Insider trading - Every dream has a price

“The point is ladies and gentlemen that greed, for lack of a better word, is good.” These are the famous words of Gordon Gekko (Michael Douglas) in the 1987 Oliver Stone movie ‘Wall Street'.

The film follows a low level day trader who strives to become a very powerful figure on Wall Street like his idol Gordon Gekko. To justify his rise to power, he uses his father's knowledge of the flight industry for his own personnel gains. He wants to get his foot into the door of the oily Gekko and sells his soul for a quick buck.

Michael Douglas, who played the financier in the movie and its sequel, is now starring in a straightto-television video for the Federal Bureau of Investigation meant to root out insider trading, the same crime that brought down the highflying Gekko in the movie. The clip features a scene from the original Wall Street movie and then Michael Douglas, who portrayed Gekko, warning the public that insider trading as a very real issue despite the fact that Gekko is fictional. He then encourages viewers to learn more about securities fraud and to report insider trading through a tip line, “if you know a greedy corporate raider who relies on illegal information to succeed, run and tell someone.”

Illegal insider trading

In stock markets, traders and investors make decisions based upon certain information available to them. This information is supposed to be available to all the members of the public, so that they may make their investment decisions accordingly.

However, there is sensitive information, which not everyone has at a particular point of time. The disclosure of this information has the potential to impact the share price of the company. As we discussed last week in the article, trading based on such inside information is called insider trading. Management information about a company, which is known by the company's directors and management, is called inside information. This information is not known to the members

Some market theorists have argued that ‘insider trading’ enhances market efficiency, smooths price volatility and reduces the likelihood of price shocks arising from unexpected events

of the public. In a stock exchange, there are a number of people who buy and sell their shares. All these persons trade on the basis of information. Insider trading is not an ethical means of trading, as inside information is not made available to everybody fairly. Knowing about a company's significant, confidential corporate developments, such as the release of a new product, could provide an unfair advantage if the information is not public, that is, if only a few people know about the developments.

The following are examples of illegal insider trading: The CEO of a company sells a stock after discovering that the company will be losing a big government contract next month The CEO'S son sells the company stock after hearing from his dad that the company will be losing the big government contract A government official realizes that the company will lose a big government contract, so the official sells the stock Some market theorists have argued that ‘insider trading' enhances market efficiency, smooths price volatility and reduces the likelihood of price shocks arising from unexpected events. The argument against is that when experts provide information that couldn't be obtained through any amount of hard work, sharing this information with a subscriber would unquestionably be unfair.

A market cannot be efficient in the long-term, when some investors have a big advantage over the majority of other investors. Those who are at a great disadvantage will eventually leave the market either because they will lose their money to the advantaged minority or because they'll want to stop losing their money. And a decreased volume of trading due to fewer investors in the market will make the market less efficient. Because buyers sometimes won't be able to find sellers, and sellers sometimes won't be able to find buyers. Insider trading is considered by many people to be no different than outright stealing.

What is insider information?

Insider information is knowledge about a publicly traded company that could be used to an investor's advantage. Knowing about a company's significant, confidential corporate developments, such as the release of a new product, could provide an unfair advantage if the information is not public, that is, if only a few people know about the developments.

It is non-public fact regarding the plans or condition of a publicly traded company that could provide a financial advantage when used to buy or sell shares of the company's stock. Insider information is typically gained by someone who is working within or close to a listed company. If a person uses insider information to place trades, he or she can be found guilty of insider trading.

Insider trading is often a temptation faced by corporate officers and board members who know of new products or inventions that could cause the stock price to rise. Those in this position must carefully adhere to special regulations when purchasing stock in their companies to avoid penalties. On the other hand, insider trading typically occurs when employees believe that the public is not valuing their stocks properly. Because insider transactions are public information, knowing that insiders are purchasing stock can signal future stock appreciation.

Who is an insider?

Section 32 (1) of Securities and Exchange Commission of Sri Lanka Act no 36 of 1987 (as amended) states that ‘an individual who is or at any time during the six months immediately preceding the appointed date has been, connected with a company shall not trade in listed securities of that company if he has information which: a) He holds by virtue of being con

nected with the company b) It would be reasonable to expect a person so connected and in the position by virtue of which he is so connected, not to disclose except for the proper performance of the functions attaching to that position and c) He can reasonably be expected to

know is unpublished price sensi- tive information in relation to those securities Similarly, Section 32 (2) provides that an individual who is connected with a company shall not trade in listed securities of any other company if he has information which: a) He holds by virtue of being connected with the first mentioned company b) It would be reasonable to expect a person so connected and in the position by virtue of which he is so connected not to disclose expect for the proper performance of the functions attaching to that position c) He can reasonably be expected to know is unpublished price sensitive information in relation to those securities of that other company and d) Relates to any transaction whether actual or contemplated, involving both the first mentioned company and that other company or involving one of them and securities of the other or to the fact that any such transaction is no longer contemplated In general, an insider is considered any officer, manager, or executive of the firm in question; in some cases, it can also be a person who was given the proprietary information by a company figurehead. Insiders are not limited to the inner circle of high-power executives. In reality, they include you and me. An insider is anyone who possesses ‘material non-public information'. This is non-public information that might be helpful in the decision to buy or sell securities. That means every employee, even the families and friends of employees, can be insiders if they have access to material non-public information.

Apart from Sections 32(1) and (2) referred to above which capture persons having direct access to information by virtue of being con- nected, Sections 32(3) to (7) and (10) extend the liability to persons who counsel or procure, communicate and obtain information.

Punishment for insider trading

Any offence under the Securities and Exchange Commission Sri Lanka Act attracts penal consequences since such an offense is treated to be criminal in nature as the law stands. Insider trading at present attracts the most severe punishment under the SEC Act which has been expressly provided for. In that, as per the Section 33 A, any person who commits insider dealing (trading) shall on conviction after summary trial by a magistrate be liable for a fine not less than Rs.1.0 million or to imprisonment of either description for a term not less than two years and not exceeding five years or to both such fine and imprisonment. Thus, it can be noted that the offence of insider trading attracts minimum punishment of Rs.1.0 million or a two-year imprisonment and that a maximum ceiling has not been specified.

Market efficiency is an important goal to which we should always be aspiring, but not at the expense of fairness. But let's be clear: Fairness does not mean equal. It means equal opportunity. And the sharing of material non-public information does not permit equal opportunity.

As for insiders, you might be the kind of person who likes to keep secrets or one who spills the beans. Either way, you need to understand what is (and is not) inside information and what you can (or cannot) do with that information. Whether or not you are an executive or in any other category, understanding insider trading keeps you from getting burned.

Ladies and gentlemen, even Gekko has recanted ‘Greed is no good'.

(Source: www.articles.businessinsider.com/www.investopedia.com)