Insider trading since the late 1960s has been the subject of both disapproval and severe regulatory control in England and America. Criminal cases and financial scandals in the 1980s and 1990s have further brought insider trading into the limelight. It is important to understand what activities of insider trading are actually unethical. In order to comprehend the unethical aspects of insider trading it is important to firstly determine a clear definition of insider trading. Insider trading is a violation of fiduciary duty and breach of trust and confidence.
It involves buying and selling a security (e.g. bonds or stock options) when the person is in posession of non-public information or material about the stock or security. “Tipping” information to another or trading by the person who was “tipped’ or misappropriating information are all violations. Insiders are usually company directors, corporate officers, employees who are usually in posession of important confidential developments that might increase or decrease the value of share. The people who are told about this information and benefit from it are “tippees” usually the friends, business associates, family members of the insiders.
It is estimated that out of all the merger and acquisition deals that took place in 2006 almost 41% deals were involved in insider trading. Insider trading generates stupendous amounts of profits ranging from 8-$12 billion per month. The Securities Enforcement Commission’s biggest priority is detecting and prosecuting those who violate fair trading. The commission is allowed by the exchange act to bring legal action against any insider traders and threat them with fines and imprisonment. The illegal gains by insider traders can also be recovered by the commission in addition to the payment of the civil penalty.
These penalties are almost three times equal to the actual profit earned or the loss avoided by the insider. A good example of an insider trading case is of ImClone Systems Incorporated. The executive and other at ImClone sold the company stocks just before announcing that their drug failed to get approval from FDA. They knew their stock would plummet and they saved themselves from the obvious losses. It was unethical and unfair for those traders that were uninformed about this particular development of the company.
The founder and CEO Sam Waksal was reprimanded for his insider trading and fraud by being charged to 87 months in prison and facing $3 million worth of fines. Insider trading has many disadvantages. Firstly, it demoralizes the investor confidence in securities markets. The markets appear less efficient and the reputation of fairness of a particular market is destroyed. It has a huge impact on small investors and overseas investors while Institutes and organization benefit overall. Small investors never find out about merger or acquisition deals before they are publicly announced.
They are unaware of any new contract or earnings shortfall of a company before it appears in a newspaper. Insider trading also leads to an unhealthy competition between informed non-insiders and informed insiders. Obviously the informed non-insiders will be driven out of the market. In this way profits of investors and managerial incentives will both be affected. In addition to this, it also raises the cost of capital for the companies that issue securities. It decreases the growth of the economy.
Liquidity traders are also affected by Insider Trading because they face the consequences of incurring losses if their agents possess better information. Alternatively, if they steer clear of trading they eventually lose the benefits they get from diversification/hedging. Although, it is being said that all forms of insider trading are unethical however it has been noted in a few cases that not all insider trading activities were unethical. Some forms of insider trading have been noted by philosophers and researchers as extremely beneficial for the economy of the country. Many factors determine whether Insider Trading is unethical or not.
It is also important to consider the manner by which information was acquired. This determines whether the trading was immoral or not. For example if the information was acquired by theft it will automatically be immoral. Overwhelming number of people agree that the market can survive and do very well without the menace of insider trading. Therefore it is desirable that restrictions be placed on insider trading. However, implementing these restrictions can be expensive and difficult. There are just too many people that can be classified as insiders and even more people that the insiders could use to route their trading.
This is the reason when restrictions are enforced they appear more like witch-hunts. Even if significant amounts of money and resources are employed it has been noted that a great deal of speculation still occurs because of insider trading.
References: • Insider trading. (2007, May 6). In Wikipedia, The Free Encyclopedia. Retrieved 13:10, May 9, 2007, from http://en. wikipedia. org/w/index. php? title=Insider_trading&oldid=128686798] • Hu, Jie & Noe, Thomas. (1997). The Insider Trading Debate. Federal Reserve Bank of Atlanta: Economic Review. Retrieved May 9, 2007, from http://www. frbatlanta. org/publica/eco-rev/REV_ABS/97ER/q4/Noe-Hu. pdf.