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Insider Trading and Business Ethics
Many people are complaining insider trading since it is unfair for some people who do not have confidential information about a certain company. People who do not have information that is not yet into the public lose their confidence and trust towards the company. Therefore, many companies lose potential investor from insider trading. Insider trading is a huge issue among people. Insider trading can be an unethical; yet sometimes it can be ethical. In this paper, we will discuss the meaning of an insider trading, who is an insider, the two types of insider trading, the ethics involved in insider trading, Martha Stewart’s scandal concerning insider trading, the Enron scandal VS. Martha Stewart scandal, the law view insider trading in the USA, the view insider trading in the UAE, finally yet importantly, five years from now what will we do if it were to happen in our company.
What is Insider Trading :
Insider trading is a word that has many definitions and connotations and which includes both legal and illegal activities. It can also be described as an insider trading of a company’s stock, securities, bonds and stock options by persons with possible access to non-public information about the company. Nevertheless, insider trading can take place lawfully every day, when trading by the corporate insiders such as officers, directors, employees and large shareholders to buy or sell stock in their own companies if this trading will not be taking advantage of the non-public information and also be within the boundaries of the company’s policies and the rules governing this trading. However, the term “insider trading" is mostly used to describe a practice in which an insider party trades based on non-public material information gained through the performance of the insider’s obligation at the company, in violation of other relationships of faith and assurance or otherwise when the non-public information was stolen from the company. In other words, insider trading is buying, selling or dealing in securities, bonds, and stocks of a company by a director, manager, or employee of the company who has confidential information that is not accessible to the public.
Who is an Insider:
An insider is a person who has entrée to the confidential information about a company or corporation that will affect the stock price or might manipulate investors’ decisions. This is “material information". Moreover, most company executives clearly have important information about the company. For example, the manager of sales knows how much the company has sold and if it rallies, the estimates provided with the investors. Moreover, others who work with the company also have material information; for instance, the accountants and auditors who do the sales forecast spreadsheets and the administrative associates who type up the press releases are also insiders. Furthermore, other people who do not work in the company, but with whom the company requires to allocate material information, are also insiders. Insiders could include brokers, bankers, lawyers and much more. In an attempt to limit the risks of being involved in legalities, a company may perform actions to restrict the number of people who have an entrée to the material information. Regardless of these attempts, there will still be people who are considered to be insiders.
Performing such actions will be beneficial for the company on several different levels. First, they will restrict a person’s ability to leak information to others. Second, as an insider, certain limits have to be placed on what that person can and cannot trade in the company’s stock and so on.
The Two Types of Insider Trading:
There are two types of insider trading, legal and illegal activities. Legal traders are performed by insiders who are familiar with the company, such as employees of publicly traded companies often buy or sell their stocks. When insiders either buy or sell in their own securities, they must state their actions to the SEC (Security and Exchange Commission). Various shareholders and dealers use the information to classify companies with their potential investment. If the insiders are buying the stock, they probably know more about their company or corporation than anyone else, so it is a superior thing to buy stocks from the company. To maintain the legality of the employees buying and selling, as of December 2005, employers are obliged to announce to their employees when it is safe for them to trade without being accused of insider trading. This is to avoid the legality issue of an insider making a buy specifically to increase investor confidence or for reasons unrelated to the company’s health.
On the other hand, illegal traders are those who trade material information to the non-public around the world, while the information and the efforts to impose them differ significantly. However, the SEC’s job is to make sure that all shareholders are making choices based on similar information. In addition, insider trading can be illegal because it ruins all choices and confidence investors have for the company. Therefore, when investors hear of any stories about the company’s performance, they will act based on the information acquired. In other words, either sell their stock, or buy more depending on how well or bad the company’s performance is. Insider trading occurs when a trade such as the selling or buying of a stock, security or bond has been affected by the leakage of confidential information that the company has not made public. Because this confidential information is not accessible to other shareholders and investors, a person who uses such information is trying to expand unfair advantage over the rest of the market. Using this important information for either buying or selling breaches clarity- the essential foundation of a capital market. Confidential information in a clear market has to be distributed in a way in which all market contributors receive it at more or less the same time. Under these circumstances, one investor can have a benefit over another investor only by acknowledging the confidential information that spread to the public. If an individual trades with non-public information, they will gain an advantage that would be impossible for the other investors to attain. This act is substantially prejudiced for an adequately functioning market. If the insider trading were to be illegal, shareholders would lose their trust in the company, which would lead to a decline in investments thus causing a great disadvantage to the company or corporation.
The Ethics Involved in Insider Trading:
Insider trading has managed to earn itself a dreadful name in the recent years. People who engage in insider trading are thought to be completely devoid of ethical values. However, not all individuals who engage in insiders trading are unethical; studies have shown that some insider trading is useful to the investment society. Some researchers in philosophy, law and economics have not decided whether insider trading should be penalized at all while others state that it should be illegal in all situations. The best thing to do is to detach those who are illegally harmed by insider trading. If such people exist, then obviously worded legislation could be passed to stop any scheme from being faithful against these people and groups, while allowing non- fraudulent transactions to be completed without dread of action. Until it can obviously be shown that an insider trading fraudulently harms an individual, there should be no law or regulation limiting the practice, since such limitations breach individual rights, it will also destroy the competition between the people and the company, and will most likely have a negative market response.
People often confuse the marketplace with a game in which rules of play are set and put into action so that everyone involved gets an even chance. The market is more similar to life itself in the sense that diverse people come with special assets, talents, looks, genetic makeup, economic and climactic conditions; and the people have to do their best with what they have. In reality, however, the theory of “insider trading“ used in business ethics has a wider meaning, which includes anyone’s capability to make agreements based on not yet publicized information of the company’s opportunities. Insider trading per se, apart from its association with fraud or violation of fiduciary duty, involves engaging in financial investments based on information others do not know about. It is apparent that such actions should be considered to be ethically immoral since they affect others unfairly. The fact that some people, or to say, insiders, have information that others don’t have, therefore, can be at a great disadvantage to the rest of the stakeholders since they cannot make use of this possibly valuable information. If the other stakeholders had knowledge of this information, they may have possibly acted in a different way and enjoyed the same advantage as the insiders.
At times, one may overhear information from someone having a conversation nearby, possibly in an elevator, bar, restaurant, or even at the barber shop. Is it wrong for others to make use of this confidential information that they overheard? In this situation, they are considered to be insiders; going back to the concept of life, people will do anything to live successfully. Unfortunately, by overhearing this important piece of information, this would still result in unfairness to others. Moreover, when a person knows confidential information about a company, they tend to become greedy and choose to keep the information to themselves which may lead to overlooking sensibility and rationality which is, after all the first of the cardinal virtues. Some people are pro insider trading because it contributes to the overall effectiveness of the market’s transactions. Those people argue that the insiders send signals to other people whose reactions can help boost the marketplace to a higher level of effectiveness and efficiency. There might be some sense to this line of argument, although it comes dangerously close to arguing that the end justifies the means. Unless the actions of the person who engages in insider trading can themselves be shown to be defensible, such arguments are no good. Insider trading, furthermore, is held ethically suspect not because of its maximum worth to the society is denied yet, but because many markets regard to fairness and equality which are the most vital criteria for an ethically decent marketplace. The marketplace is engaged by the respect of people’s rights. Within the marketplace, considering the respect of an individual’s rights insider trading is perfectly unobjectionable.
The Martha Stewart Scandal:
There have been several business related scandals over the years. Of the most scandalous and publicized cases is the Martha Stewart insider trading scandal. Martha Helen Stewart is a multi aspect celebrity and a founder of several business ventures. Publisher of her own magazine “Martha Stewart Living", host of her own talk show “Martha" and author of several bestselling books, Stewart was named the third most powerful woman in America by Ladies Home Journal in 2001. Later that year, Stewart engaged in illegal insider trading actions where she sold all of her 3,928 shares in ImClone Systems, avoiding 45,673 dollars in losses. The next day, the stock value of the ImClone shares fell 16%. For several months to come, Stewart was the center of attention of the media circle, being subjected to heavy media scrutiny. According to the prosecutors in her January 2004 trial, Stewart’s broker Peter Bacanovic ordered his assistant to inform her that the CEO of ImClone Samuel D. Waksal was selling all his shares before the Food and Drug Administration ruling about ImClone’s rejected cancer drug went public and his share value declined. Stewart was found guilty in March 2004 of several charges. Conspiracy, obstruction of an agency proceeding and two counts of making false statements to federal investigators were of these charges and in July of that year, both her and Bacanovic were sentenced to serve five months in a federal correction facility, five months of home confinement and electronic monitoring and two years of supervised release. Stewart also had to pay a fine of 30,000 dollars while Bacanovic had to pay 4,000 dollars. Waksal was charged with securities fraud, bank fraud, obstruction of justice, and perjury. In October, 2005 Stewart was not given notice that due to her criminal record, she was not eligible for entrance to Canada under the Immigration and Refugee Protection Act. In August, 2006, a settlement was reached in the civil case against Stewart. She agreed to a five-year ban from serving in any type of financial-related administrative position at any public company. Additionally, she agreed to pay the maximum penalty of 195,000 dollars, accumulating to three times the losses she avoided. Bacanovic also had to pay penalties which summed up to approximately 75,000 dollars and was banned from practicing brokerage, dealing or financial advising. In June, 2008, Stewart was denied a visa to enter Great Britain due to new rules to safeguard British borders.
The Enron Scandal vs. The Martha Steward Scandal:
On a similar note, Enron was an American energy company that had some scandals of its own. It was thought to be one of the world’s best electricity, natural gas, pulp, paper, and communications companies. Sharon Watkins, who was the vice president of Enron, confirmed that she made 47,000 dollars in 2001 from the sale of her Enron stock. However, Watkins sold her stock because she was concerned about the real value of the company after her meeting with Ken Lay, the CEO and chairman of Enron. While basing her decision to sell her shares on the information she acquired from the meeting, this information was not yet made public which would imply that her actions are based on insider trading. Yet, she denied that she has committed the fault of insider trading or that the Government made any promise not to prosecute her for actions. On the other hand, Martha Stewart went to prison because of a 45,673 dollar profit for selling her stocks based on information she gained that was not made public and was considered to be insider trading. As opposed to the Martha Stewart case, Watkins made no false statements to the federal investigators and no evidence of insider trading actions was found. Her choice to sell her shares was ruled to be of her own opinion and her personal thoughts and opinions concerning Enron.
How the Law Views Insider Trading in the USA:
The reason that most investors in The United States of America are investing their capital into the American stock market is because they believe that their government has mandated honest, fair and fraud-free transactions in its stock market to uphold its integrity and image. This in itself spreads relief and confidence among the investors. In response to the several fraud cases concerning insider trading within stocks, bonds and securities, the SEC (Securities and Exchange Commission) has mandated laws and rules that prevent investors from engaging such actions. These laws are adopted from and based on the common law tradition of England which prohibits insider trading.
After the stock market crash in the United States in 1929, the Securities Exchange Act of 1934 addressed insider trading straightforwardly in sections 16(b) which bans short-swing profits that are obtained in a period less than six months by insiders in their own corporation’s stock, that is, directors, officers or those holding more than ten percent of the stock of the corporation. Also, Section 10(b) of the Act prevents any form of manipulation, bribery, deception and scheming the breaking of the rules and regulation described in the Securities and Exchange Commission. According to Rule 10b-5 of the Securities and Exchange Commission, it is illegal for any individual to
Directly or indirectly to utilize any form of device, plot, bribery or deception to deceive
Falsify or exclude a statement of a material fact
Employ in any action that would imply deceit or fraud upon any individual associated with the purchase or sale of a security.
Based on the several lawsuits that have occurred with regards to insider trading, the Commission has enacted the following rules and regulations:
Any dealer or broker that trades while in possession of information that he receives from a corporation that has not been made public is violating Rule 10b-5.
Anyone that possess inside information that has not been made public is obliged to either disclose the information to the other stakeholders or to refrain from buying or selling since this would give the person an unfair advantage and it is considered to be fraud.
Trading in any material nonpublic information obtained regarding tender offers from an insider is considered illegal.
According to the Court, there are distinct arguments for barring insider trading. The Court emphasized that barring insider trading is to assure honest stock markets and therefore promote fortified confidence. Investors are more likely to invest their capital in a market which ensures confidence and trust rather than in a market where the law overlooks the misappropriation of nonpublic information. Also, the Court recognizes that a company’s confidential information succeeds to be the property to which the company has an exclusive right of use. It is considered to be a violation of fiduciary duty to secretly misappropriate such information.
The misappropriation theory, which states that anyone from the workforce who misappropriates information from their employer and trades on that information in any stock, whether it is in the employer stock or otherwise, is guilty of insider trading. This theory is now a part of the United States law. In addition, any individual that has no fiduciary relationship to an issuer may be accountable for trading in stocks of an issuer while in possession of information gathered in the breach of a relationship of trust and confidence.
How the Law Views Insider Trading in the UAE:
The Dubai and Abu-Dhabi Stock Exchange rules and regulations have their differences, but they are unanimous when it comes to insider trading actions. Insider trading is banned in two ways under the laws of Dubai and Abu-Dhabi. Authority Law thirty seven prohibits the exploitation of information that has not been made public that could possibly affect the prices of securities, stocks or bonds. Article thirty nine prohibits engaging in the trade of securities, stock or bonds based on knowledge obtained from non public information. It is made clear in Authority Law thirty nine that the employees of a company, including those of high rankings such as chairmen and the members of the board are barred from exploiting inside information. Additionally, the chairman, members of the board of director or any employee of a company may not spread any false information about the company’s share transactions, or release information which may affect the price of the security, stock or bond which has not been affirmed to the Authority. A person charged with insider trading will be liable to imprisonment for a period between three months and three years, no more or less. Also, a fine between one hundred thousand Dirhams and one million Dirhams will be charged, no more or less. In addition to the above, one important thing to note is that DIFC obligates that no person shall be a Director is s/he has been found guilty of insider trading, or the equivalent, in any jurisdiction, at any time.
To sum up, insider trading is selling or buying stocks, bonds, and securities from a company with nonpublic confidential information about the company. There are two types of insider trading legal and illegal, legal insider trading are the employees, manager or who works in the company trades their stocks, bonds or securities within the information that they know from the company. While the illegal insider trading, are those who trade with important information that is not in the public. Anyone can be an insider, an insider can be an individual who works in the company, an individual who over hears information, or a broker. Insider trading can be an advantage for some people and a disadvantage for others; an advantage for people who knows about the confidential information and they buy or sell based their decision about the information that is not yet for the public. Therefore, they can benefit from this information, gain profits, and avoid losses. On the other hand, it is a disadvantage for the people who do not know about the confidential information; they can lose a lot of money. This action is unreasonable for others. It is an unethical action done by the insiders because it is unfair for the other stockholders and investors. There are many scandals concerning insider trading such as the famous icon Martha Stewart who was accused of insider trading she avoided a very high loss by selling her stocks, Enron and many more. The law prohibits insider trading in both countries the United States of America and the United Arab Emirates because it affects many people. Therefore, insider trading should be prevented and whoever is accused of being an insider trading should be penalized for such action.