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Insider Trading

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Insider Trading

Larry Minor


Park University

March 8, 2012

Insider Trading

Let us begin with the basic concept that insider trading occurs when an officer of a public corporation uses nonpublic information during their trading activities on the open market. There are different schools of thought about what constitutes insider trading and are those classified as inside traders breaking the law. There are also conflicting views on insider trading with regard to the question is it a crime at all and if so who does it harm anyone. Strange as it may seem there are those who submit that insider trading is good for the market.

To the nonprofessional or the public at large, insider trading may appear to be a simple matter to detect, to prove, and to correct. However, nothing could be further from the truth. Briefly consider when cases of insider trading surfaces, hundreds occur daily that go largely undetected. One should consider the disturbing notion that the market cannot and may have never functioned without what we call insider trading. For us to consider this premise, in particular, it may be a bridge too far for our purposes here today.

There is another basic question to consider concerning insider trading. That is, what or who determines who is an insider and who is an outsider in this arena of business of trading? Let us look at some of the players in this game of business. Our field of play will be the market and some of the players are the corporations, CEOs, board of directors, managers, and the shareholders or also known as invertors. Let us consider that the aforementioned are members of the home team. This leaves one to ponder who the members of the away team are. Those that could be members of the away team are lawyers who service these public corporations, consultants, accountants, day traders on the floor, and even the mail clerk who delivers the daily mail in the corporations building.

Since we have identified some of the players, let us look at who are the umpires in this game. The head umpire is the Security Exchange Commission or also known as the SEC. The home plate umpire is "what is insider trading"? The first base umpire is "who is an insider"? The third base umpire is "who is an outsider"? We do not have a full team yet but we cannot have a game without the most basic item and that would be the ball. For our discussion, we will consider "information" to the ball. For the game of insider trading, the ball that helps to score is information. The timing of the information helps to score in this game. . It comes down to who knew what and when who knew what and what who did with what one knew! Boatright (2009) indicates that "Insider trading is commonly defined as trading in the stock of publicly held corporations on the basis of material, nonpublic information" (p. 391). He also highlights that the illegal use of nonpublic information derives from the following.

The key points are that a person who trades on material, nonpublic information has engaged in insider trading when (1) the trader has violated some legal duty to a corporation and its shareholders: or (2) the source of the information has such a legal duty and the trader knows that the source is violating that duty. (Boatright, 2009, p. 391)

This submission on this subject is by no means an exhaustive measure of all of the possible players or parties in the enormous field of market trading. The intent is to present the reader with a basic understanding of the game, players, field, and the rules of insider trading.

Let us begin with who umpires and administers the rules of the game of insider trading. The United States government, through the Security Exchange Commission, according to Sun and Yulong (1998), the U.S. government's regulations on insider trading has been traced back to 1934 (p. 65). During this time after the crash of 1929, manipulation, and fraud were widespread occurrences in the securities markets. In some corners of debate, there is speculation that fraud, and inside trading caused the economic crash of 1929. Thus, in 1934 the Security Exchange Act became the law to address this issue (Sun & Yulong, 1998, p. 65). The SEC is the regulating arm of the U.S. government that monitors the markets in our exchange system. The Security Exchange Act, in particular, regulates short- term trading very closely. In other words, when individuals has nonpublic information, they should not use this information to profit from by making short- term trades, whereas, those without the information do not have the same opportunity.

Between 1984 and 1988, the Insider Trading Sanctions and the Insider Trading and Security Fraud Enforcement Acts. These acts, according to Sun and Yulong (1998), broadened that SEC's authority to seek legal measures and to increase both civil and criminal penalties to trading in derivative instruments (p. 65).

As one may glean from the aforementioned, insider trading is not new to this generation. The SEC has been contending with, what it deems, as criminal activity, for at least 70 years. Since the examination of the umpire is complete, let us continue with some of the players in this game of insider trading.

The Security Exchange Commission's official definition of an insider are the chairperson, directors, officers, managers, etc., and principle shareholders with 10% or more of their own firm's common stock (Sun & Yulong, 1998, p. 66). By definition, the aforementioned individual would be deemed in some circles, as the owners the information used as currency to profit from "insider trading." Could one conclude that these owners are only using what is rightfully theirs to profit in the market? There are circles that advocate that insider trading is acceptable and that it harms no one in particular. According to McGee (2008), "the perspective of utilitarian ethics asserts that any transaction is ethical provided the gains exceed the losses (p. 206). The question may arise for some, if these players or insiders own that information and harm has come to no one in particular, what is unethical about insider trading? The key term is nonpublic information. For example, when you purchase an automobile from a dealership, the information about the vehicle is public knowledge for those who are willing to do the research. With this information, the customer uses it to his or her advantage to negotiate the best deal in their favor. Nevertheless, if one does not make an effort to arm them



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