Should Unregulated Stock Manipulation by Privileged Individuals Be Considered Innocuous? Is Legality Warranted?
It might astonish many that insider trading isn't explicitly stated in any legislation. It's generally understood to encompass trading in stocks or securities by individuals with access to confidential and non-public information that isn't publicly available.
Following the Stock Market Crash of 1929, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934, aiming to curb the misconduct that led to the crash. Section 10(b) of the Securities and Exchange Act of 1934 was further clarified with the adoption of Rule 10b-5, making it unlawful to engage in fraud in connection with the purchase or sale of a security.
Throughout the history of insider trading cases, the definition of an 'insider' and the circumstances under which insider trading is considered illegal have fluctuated. For example, if a company executive sells a large quantity of his company's stock based on confidential, material information, what if he passes this information to his brother-in-law who isn't an insider? And what if the brother-in-law doesn't pay anything in return for the information? While the executive would undeniably breach his fiduciary duty, what duty does the brother-in-law owe? In 2016, the Supreme Court, in the Salman vs. United States case, ruled that the brother-in-law was guilty of insider trading if he knew or reasonably should have known that the information was material and not public.
Major INSIDER TRADING CASES
Martha Stewart
Martha Stewart, often associated with insider trading in popular culture, was never charged with insider trading, but instead with obstruction of justice and lying to federal investigators when she sold her shares in ImClone Systems after receiving confidential information from her broker at Merrill Lynch about ImClone Systems' CEO, who was also a Merrill Lynch client.
Raj Rajaratnam
Hedge fund manager Raj Rajaratnam was convicted of insider trading and sentenced to 11 years in prison. Rajaratnam cultivated a vast network of corporate insiders from various companies, who supplied him with confidential and non-public information in exchange for payments.
Ivan Boesky
Boesky profited through investing with inside information obtained from investment bankers involved in mergers and acquisitions. He was sentenced to 3 years in prison and fined $100 million. He is most famously remembered for inspiring the famous quote of the character Gordon Gekko in the movie "Wall Street": "Greed is good." Boesky's actual words were, "Greed is all right, by the way. I think greed is healthy."
SAC Capital and Steven Cohen
SAC Capital, led by Steven Cohen, was charged with insider trading, and one of its employees, Matthew Martoma, was convicted of insider trading in relation to information obtained from doctors linked to pharmaceutical companies researching a potential Alzheimer's disease drug. Martoma was sentenced to 9 years in prison.
SAC Capital pleaded guilty to insider trading charges and was fined $1.8 billion. As part of its settlement plea agreement, SAC Capital agreed not to handle outside investors' funds, but was allowed to remain in business with Steven Cohen as its sole investor. Cohen was also prohibited from managing investments for clients other than himself for 2 years, after which he established a new hedge fund, Point72 Asset Management, and now owns the New York Mets outright, which he purchased for $2.4 billion in 2020. No criminal charges were ever brought against Cohen.
Preet Bharara
Preet Bharara, the U.S. Attorney for the Southern District of New York from 2009 to 2017, had jurisdiction over crimes affecting Wall Street and aggressively pursued insider traders, winning 84 out of 85 insider trading cases. However, following the 2008 financial crisis, he was not as zealous in prosecuting high-ranking executives from the many companies implicated in the disaster that wreaked havoc on the economy. No criminal charges were filed against any significant executives.
This raises the question of whether insider trading should be legal.
Arguments in favor of legalizing insider trading
- It can serve as a legitimate form of compensation for lower-paid company employees who can utilize the information to their advantage, enabling them to be paid lower salaries while still benefiting the company.
- Some categorize it as a victimless crime. Unlike the crimes of the 2008 financial meltdown, no shareholder or company incurs a loss due to insider trading. Who is affected?
- Prosecuting insider trading cases is costly and time-consuming, with few apparent public benefits.
- Insider trading contributes to market efficiency by enabling non-public information to be reflected in a stock's price more rapidly.
The primary argument supporting the maintenance of insider trading's illegality is that individuals would not invest in the stock market if they considered it to be unfair, with insiders earning disproportionately higher profits at the expense of others. Critics argue that this would lead to less capital being invested. This argument seems questionable when considering that institutional investors, such as mutual funds, hedge funds, pension funds, and large financial institutions, account for 90% of today's stock trades. Is it likely that these companies, with their extensive research and analysts, would reduce their trading due to the presence of insider trading?
In the realm of personal finance, individuals should be aware of the potential consequences of sharing inside information, even if they are not directly involved in insider trading. This is because breaching such confidentiality can lead to legal repercussions, as seen in the Salman vs. United States case.
Insider trading laws also extend to financial advisors and investment managers, who have a fiduciary duty to their clients. Misusing confidential information for personal gain, such as making trades based on inside tips, can result in severe penalties, including fines and imprisonment.
