Insider trading, the bane of many Indians who were caught and jailed for their infamous acts is not new to USA. Even in 1700s, Mr. Nilliam Duer, Assistant Secretary, Treasury Department of Federal Government, USA, used his position to guide the purchase of bonds. This article intends to guide its evolution, current rules and show the encircling future.
Illegal insider trading refers generally buying or selling a security, in breach of fiduciary duty or other relationship, on the basis of material non public information about the security.
Insider trading violations may also include:
- Tipping such information
- Trading by the person who was tipped
- Securities trading by those who misappropriate such information.
The persons to indulge in insider trading can be any one like employees like corporate officers, directors, family members, employees linked bankers, lawyers or others even like printers who produced the material or even barbers who passed on the information to any one who got the benefit of selling or buying the securities of the company whose information was exchanged. Obviously, the barbers got the information from some big wigs of corporates while cutting their hair and had juicy conversations.
Now that some basic idea of insider trading has been understood, let us go through the evolution of the same through history of United States security markets.
The great depression and its aftermath of financial disaster forced the then US Government to bring the two most important security legislations of the country. Till date through upgradation of its rules, regulations and application of technology these laws rule the world financial market.
Who are these surpassingly enacted acts?
1. Security act of 1933
2. The Securities Exchange Act of 1934 (SEA)
These acts opened the window for a small man to know about the formation of companies, capital, management of the company, the financial developments and their rights as investors. Though their names look almost same, they serve different roles in financial world.
Security Act of 1933
It has two basic objectives as per U.S. Securities and Exchange Commission, a legal body established by SEA to govern the security market.
They are(I would like to quote from its website) https://www.investor.gov/introduction-investing/investing-basics/glossary/registration-under-securities-act-1933
- “To require that investors receive financial and other significant information concerning securities being offered for public sale; and
To prohibit deceit, misrepresentations, and other fraud in the sale of securities. “
Yes, you have guessed the same. Securities before being offered to the public are controlled by this organization.
SEC completes this task by requiring companies disclose important financial information by registration of securities.
The main goal is to enable the investor to have a good information about the company before purchasing their securities. In simple terms, any company willing to get registered is expected to get registered with SEC or get an exemption for the same.
The registration form to be filed with SEC needs the following information:
1. Full details about the company’s business and its properties
2. Details about the security to be offered for sale
3. Financial statements to be certified by independent accountants, popularly known in USA as Certified Public Accountant, like the writer of this article, myself.
4. Complete information about the management.
Registration statements as well as prospectuses become public the moment, they are filed electronically with SEC.
Some securities like private offerings to a limited number of persons or institutions, interstate offerings or securities of municipal, state, and federal governments are exempted from registration to avoid cost.
5. Now the time to get full information about
“The Securities Exchange Act of 1934 (SEA)”
SEA came into existence to govern securities transactions in the secondary market, after issue, to ensure financial transparency, less fraud and no manipulation.
SEC, a product of SEA, has unlimited powers to oversee securities which consist of stocks, bonds and over the counter securities, monitor the markets on day to day basis, and regulate financial professionals like brokers, dealers and investment advisors. Monitoring submission of financial reports by publicly traded companies is part of its routine duties. This was intended to instill confidence in investors.
Primary requirements for listed companies on stock exchanges include registration of securities listed on stock exchanges, disclosure of periodical financial statements, proxy solicitations, margin and audit requirements. These formal rules and regulations enacted from time to time has developed an air of investor confidence. For regulating a huge securities market in U.S.A. SEA, has given enormous powers to SEC. It has a president and commissioners for the following divisions.
- Division of Corporation Finance,
- Division of Trading and Markets,
- Division of Investment Management,
- Division of Enforcement and Division of Economic and Risk Analysis
SEC has the required authority to lead investigations on violations indulged such as insider trading, selling unregistered stocks, manipulation of market prices, disclosing financial information and meddling with broker/customer integrity.
Insider trading
Let us learn more about insider trading, one of the most tasks being investigated by SEC, regularly to protect the interests of an average investor.
Time and tide wait for none. So is the greed for using nonpublic information for profiteering.
Evolving time, brought more miseries for a genuine investor expecting sun rise next day at every evening earlier.
But genuine legislators, lawyers or the common voters impressed upon the legislature to tighten the punishment for insider trading and two more acts took place.
Virtually quoted by all researchers, they are named as under:
1. Insider Trading Sanctions Act of 1984
2. The Insider Trading and Securities Fraud Enforcement Act of 1988
Yes, to deter the illegal insider trading, the first law creates a civil penalty of up to three times the profit gained, or loss avoided, through trading while in possession of material nonpublic information. One of its origin emanated when in 1904, the Kansas Supreme Court approved the notion that a director has a duty to all shareholders to disclose material information about the corporation. Too radical a thought at that stage in American investing market.
Between 1979 and 1981 the SEC charged thirty-three individuals with insider trading violations. This indicates the enormity of the crimes committed and the earnestness of SEC to act rather than a mute spectator. Since 1982, it went up to 49 cases which resulted in insider trading annulling the common investor the benefit of acting on material information to benefit himself/herself.
The ITSA also increased the maximum criminal fine from $10,000 to $100,000. The increase was justified on inflation since 1934, when the other security law was passed. However, to controlling persons and to aiders and abettors, the treble damage provision will not apply unless they benefitted from possession of material information.
Let us turn our attention to The Insider Trading and Securities Fraud Enforcement Act of 1988.
We may also actually look at some of the publications of corporate bodies who have implemented avoidance of insider trading which has been trembling both the investors and corporates whose officials contribute towards this tremor.
The Insider Trading and Securities Fraud Enforcement Act of 1988
It will be interesting to know that SEC in spite of its vast powers, budget and vast qualified man power, does accept out of court settlements with corporates which while accepting no illegal act, agree for fines strong enough to deter future insider traders.
Now, the complete tit bits about the above act of 1988.
Tit bits
The Insider Trading Act was signed into law on Nov. 19, 1988, by then-President Ronald Reagan, popularly known as the savior of American economy which hovered around 20% inflation and people were forced to stand in long queues to get gas, as they call petrol in USA. The full name of the act is
The Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA)
ITSFEA came into existence because of increase in number of cases coupled with explosion in amounts of insider cases. The act empowers SEC:
- Impose stiff monetary penalties
- Guilty parties may spend considerable time up to 5 years in jail, depending upon the gravity of the crime
- The fine went up at either 300% of the amount of the money made through trades or $1 million whichever is higher.
Why not we actually look at insider trading norms prescribed by any corporate readily available in the web, as per legal requirements.
Let me take you directly to the following web site of Myers Industries Inc., dealing with Insider trading policy and procedure.
http://s2.q4cdn.com/555961355/files/doc_downloads/myers_inc/MYE-Insider-Trading-Policy-and-Procedure-FINAL-eff-January-25-2019.pdf
Seriously worded and guarded to protect the company from any legal complications, the material really explains the reality in simple language adequate enough to nail the fact that the concerned persons from its company adhere to the policy and get fired in case of employees or face both civil and criminal penalties in case of others.
I have no option than basing my arguments as per the facts given in the web site. The language used is mine only.
The purpose of the policy is applicable to officers, directors and other related individuals like lawyers, accountants, IT professionals, or any one directly dealing with the material nonpublic information of the organization. It guides the concerned persons on insider trading policies.
Scope
The policy does mention the company’s common stocks, options for common stocks, preferred stock, warrants and convertible debt securities, as well as to derivative securities relating to the Company’s stock, whether or not issued by the Company, such as exchange-traded options.
The company has to identify certain individuals like directors and executive officers who are subject to the reporting and liability provisions of Section 16 of the Securities Exchange Act of 1934 since they invariably deal with material nonpublic information as part of their executive functions.
What is material nonpublic information, the word most used in this act?
I have to compulsorily reproduce the list identified by the company as under (quoted from said web site). But I may explain in case of any difficult technical word.
Examples of such information include, but are not limited to:
1. annual and quarterly earnings results that have not been announced;( Most widely misused item)
2. significant changes in operating data that could impact future earnings;
3. projections of future earnings or losses;
4. changes in the Company’s dividend policy;
5. stock splits; (It helps some investors)
6. changes in management;
7. offerings of securities by the Company;
8. news of pending or proposed acquisitions or joint ventures;
9. news of the disposition of a subsidiary;
10. impending bankruptcy or financial liquidity problems; (One can recall the recent history of Yes Bank stock which underwent from the peak of Rs 350 to Re 5 in the recent history as an example. Who can deny that concerned officials of the company might have made a fortune at the miseries of an average investors like ourselves?)
11. gain or loss of a substantial customer or supplier;
12. significant pricing changes;
13. new product or service announcements of a significant nature;
The list goes on amidst your curiosity.
Certain periods, namely, black out periods, quarterly black out periods and event-specific periods have also been mentioned for the strict adherence by section 16 of the act individuals which is mandatory.
Expectedly, the company appointed an insider Trading Compliance Officer to deal with all legal issues of insider trading as well as submission of reports to regulatory authorities.
It is not out of place to quote the punishments mentioned in the corporate policy on insider trading.
Insiders may be subject to:
(i) a civil penalty of up to three times the profit gained or loss avoided;
(ii) a criminal fine (no matter how small the profit) of up to $5,000,000; and/or
(iii) up to 20 years in jail for engaging in transactions in the Company’s securities at a time when they have knowledge of material nonpublic information regarding the Company.
For a company (as well as any supervisory person) that fails to take appropriate steps to prevent illegal trading:
- a civil penalty of up to the greater of $1.425 million or three times the profit gained or loss avoided;
- a criminal fine (no matter how small the profit) of up to $25,000,000; and/or
- the civil penalties may extend personal liability to the company’s directors, officers, and other supervisory personnel if they fail to take appropriate steps to prevent insider trading.
Conclusion
The original idea for an article on insider trading started when I planned to appear for the test of an independent director being conducted by Ministry of Corporate Affairs or its appointed agency organizations. If I become an independent director, one presumes a comfortable living like attending Board Meetings, have a nice lunch, dinner or visit exotic places for Board meetings. One of my friends who was a CMD of a public sector and later became an independent director of a private sector bank narrated the comforts he enjoyed. But recently he resigned quoting the regulatory authorities who had taken serious note of the role played by the independent director. Imagine if and of the directors including this individual have played a role in buying or selling the stocks of this bank or its associates, what would have been the financial disasters to an average investor like myself for the past 40 years who only judge based on published public information.
Insider trading in U.S.A. was intentional with the expectation, India would definitely follow the path of that country. You are already aware that Insider Trading has started occupying an important role with SEBI who has shown admirable results with no non sense policies.
Please watch my words SEC would also guide us in our future plan of action in India.
Well, our IT giants like T.C.S., Infosys or others have already started their roles in U.S.A. Let us be assured that knowledge about insider trading in that country would help them to follow the rules as well as avoid legal penalties.
————I compulsorily referred to the following web sites for policies and practical examples. I thank them.
http://s2.q4cdn.com/555961355/files/doc_downloads/myers_inc/MYE-Insider-Trading-Policy-and-Procedure-FINAL-eff-January-25-2019.pdf
https://www.investor.gov/introduction-investing/investing-basics/glossary/registration-under-securities-act-1933
Virginia Law Review 455 April 1985 A CRITIQUE OF THE INSIDER TRADING SANCTIONS ACT OF 1984 Stephen Bainbridge*
(It is a pleasure to read articles from Virginia Law Review which maintains international standards but makes it easy for a commoner like myself to understand the laws carefully)
U.S. Securities and Exchange Commission web site
https://www.sec.gov
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