Introduction
Insider trading involves workers of a public firm who have access to nonpublic, material information on the organization, purchase or sell securities, or influence trading in the organization’s stock or other securities. It can be legal or illegal, depending on when the insider completes the trade and the country’s regulations. Insider trading is deemed illegal if traders conceal relevant material information; they may face severe legal repercussions. Legal stock trading happens when investors disclose relevant information when they buy or sell the stock (Vasmatkar et al., 2022).
Furthermore, illegal trading may occur if traders use their access to information to tip others about material non-public information. Material information is the information that influences the decisions of buyers and sellers of securities. On the other hand, nonpublic information is information that does not exist in the public domain. This paper examines the prevalent issues of insider stock market trading by analyzing the current framework of insider trading legislation and taking a stance on whether the framework is practical or requires modification.
Analysis of the Existing Framework of Insider Trading
In the United States, federal law is the principal authority that regulates activities such as insider trading. The federal private civil rights of action, federal prosecutors, and the Securities and Exchange Commission are responsible for upholding the law in their respective states (Vasmatkar et al., 2022). However, the influence that state legislation has played has been relatively minimal.
It is against the law in the United States for a company trustee to invest in the stocks of their firm based on important nonpublic information before the information has been made public (Vasmatkar et al., 2022). Trustees are prohibited from trading or tipping for their own financial gain. Under some circumstances, it is also forbidden for individuals who are not trustees to engage in tipping or trading.
Firstly, “tippees” who know that their “tipper” has violated a professional obligation by providing them with intelligence are not permitted to invest in it or provide it to others as a tip. Secondly, individuals with a commercial or professional connection to the organization and access to confidential information are prohibited from investing in or disclosing that information to others. Thirdly, individuals who misrepresent information breach a duty to an employer (that does not issue the securities) and are considered to have committed a crime (Vasmatkar et al., 2022). Finally, the law prohibits individuals with access to material and nonpublic information from a tender offer received from a target or bidder from using it to trade (Vasmatkar et al., 2022). Insiders of the targets and bidders are prohibited from disclosing information to any individual who is likely to use it for trading in stock markets.
Rule 10b-5 Prohibition on Insider Trading
Rule 10b-5 of the Securities and Exchange Commission bans corporate directors, officers, and other workers with inside knowledge from using secret corporate information to trade in the organization’s stock for profits. This law prohibits the disclosure of non-public, confidential company information to outside parties, using the term “tipping.” The rule considers an insider to be any individual who is a 10% shareholder, director, officer, or has access to inside information due to their relationship with the organization’s directors, shareholders, or officers (Vasmatkar et al., 2022). Additionally, family members of insiders, whether residing with them or not, whose trading activities are influenced by the insiders, should not have access to confidential information for trading purposes.
Buying and Selling of Securities Based on Material Nonpublic Information (Affirmative Defense)
This law presents traders with a credible defense to insider trading malpractice where it is clear that the trader’s judgments were not based on material nonpublic information that was known to them. The law responds to Section 10 of the Act and Rule 10b-5 by determining the situations in which trading is considered to be based on material non-public information in insider trading cases (Vasmatkar et al., 2022). It prohibits the use of deceptive and manipulative devices relating to the sale or purchase of securities of an issuing company based on material non-public information of the company or the securities, in response to breaching the duty of confidence or trust owed to the company issuing the security.
Based on § 240.10b5-1(II), a trading activity is considered to have failed to adhere to the “material nonpublic information” if the traders demonstrate that they had entered a binding agreement for the trade or had planned to trade without possession of the material nonpublic information. Additionally, the insider will be liable for malpractice if the traders demonstrate that the trade plan specified the date, amount of securities, and relative prices (Vasmatkar et al., 2022). They should also provide a computer program, algorithm, or written formula for determining the securities’ dates, prices, and amounts. Furthermore, they should give other individuals who lack knowledge of material nonpublic information discretion over the power to execute the trade under the plan (Vasmatkar et al., 2022). Finally, the traders must demonstrate that the trade was executed in accordance with the plan.
Consequences of the Insiders’ Trading Violation
The law provides legal measures for addressing insider trading violations through criminal felony prosecution for severe cases, encouraging private litigation against insiders by a stockholder of an organization, and enforcement of civil action by the SEC. The SEC will initiate an enforcement action against the insider to request an order for cease-and-desist, to prevent the insider from serving as an officer or director of a public company, and to seek a monetary penalty for the insider’s malpractices.
Section 16 Liability
To prevent potential malpractices by insiders, Section 16(b) of the Securities Exchange Act of 1934 holds insiders liable for any profits on sales followed by purchases or purchases followed by sales of a company’s securities within six months. The law does not require tracing shares to achieve the target. However, the SEC practitioners will match the sales made by the insiders against the purchases made within six months to determine trading violations. If discrepancies are found, the insider will be liable for trading malpractice and sued. Additionally, they may face disciplinary actions, including immediate termination of the employment contract.
Insider Trading Law Flaws
Insider trading laws have been critical in minimizing the illegal and unethical trading practices conducted or influenced by companies’ trustees. Several high-profile cases have been brought to courts to prosecute and discipline suspects. Therefore, most companies’ trustees have been afraid to engage in the practice to avoid lawsuits and any disciplinary actions. However, insider trading laws should be improved to deal with insider trading malpractices. Although the law has implemented stringent measures to address insider trading, trustees still find ways to trade or influence trade undetected (Patel & Putnins, 2020).
After analyzing the United States’ prosecuted insider trading cases and using novel structural estimation techniques, Patel and colleagues discovered that such malpractices occur in 20 earnings announcements and one in five mergers and acquisitions. Factors that enhance insider trading and influence sales and purchases include the vast majority of trustees with access to non-public information, the value of inside information, and stock liquidity (Patel & Putnins, 2020). Therefore, insider trading laws should be reformed to effectively address insider trading.
Conclusion
Insider traders may purchase, sell, or influence the selling and purchasing of securities for personal gain. Therefore, they may make more profit at the expense of other shareholders, discouraging corporate investment. In the long term, insider trading may hinder a country’s development, as it prevents investors from accessing capital through stock markets.
This paper elaborates on the framework of insider trading laws by examining how the SEC and other regulators address insider trading. Additionally, the paper has elucidated how insider trading laws have failed to combat crime. Therefore, governments should review their strategies and develop measures to expose, prosecute, and discipline those who violate these laws.
References
Patel, V., & Putniņš, T. J. (2020). How much insider trading happens in stock markets? Web.
Vasmatkar, A. D., Bikram, K., & Prakash, V. (2022). Understanding and conceptualizing insider trading laws of India & US. Journal of Positive School Psychology, 6(5), 7691-7696.