Insider trading

Insider trading is the buying and selling of shares of stock in a CORPORATION by the company’s managers, BOARD OF DIRECTORS, or other individuals with a financial interest in or knowledge of the company. Some insider trading is legal and closely watched in the marketplace, while other insider trading is illegal and closely scrutinized by securities- industry authorities. Managers, directors, and individuals who own 10 percent or more of a company’s shares must disclose the purchase or sale of shares to the SECURITIES AND EXCHANGE COMMISSION (SEC) by the 10th of the month after their action. However, it is illegal for insiders to buy or sell stock based on their knowledge of material corporate developments that have not been made public. Material corporate developments may include MERGERS AND ACQUISITIONS, NEW PRODUCT DEVELOPMENT, divestitures, key personnel departures or appointments, and any other news that could affect the price of a company’s stock. In 1984 the Insiders Trading Sanctions Act imposed penalties of up to three times a trader’s PROFITs on any trader who intentionally “tips” private market-sensitive information to a third party who then profits by trading based on that information. In 1988, incensed over continued insider-trading abuse on WALL STREET, Congress unanimously passed the Insider Trading and Securities Fraud Enforcement Act, extending penalties to employers or “controlling persons” who do not take steps to prevent illegal employee trading. Controlling persons are subject to civil penalties up to the greater of $1 million or three times the amount of illegal-trading profit. In addition to civil penalties, insider trading is subject to criminal prosecution, and professionals (accountants and lawyers) may be suspended or barred from practice. Over the years, the SEC has been given increased power to oversee and curtail insider trading. One of the most notorious cases of insider trading involved Ivan Boesky, an arbitrageur who bought shares of stock in companies that were about to be taken over by another firm at an abovemarket price. Boesky learned in advance of these transactions through Dennis Levine, an investment banker, who worked in a company providing the financing for the takeovers. When confronted by the SEC in 1986, Boesky agreed to an out-of-court settlement banning him from securities trading, payment of a $100 million fine, and three years in jail. Determining what is insider trading is generally based on the answers to three questions:
• Is the information public?
• Is the information material?
• Is there a fiduciary relationship?
Information is considered public when it has been distributed through the media, allowing the public to learn about it. Press releases, wire-service reports, and reports through business newspapers allow buyers and sellers in the STOCK MARKET to learn about and interpret information. If the public does not know about the information, it would be illegal to trade based on that information if it is significant enough to influence the stock’s price. What is and is not material information is a difficult question to answer. The SEC analyzes trading in stocks before and after important announcements. Using statistical variation from the norm, the commission looks for larger-than-normal trading activity just before a material event. After September 11, 2001, U.S. and global securities regulators analyzed stock and options trading in airline, INSURANCE, and financial stocks just prior to the attack. While trading volume was higher than normal, to date no known links have been made between terrorists and the individuals engaging in the stockmarket transactions. The third question of fiduciary relationship addresses whether or not an individual with information is an “insider.” Any officer, director, or employee of a company is considered a “traditional insider,” who must either make the information available to the public or refrain from trading or tipping other people who might trade. “Temporary insiders” include auditors, lawyers, brokers, and investment bankers who do not work for the company but often have access to sensitive, nonpublic information. As previously stated, insider trading can also be a legal activity watched closely by stock-market investors. For years investors have monitored the ratio of insider (officers and directors) sales to purchases of company stock, but like all investors, insiders have many reasons for buying and selling stock that don’t rely solely on their perceptions of the company’s future profitability. For example, in the late 1990s, Bill Gates, Microsoft’s CHIEF EXECUTIVE OFFICER, announced that he would sell shares of his company over time, both to diversify his ASSETS and to finance the endowment he and his wife, Melinda, were establishing. Nevertheless, investors and financial news services often track insider-trading activity. When insiders sell shares, stockholders worry that there is impending trouble ahead. But as managers of companies are increasingly offered STOCK OPTIONS, the reported statistics distort the reality of insider trading. Options are not included in purchases of shares, but sales based on the exercising of options are included in insider trading.