The Truth About Insider Trading

The U.S. Securities and Exchange Commission (SEC) allows those inside a corporation to buy and sell stocks from the company in which they work. Nevertheless, all insider trading activities must be reported to the SEC and follow strict guidelines to ensure that the trades are ethical and legal. Despite this regulation by the SEC, there are still insiders that engage in illegal insider trading (U.S. Securities and Exchange Commission, 2001). "Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security" (U.S. Securities and Exchange Commission, 2001, para. 2). Illegal insider trading is not limited to those that actually work for a company, though. Instead, relatives, friends, and other acquaintances of employees, as well as anyone that may have some other association with a company (i.e., legal council or accountant) and even government employees should not act upon any material company information until a day or so after it has gone public to avoid any liability (Rosen, 1993; U.S. Securities and Exchange Commission, 2001). Although this strict regulation may seem a bit excessive, most experts reason that the SEC's regulation is absolutely necessary to keep things fair. They insist that all investors (inside and outside the company) should have an equal opportunity to make money or avoid a loss. But when an insider uses privy information when trading their stocks, he or she puts those outside the firm at a clear disadvantage (Haddock, 2002).

Consequently, anyone that purposefully violates this regulation must be penalized. When illegal insider trading occurs, there are three prosecutors that may get involved in the case. First, the SEC can file civil charges against guilty individuals, since the commission is in charge of regulating companies, including in the area of insider trading. Furthermore, the U.S. Attorney General may choose to file criminal charges against those who are serious offenders. Finally, individuals that were harmed by the insider trading might have the option to bring their own civil cases (state or local courts) against those guilty of insider trading to seek compensation for personal damages. The extent of the charges varies from case to case, depending upon the severity of the violation(s) and the number of violations (Rosen, 1993; U.S. Securities and Exchange Commission, 2001). By law, the SEC can the offender to pay a penalty of up to three times the amount of the money gained or the losses avoided theough the illegal insider trading. Ultimately, though, it is up to the SEC to determine how lenient or strict they should be in each case, taking into consideration all the facts and motivations in each individual case (Thomas, 2004; University of Cincinnati College of Law, 2008).

One good example of how easily one can commit illegal insider trading is the case of E. Garrett Bewkes Jr. and his son, Robert Bewkes. Several hours before an important board meeting for the company Interstate Bakeries, Mr. Bewkes called his son, as he often does. During this regular conversation, he complained about how badly business was going for the corporation and remarked that his son should get rid of any stock he might have in the company. As a result, his son Robert sold $230,000 in stock for himself, as well as relatives and some of his clients. A week later, when the state of the company was announced to the public, company stocks dropped 25%. In the end, the SEC prosecuted both men for insider trading. Mr. Bewkes was forced to pay a fine of $67,517 and to resign from his director position at Interstate. His son, in contrast, was required to pay a $137,306 penalty and suffer a 5-year ban from participating in securities industry (Thomas, 2004).

However, some insiders actively try to cheat the public. For example, in 2002, Joe Nacchio committed a series of illegal trades that cheated people out of $52 million. At the time, Nacchio was a CEO of Qwest Communications, and the company was caught up in fraud and scandal, helping to bring financial instability to Qwest. But rather than come clean about the company's illegal and unethical dealings, he choose to think only of his own investments and sold his stocks without ever informing the public of the serious risk against any investment in Qwest. Because of Nacchio's deliberate actions to hide the company's corruption and mislead the public, he received a sentence of 6 years in prison and was required to forfeit the $52 million he gained from the trades and to pay an additional $19 million for damages he caused other investors (Associated Press, 2007).

References:

A&E Television Networks. (2007). November 14, 1986: Ivan Boesky confesses to illegal stock trading activity. Retrieved August 3, 2008, from http://www.history.com/this-day-in-history.do?action=Article&id=1188

Associated Press. (2007, July 27). Ex-Qwest CEO given six years in prison: Nacchio is ordered to forfeit $52 million, pay a $19 million fine. Retrieved August 4, 2008, from http://www.msnbc.msn.com/id/19996449/

Haddock, D. D. (2002). Insider trading. In The concise encyclopedia of economics. Retrieved August 4, 2008, from the Library of Economics and Liberty Web site: http://www.econlib.org/library/Enc/InsiderTrading.html

Rosen, R. C. (1993, February). An accountant's guide to the SEC's new insider trading regulations (accountant's liability). The CPA Journal. Retrieved August 1, 2008, from the New York State Society of CPAs Web site: http://www.luca.com/cpajournal/old/13808667.htm

Thomas, Jr., L. (2004, May 16). Psst. Why insider trading keeps going. The New York Times. Retrieved August 3, 2008, from http://query.nytimes.com/gst/fullpage.html?res=9A00E0DE163FF935A25756C0A9629C8B63

University of Cincinnati College of Law. (2008). Securities Exchange Act of 1934: Section 21A-Civil penalties for insider trading. In Securities lawyer's deskbook. Retrieved August 2, 2008, from http://www.law.uc.edu/CCL/34Act/sec21A.html

U.S. Securities Exchange Commission. (2001). Insider trading. Retrieved August 1, 2008, from http://www.sec.gov/answers/insider.htm