Insider Trading: When Greed takes over Ethics

Insider training refers using undisclosed information for the purposes of making profit. This illegal trading is quite common in the world of stocks, shares and securities. It gives the phrase information is power a whole new meaning.

The more infamous form of insider trading is the illegal use of undisclosed material information for profit. It’s important to remember that this can be done by anyone, including company executives, their friends and relatives, or just a regular person on the street, as long as the information is not publicly known. For example, suppose the CEO of a publicly-traded firm inadvertently discloses his/her company’s quarterly earnings while getting a haircut. If the hairdresser takes this information and trades on it, that is considered illegal insider trading, and the SEC may take action.

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If you thought that insider training was joke then wait till you know some of the people who have gone to jail because of it. One of them is of course none other than Martha Stewart. The famous homemaker was in prison for five months.

What Martha Stewart Did Wrong

On December 27, 2001, media mogul and celebrity homemaker Martha Stewart sold her stake in the biotech company ImClone. Two days later, the company’s stock dropped 16 percent when the Food and Drug Administration said it had rejected the ImClone’s main drug, Erbitux, for cancer treatment. Stewart had owned 4,000 shares of ImClone. By selling just before the FDA’s announcement, she avoided losses of $45,673, a tiny fraction of her net worth, which Forbes had estimated at $700 million just six months earlier. However, that trade would end up being one of the defining actions of her career – and the one that landed her in a federal prison.

Stewart was not the only ImClone investor who avoided heavy losses ahead of the FDA’s decision. On the same day she placed her trade, Sam Waksal, ImClone’s chief executive, had sold a $5 million stake, along with his daughters’ full holdings in the company.

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Even business journalists have been convicted for facilitating insider trading. If you are a business reporter and you get information related to trading kindly do not leak it.

  1. Foster Winans (AP)

Winans is a former Wall Street Journal writer who penned the influential “Heard on the Street” column in the early 1980s. Able to move markets with his words, he leaked inside information from his reporting to a stock broker, who would make beneficial trades on his behalf. The columnist was convicted in 1985 and remains a syllabus staple in journalism ethics classes across the country.

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As much it is not easy to identify the direct victims of insider trading, the effects are still felt. This is especially true for the markets.

How it affects the market?

The impact of illegal insider trading is considered negative for both the small investors and for the markets. Illegal insider trading ensures that there is no fair play involved and there is no fair demand and supply of stocks, all detrimental to the functioning of a healthy capital market.

Illegal insider trading weakens the faith of investors in the investing system and an unchecked insider trading could keep off people from investing capital and this could potentially harm the economy as a whole.

Safety measures to detect insider trading

In India, the first set of regulations for insider trading was introduced in 1992 by the Securities and Exchange Board of India (SEBI). The regulations restricted insiders and companies in trading securities during times of possession of undisclosed price-sensitive information and barred them from sharing it with any other person outside the company.

Sebi has also prescribed disclosure norms for any directors/officers holding shares in the company besides amending the Model Code of Conduct in 2008 that restricts the directors/officers who have bought or sold shares from getting into an opposite transaction within the next six months to sell and buy shares.

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Categories: Trading