaging in transactions in which they have an unfair advantage. As more businesses attempt to protect their interests and reduce their risk of investing in stocks that are inefficient, laws will likely be developed to limit the ability of insiders to trade stock.
In the United Kingdom, the Financial Services Authority has taken action against a number of individuals and organizations involved in what it calls “gambling” or “insider trading.” According to the FSA, a broader scope of the market abuse act has been brought out to include situations where an individual or organization takes positions in shares of a publicly traded company based solely on rumors or ‘inside information’ which is not disclosed to the relevant public prior to the transaction Insider trading. Although a number of media reports have referred to the UK broadside as a gambling law, it was actually covered under a different law – the market abuse act.
The law in the United Kingdom covers individuals and institutions than including hedge funds, investment advisers, market makers and corporate insiders. Under the terms of this law, individuals can be prosecuted for providing or receiving confidential information in contravention of confidence, secrecy or similar restrictions. It also covers activities related to attempts to manipulate the price of a publicly traded product.
There are many elements that make insider trading a complex area of study. For starters, it is very easy to get inside information. It is also easy to mis-purchase securities and it is also easy to trade without revealing your position to the outside world. Corporate insiders typically rely on a group of like-minded investors to buy their stock options and other securities. Financial reporting guidelines are so complex that most brokers and companies that provide trading platforms cannot offer reliable information regarding stock options.
An important aspect of this trading method is the fact that insiders frequently are aware of major events that affect the market. For instance, it is common knowledge among savvy insiders that the price of oil will rise. Traders then place a bet that the price of oil will rise because they believe that the world’s oil production will fall within a few months to a year. This trading technique, however, is based on the mistaken assumption that the United States will remain a key producer and oil will be available at reasonable prices once the demand for oil rises above a certain level.
Based on the U.S. House of Representatives’ investigation into securities fraud and other insider trading schemes, many investors and brokerage firms were identified as providing opportunities for fraudulent activity. The results of this investigation demonstrated the inability of the industry’s leaders to police their activities. The Securities and Exchange Commission was widely criticized for failing to aggressively pursue cases against the largest publishers of bogus stock tips. The commission was also criticized for allowing one company, motivated by financial giants Morgan Stanley and Lehman Brothers, to use a loophole in the law allowing it to alter its definition of what constitutes “material nonpublic information” from the protection of investor confidence.
There is no doubt that the securities exchange act has made some improvements since 1999 when an insider trading case was brought against the world’s largest brokerage firm. However, it was determined that the company was protected by the Supreme Court ruling in favour of Lehman Brothers. Because of this loophole, brokerage firms can still freely provide biased inside information to clients by hiding the identity of the person giving the advice. This loophole was also found to exist with respect to the London Stock Exchange and its futures market. This means that even today, it is extremely difficult for brokers to prove that their clients have provided them with inside information.
The bottom line is that the Securities Exchange Commission and the government are in the business of protecting the American people. Any attempts to impinge on this right are unlawful. If insider trading is to be punished then the punishment should be a deterrent against providing anyone with inside information. Otherwise, if people believe that they can go on trading stocks based solely on rumors that are largely uncensored, then we are headed for major losses. If investors want to protect the market from unscrupulous insiders and illegal stock market trading, they need to implement strict regulations and insist upon full disclosure.