Insider trading
Insider trading is the trading of a public company's stock or other securities (such as bonds or stock options) based on material, nonpublic information about the company. In various countries, some kinds of trading based on insider information are illegal. This is because it is seen as unfair to other investors who do not have access to the information, as the investor with insider information could potentially make larger profits than a typical investor could make. The rules governing insider trading are complex and vary significantly from country to country. The extent of enforcement also varies from one country to another. The definition of insider in one jurisdiction can be broad and may cover not only insiders themselves but also any persons related to them, such as brokers, associates, and even family members. A person who becomes aware of non-public information and trades on that basis may be guilty of a crime.
"Inside information" redirects here. For other uses, see Inside Information (disambiguation).
Trading by specific insiders, such as employees, is commonly permitted as long as it does not rely on material information not available to the general public. Many jurisdictions require that such trading be reported so that the transactions can be monitored. In the United States and several other jurisdictions, trading conducted by corporate officers, key employees, directors, or significant shareholders must be reported to the regulator or publicly disclosed, usually within a few business days of the trade. In these cases, insiders in the United States are required to file Form 4 with the U.S. Securities and Exchange Commission (SEC) when buying or selling shares of their own companies. The authors of one study claim that illegal insider trading raises the cost of capital for securities issuers, thus decreasing overall economic growth.[1] Some economists, such as Henry Manne, argued that insider trading should be allowed and could, in fact, benefit markets.[2]
There has long been "considerable academic debate" among business and legal scholars over whether or not insider trading should be illegal.[3] Several arguments against outlawing insider trading have been identified: for example, although insider trading is illegal, most insider trading is never detected by law enforcement, and thus the illegality of insider trading might give the public the potentially misleading impression that "stock market trading is an unrigged game that anyone can play."[3] Some legal analysis has questioned whether insider trading actually harms anyone in the legal sense, since some have questioned whether insider trading causes anyone to suffer an actual "loss" and whether anyone who suffers a loss is owed an actual legal duty by the insiders in question.[3]
Legal[edit]
Legal trades by insiders are common,[4] as employees of publicly traded corporations often have stock or stock options. These trades are made public in the United States through Securities and Exchange Commission filings, mainly Form 4.
U.S. SEC Rule 10b5-1 clarified that the prohibition against insider trading does not require proof that an insider actually used material nonpublic information when conducting a trade; possession of such information alone is sufficient to violate the provision, and the SEC would infer that an insider in possession of material nonpublic information used this information when conducting a trade. However, SEC Rule 10b5-1 also created for insiders an affirmative defense if the insider can demonstrate that the trades conducted on behalf of the insider were conducted as part of a pre-existing contract or written binding plan for trading in the future.[19]
For example, if an insider expects to retire after a specific period of time and, as part of retirement planning, the insider has adopted a written binding plan to sell a specific amount of the company's stock every month for two years, and the insider later comes into possession of material nonpublic information about the company, trades based on the original plan might not constitute prohibited insider trading.
Arguments for legalizing[edit]
Some economists and legal scholars (such as Henry Manne, Milton Friedman, Thomas Sowell, Daniel Fischel, and Frank H. Easterbrook) have argued that laws against insider trading should be repealed. They claim that insider trading based on material nonpublic information benefits investors, in general, by more quickly introducing new information into the market.[48]
Friedman, laureate of the Nobel Memorial Prize in Economics, said: "You want more insider trading, not less. You want to give the people most likely to have knowledge about deficiencies of the company an incentive to make the public aware of that." Friedman did not believe that the trader should be required to make his trade known to the public, because the buying or selling pressure itself is information for the market.[9]: 591–7
Other critics argue that insider trading is a victimless act: a willing buyer and a willing seller agree to trade property that the seller rightfully owns, with no prior contract (according to this view) having been made between the parties to refrain from trading if there is asymmetric information. The Atlantic has described the process as "arguably the closest thing that modern finance has to a victimless crime".[49]
Legalization advocates also question why "trading" where one party has more information than the other is legal in other markets, such as real estate, but not in the stock market. For example, if a geologist knows there is a high likelihood of the discovery of petroleum under Farmer Smith's land, he may be entitled to make Smith an offer for the land, and buy it, without first telling Farmer Smith of the geological data.[50]
Advocates of legalization make free speech arguments. Punishment for communicating about a development pertinent to the next day's stock price might seem an act of censorship.[51] If the information being conveyed is proprietary information and the corporate insider has contracted not to expose it, he has no more right to communicate it than he would to tell others about the company's confidential new product designs, formulas, or bank account passwords.
Some authors have used these arguments to propose legalizing insider trading on negative information (but not on positive information). Since negative information is often withheld from the market, trading on such information has a higher value for the market than trading on positive information.[52][53]
There are very limited laws against "insider trading" in the commodities markets if, for no other reason than that the concept of an "insider" is not immediately analogous to commodities themselves (corn, wheat, steel, etc.). However, analogous activities such as front running are illegal under US commodity and futures trading laws. For example, a commodity broker can be charged with fraud for receiving a large purchase order from a client (one likely to affect the price of that commodity) and then purchasing that commodity before executing the client's order to benefit from the anticipated price increase.
Commercialisation[edit]
The advent of the Internet has provided a forum for the commercialisation of trading on insider information. In 2016 a number of dark web sites were identified as marketplaces where such non-public information was bought and sold. At least one such site used bitcoins to avoid currency restrictions and to impede tracking. Such sites also provide a place for soliciting for corporate informants, where non-public information may be used for purposes[54] other than stock trading.[55]
Legal differences among jurisdictions[edit]
The US and the UK vary in the way the law is interpreted and applied with regard to insider trading. In the UK, the relevant laws are the Criminal Justice Act 1993, Part V, Schedule 1; the Financial Services and Markets Act 2000, which defines an offence of "market abuse";[56] and the European Union Regulation No 596/2014.[57][58] The principle is that it is illegal to trade on the basis of market-sensitive information that is not generally known. This is a much broader scope than under U.S. law. The key differences from U.S. law are that no relationship to either the issuer of the security or the tipster is required; all that is required is that the guilty party traded (or caused trading) whilst having inside information, and there is no scienter requirement under UK law.[6][59][60]
Japan enacted its first law against insider trading in 1988. Roderick Seeman said, "Even today many Japanese do not understand why this is illegal. Indeed, previously it was regarded as common sense to make a profit from your knowledge."[61]
In Malta the law follows the European broader scope model. The relevant statute is the Prevention of Financial Markets Abuse Act of 2005, as amended.[62][63] Earlier acts included the Financial Markets Abuse Act in 2002, and the Insider Dealing and Market Abuse Act of 1994.[64]
The International Organization of Securities Commissions (IOSCO) paper on the "Objectives and Principles of Securities Regulation" (updated to 2003)[65] states that the three objectives of good securities market regulation are investor protection, ensuring that markets are fair, efficient and transparent, and reducing systemic risk.
The discussion of these "Core Principles" state that "investor protection" in this context means "Investors should be protected from misleading, manipulative or fraudulent practices, including insider trading, front running or trading ahead of customers and the misuse of client assets." More than 85 percent of the world's securities and commodities market regulators are members of IOSCO and have signed on to these Core Principles.
The World Bank and International Monetary Fund now use the IOSCO Core Principles in reviewing the financial health of different country's regulatory systems as part of these organization's financial sector assessment program, so laws against insider trading based on non-public information are now expected by the international community. Enforcement of insider trading laws varies widely from country to country, but the vast majority of jurisdictions now outlaw the practice, at least in principle.
Larry Harris claims that differences in the effectiveness with which countries restrict insider trading help to explain the differences in executive compensation among those countries. The US, for example, has much higher CEO salaries than have Japan or Germany, where insider trading is less effectively restrained.[9]: 593
By nation[edit]
European Union[edit]
In 2014, the European Union (EU) adopted legislation (Criminal Sanctions for Market Abuse Directive) that harmonised criminal sanctions for insider dealing. All EU Member States agreed to introduce maximum prison sentences of at least four years for serious cases of market manipulation and insider dealing, and at least two years for improper disclosure of insider information.[66]
Australia[edit]
The current Australian legislation arose out of the report of a 1989 parliamentary committee report which recommended removal of the requirement that the trader be 'connected' with the body corporate.[67] This may have weakened the importance of the fiduciary duty rationale and possibly brought new potential offenders within its ambit. In Australia if a person possesses inside information and knows, or ought reasonably to know, that the information is not generally available and is materially price sensitive then the insider must not trade. Nor must she or he procure another to trade and must not tip another. Information will be considered generally available if it consists of readily observable matter or it has been made known to common investors and a reasonable period for it to be disseminated among such investors has elapsed.
Norway[edit]
In 2009, a journalist in Nettavisen (Thomas Gulbrandsen) was sentenced to four months in prison for insider trading.[68]
The longest prison sentence in a Norwegian trial where the main charge was insider trading, was for eight years (two suspended) when Alain Angelil was convicted in a district court on December 9, 2011.[69][70]
General information
Articles and opinions
Data on insider trading