Insider trading is a topic of intense discussion among academics and industry experts in the financial sector regarding whether it benefits or harms markets. Insider trading is defined as the acquisition or sale of securities by a person who has access to substantial, non-public information.
Insider trading is not just a problem for corporate executives, board members, and workers. If they obtain access to private information, outside investors, brokers, and fund managers may potentially break the law while engaging in insider trading.
One defense of insider trading is that it permits nonpublic knowledge, not simply publicly available information, to be reflected in the price of an asset. Insider trading is opposed by those who believe it would improve market efficiency.
The trend of the price, for instance, informs other shareholders as insiders and other parties with insider information buy or sell a company's shares. Prospective investors and existing investors can both buy and sell based on price changes. Current investors might sell for more money, while potential investors could buy at greater prices.
Postponing the Inevitable?
Another argument in support of the practice is that prohibiting it would just postpone the inevitable and result in investor mistakes. The price of a security will change based on relevant facts.
Let's say an insider hears positive news about a business but is unable to purchase its stock. Then, a price increase is avoided from occurring for those who sell during the interval between when the insider discovers the news and when it becomes known to the general public. Errors may occur if investors are denied easy access to information or obtain it inadvertently through price changes. If the data had been ready earlier, they might have traded a stock they otherwise would not have, such as buying or selling it.
Insider trading laws can put innocent people in jail, especially if they are strictly enforced. Due to the difficulty in determining what is and is not legal as rules grow increasingly complex, participants sometimes inadvertently break the law.
For instance, a person having access to sensitive information can unintentionally reveal it to a visited relative while on the phone. If the relative uses that knowledge and is detected, the person who unintentionally revealed it might also face prison time. Risks of this nature cause people to become so afraid that they look for work elsewhere.
The claim that insider trading is not significant enough to warrant prosecution is another justification for permitting it. To execute the laws against insider trading, the government must use its little resources to apprehend peaceful traders. Since the government can divert funds from instances of blatant theft, violent assault, and sometimes even murder, looking after insider trading has an opportunity cost.
Defenses of Insider Trading
One defense against insider trading is that the public might believe that markets are unfair if a small number of people trade on important nonpublic information. As a result, regular investors can lose faith in the financial system and avoid participating in rigged markets.
Insiders with access to secret information might be able to profit from gains and prevent losses. As a result, the inherent risk that investors who lack the information disclose while making investments is effectively eliminated. Businesses would have more trouble raising money if the public loses faith in the markets. There may not be many outsiders remaining in the end. Insider trading might thus be completely eliminated.
Another defense against insider trading is that it deprives investors of getting the full value for their assets when they don't have access to inside information. Before insider trading took place, if nonpublic knowledge got widely known, the markets would incorporate it, leading to appropriately valued stocks.
Let's say a pharmaceutical company announces in a week that Phase 3 trials of a new vaccine were successful. An investor then has the chance to take advantage of that nonpublic information.
Whenever the information was made available to the public, one such investor might buy shares of the pharmaceutical company. By purchasing call options, the investor could stand to gain greatly from a price increase that occurs after the information is made public. Without knowing that the Phase 3 trials were successful, the investor who traded the options most likely might not have performed so.
Court judgments of other statutes, such as the Securities Exchange Act of 1934, made some forms of insider trading illegal. The Securities and Exchange Commission (SEC) must be informed of any purchasing or selling action by directors of a firm in order for insider trading to be considered legal.
Members of Congress were exempt from insider trading rules for a very long time. Throughout most of the financial crisis in 2008, some parliamentarians sought to benefit from significant private data, which brought this issue to the public's notice. To address this issue, the STOCK Act was overwhelmingly approved by Congress and became law in 2012 under President Barack Obama.
Michael Milken, referred to throughout the 1980s as the "Junk Bond King," is an example of insider trading. During his time at the now-defunct investment bank Drexel Burnham Lambert, Milken became renowned for trading trash bonds and contributed to the growth of the market for sub-investment grade debt.
Milken was charged with exploiting secret information about junk bond agreements that investors and businesses were orchestrating to acquire rival businesses. He was accused of using the rise in the takeover targets' stock values following the announcement of the deal by using the information to buy shares in them.
Imagine that the shareholders who sold Milken their stock knew that bond arrangements were being set up to pay for the acquisition of those businesses. They probably would have kept their shares in order to benefit from the increase. Instead, only those in Milken's position might profit from the non-public information. In the end, Milken admitted to engaging in securities fraud, was sentenced to two years in prison, was fined $600 million, and was permanently barred from the securities industry.
Insider trading has both supporters and detractors. Opponents of insider trading contend that it tilts the playing field in favor of those who possess confidential information. Insider trading proponents contend that doing so reduces risks and improves market efficiency.
Regardless of one's position, Insider Trading is currently prohibited and is subject to harsh penalties, including fines and jail time. If you also want to start your insider trading journey, you can begin with the Spiking Race to 100 where you will find top insider secrets for great winnings.