Insider Trading

Insider trading is the act of buying or selling company stocks and securities based on information not known to the public. An insider is considered any officer, manager,

or executive of the firm in question; in some cases, it can also be a person who was given the proprietary information by a company figurehead. Generally, insider trading is illegal, but there are laws and regulations that some are willing to skirt in order to practice trading that they consider “legal” insider trading.

Insider trading is considered by many people to be no different than outright stealing. U.S. laws concerning insider trading have become increasingly more strict throughout the years and include swift punishment for those who garnered the insider information to make the trades as well as those who do the trading, regardless of their involvement or relationship (or lack thereof) to the firm. Several laws now protect companies and employees from insider trading and its negative impact on stocks and the open market in general. Even firms with highly globalized presences with identities on all the world markets now have the legal protection to combat insider trading.

U.S. LAWS AND REGULATIONS AGAINST INSIDER TRADING

Insider trading laws have evolved with the open market since its onset, but many were born after the devastating crash of the stock market in 1929. The 1934 Securities Exchange Act is the backbone for almost any law or regulation against insider trading as well as other types of securities fraud. Considered an appendage of (or sister to) the 1933 Securities Act, the Securities Exchange Act reaches further to protect stocks, while the Securities Act covers issues more germane to securities. Essentially, sections 16(b) and 10(b) of the Securities Exchange Act outline unlawful trading practices and these sections explain—through various rules of the U.S. Securities and Exchange Commission (SEC)—exactly what fraudulent trades are and who can perpetrate them. The 1934 act also denotes when a trade is considered unlawful.

Insider trading can cause major shifts in what the public chooses to do in terms of buying or selling of a firm's stocks or securities. This is the main reason why stocks and companies, as well as their shareholders, must be protected against trades that are based on information that is unknown to the public. In a 1966 federal court case (SEC vs. Texas Gulf Sulphur Company ), it was decided that any person who is party to information not yet publicly known about a firm's stocks or securities has a duty to stockholders and to the firm in question. The privy person can either choose not to trade and sit on the information, or share what he or she knows in a public manner so that everyone can benefit. In this way, the shareholders and the company's holdings are not devalued by trades based on the information at hand.

Many of the parameters that determine the difference between legal and illegal insider trading are determined by the SEC. According to the SEC, the two most recent rules (10b5-1 and 10b5-2) further protect both investors and companies by outlining exactly when information is considered public or nonpublic and by determining when exceptions are to be made (for example, when a trade is made but the person trading can prove that it was made on the basis of something other than nonpublic information). Additionally, 10b5-2 explains when a person would be required to pay a penalty for use of insider information and what, exactly, constitutes misappropriated information in regards to information used by parties with no direct ties to the firm in question.

EFFECTS AND FUTURE OF INSIDERTRADING

The rules and regulations established by the acts of 1933 and 1934—as well as various court cases that further tailored the laws against insider trading—were further built upon, reexamined, and revised following the boom of corporate mergers in the 1980s. It was not until this time that it became illegal to sell insider information. The case United States vs. Newman made it illegal for the first time for a nonrelated party, not just a company insider, to engage in trades based on nonpublic information.

The laws and regulations against insider trading have become progressively more severe because the potential negative effects that insider trading can have are devastating. With mergers on the rise as they were in the 1980s, and with more money invested in the stock market by more people than ever before, insider trading is again a deadly threat. Businesses moving to a global stage will want to protect assets to the best of their abilities, and a strong policy against insider trading is a crucial aspect of that protection.

The United States has the reputation for the least acceptance and lowest tolerance for insider trading. Other major world players—including China, India, and members of the European Union—have started to adopt many of the same perspectives and laws concerning insider trading of stocks and securities as corporations from every locale move in the multinational direction.

BIBLIOGRAPHY

Ali, Paul U. and Greg N. Gregoriou. Insider Trading: Global Developments and Analysis. Boca Raton, Florida: CRC Press, 2008.

Macey, Jonathan R. Insider Trading: Economics, Politics, and Policy. Washington, D.C.: AEI Press, 1991.

Newkirk, Thomas, and Melissa A. Robertson. “Speech by SEC Staff: Insider Trading—A U.S. Perspective.” Available from: http://www.sec.gov/news/speech/speecharchive/1998/spch221.htm.

“U.S. Securities and Exchange Commission: Insider Trading.” Available from: http://www.sec.gov/answers/insider.htm.