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Principles of Business: Insider Trading Contents Abstract 1 The Scenario 2 Identification and Description of the Crime 2 Agency Responsible for Prosecuting the Crime 3 Prescribed Punishments 5 Real-life Examples 5 Conclusion 6 References 6 Abstract Insider trading has been a recurring phenomenon in almost every place in the world that boasts of a securities market. It is major crime that is mostly committed by the corporate insiders armed with the knowledge of any imminent happening that could abruptly change the price structures of the companys stock. It has been generally observed that bulk of this crime is committed by people at high places in a company who are generally privy to confidential information that is yet to be made public. While there have been numerous instances of insider trading offences in the United States, the US Securities and Exchange Commission has always been rising to the occasion rather competently by bringing the culprits to book.
At the same time, the Commission has never intended to be harsh on people or organizations indulging in inside trading within the boundary of accepted norms and that are permissible by law. The Scenario Jack and Diane, a married couple, worked as executives in Electro-Source, which is a large multinational electronics company. While Jack is a director in the marketing division, Diane holds the appointment of a Vice President. Both the spouse hold in their names a good number their companys stock, market performance of which was bound to be of great importance to them in their future lives.
As top executives of the company they were invariably privy to all types of confidential information relating to the concurrent status and performance of their company. Jack, one Friday, came to know of the news of loss of a large government contract by the company that could plunge the company stocks to a very low level. Once the news of the loss of the contract was divulged by Jack to Diane, the couple decided to sell their shares immediately in the stock market. The value of the stock was still at a higher level (in view of the companys buoyant position linked to the outcome of the said contract) as the couple sold their stocks to investors who were not aware of the companys latest fate in relation to the government contract.
Identification and Description of the Crime As a result of selling the stocks when the market price was at a very high level, both Jack and Diane no doubt made a huge profit from the deals. However, the timing of their sale was highly improper as far as good business practice is concerned. It was also a criminal act known as insider trading. While the term insider trading has many connotations, it basically implies involvement of the insiders of company such as directors, officers and even ordinary employees in trading in the stock of their own company while being privy to unpublicized information. Insider trading takes place in almost every country in the world and in almost all the markets in various forms. This is rather natural, because all these insiders are definitely entitled to trade in the security market - even in their own companys stock and being privy to inside information, good or bad.
This right notwithstanding, the trading is required to be done within the purview of the companys policies as well as the laws / regulations governing the subject. Insider trading is only deemed as a crime when the so called insider takes undue advantage of some information about his company that is not public and when other hapless investors are not aware of the same. The criminal angle of the advantage lies in the insider selling his stock and making an unseemly profit after being alerted about some news that is likely to drive the stock price to a much lower level. That was exactly the case in the scenario given above. Both Jack and Diane misused their insider positions to make undue profit out of some hapless investors. They definitely crossed the limit of fair business practice laid down by the industry as well as the law.
Agency Responsible for Prosecuting the Crime United States Securities and Exchange Commission (also known as SEC or simply Commission), which is normally the controlling authority for US stock markets, is responsible to process all cases of insider trading. Securities and Exchange Act of 1934 (enacted along with Securities Act of 1933 by the US Congress after the stock market crash of 1929) is the governing document on insider trading in securities. The specific sections are: Section 16 (b) This section forbids short-swing profits - profits earned in less than six months time - by any insider in his companys stock (barring a few typical circumstances). The section, however, is applicable only to persons of director / officers status (people who are generally more privy to confidential company information) holding shares in excess of 10 %.
Section 10 (b) As noted in a SEC bulletin of Oct 19, 1998 (Speech by SEC Staff: Insider Trading A US Perspective), this section of the Securities and Exchange Act of 1934 makes it unlawful for any person "to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe. " (web) In order to implement Section 10 (b), the Commission introduced Rule 10 b- 5, which, according to the above quoted SEC bulletin, states the following: It shall be unlawful for any person, directly or indirectly... , (a) to employ any device, scheme, or artifice to defraud, (b) to make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or (c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of a security. (web) Prescribed Punishments The punishments prescribed for insider trading in US can be best enumerated as follows: Private civil remedies as per Section 20 A of the Exchange Act of 1934. Under this provision persons adversely affected by insider trading are entitled to file suits against unfair traders to recover their avoidable losses. Security and Exchange Commission is authorized to impose criminal as well as civil penalties and punitive civil awards against traders found indulging in the unlawful practice. As per the Insider Trading Sanctions Act 1984 the civil penalty ranges from confiscation of the profits to three times of the amount of gratuitous profits. As for criminal penalties, the 1984 act has enhanced it from USD 10, 000 to USD 100, 000. As per the Insider Trading and Securities Fraud Enforcement Act 1988, the penalties imposed by a court it can amount to three times of the illegal profits.
Real-Life Examples According to a SEC bulletin dated June 04, 2003, the Commission initiated a securities fraud charges against Martha Stewart as well as her former stockbroker, Peter Bacanovic with a charge of illegal insider trading by the former. She was alleged to have sold the stock held by her in a biopharmaceutical company, Im Clone Systems, Inc. , in December 2001, aided by an unlawful tip from Bacanovic. Both were indicted criminally by US legal authorities. (web) In another instance (reported in another SEC bulletin of July 8, 2004), SEC filed civil charges against Kenneth L. Lay, former Chairman and Chief Executive Officer of Enron Corp. , for his indulging in a major scheme to defraud through fabricating a false financial results in respect of Enron and making it public with the aim to mislead the investors about Enron's business health. The charges against Lay were numerous. (web) While many of the cases normally ended in penalties, there were some when the alleged persons have gone scot-free. One such case involved Vincent Chiarella who, according to an article published in The Concise Encyclopedia of Economics (1993 / 2002), was freed of the charges by the US Supreme Court from a charge of making USD 60, 000 as illegal profit from insider trading, which was allegedly prompted by unpublicized information relating to a firm other than his own. (web) Conclusion Insider training may be an ongoing practice in markets worldwide and may have its own advantages for select groups of people.
All the same, it should not be used as an instrument to make ones own coffer grow while inflicting serious harm on other uninformed, hapless investors. While the United States Security and Exchange Commission have instituted a number of measures to prevent the crime, there is a need to educate the corporate employees on the very issue. A conscientious effort at relevant levels and award of exemplary punishments for the offenders will go a long way in arresting the undesirable crime. References 1.
US Security and Exchange Commission (April 19, 2001). Insider Trading. Retrieved on Dec 21, 2007, from web 2. US Security and Exchange Commission (Oct 19, 1998). Speech by SEC Staff: Insider Trading A US Perspective. Retrieved on Dec 21, 2007, from web 3.
Haddock, David D. (1993 / 2002). Insider Trading. The Concise Encyclopedia of Economics. Retrieved on Dec 21, 2007, from web html 4.
US Security and Exchange Commission (July 8, 2004). SEC Charges Kenneth L. Lay, Enron's Former Chairman and Chief Executive Officer, with Fraud and Insider Trading. Retrieved on Dec 21, 2007, from web 5. US Security and Exchange Commission (June 4, 2003). SEC Charges Martha Stewart, Broker Peter Bacanovic with Illegal Insider Trading.
Retrieved on Dec 21, 2007, from web 6. Learn About Law. Com (2007). When Grid is Not Good: The Law of Insider Trading.
Retrieved on Dec 21, 2007, from web
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