What is insider trading and is it happening unchecked?

Krish Chopra, Year 12


The mechanisms behind one of the most serious financial crimes.

The mechanisms behind one of the most serious financial crimes.

What is insider trading?

Insider trading is defined by Investopedia as “the trading of stocks or securities by employees or benefactors with non-public confidential information about the company”. In simpler terms it is using confidential information to benefit by shorting or buying a stock. It is deemed illegal and comes with its own personal sentencing and laws to minimise the occurrence of what is considered as one of the most serious financial crimes , shortly after fraud and securities fraud. However there is a legal form of insider trading , this is when a directors of the company purchase or sell shares but fully disclose these transactions to the national financial authority. However , the more important question is to which extent is insider trading going on and is it going on unchecked. In America the SEC claims to have a tight grip over the corrupt trades in the NYE stock exchange but how tight is the “grip”.

A key example of illegal insider trading and why it is necessary to cut down and minimise how often it occurs is the Albert H Wiggin case of 1929. Wiggin was the respected head of Chase national bank, Wiggin was in a position where running Chase into the ground would lead him to more benefit, he used private family accounts to build up share in his own company. When the 1929 crash hit Wiggin legally made over 4 million dollars , this was outrageous , the public furious and investors alike protested causing him to decline his $100,000 a year pension but the damage was done. The money was legal and in his account and there was nothing anyone could do about it. This is what led to the tightening of SEC and global financial laws alike. This is one of the many examples of insider trading and it is essential to remember a large amount of traders are not caught.

Why is it so hard to catch insider trading?

Insider trading is near impossible to catch without an obvious lead or a witness. Millions of trades are conducted per day and it is very difficult to tell which are legitimate but some trades stick out like a sore thumb. The factor that makes it most difficult is that no one in the investing world is going to open up and admit they have breached their duty. The severe penalties also discourage people from coming out as you are likely to lose your job and perhaps be blacklisted from the finance industry for the rest of their life. This results in the majority of cases being concealed and going unchecked. According to the SEC in the US the maximum fine per conviction of insider trading is 5 million dollars and up to 20 years imprisonment . Alternatively in the United Kingdom , the maximum imprisonment is 10 years but fines can be infinitely large, mostly dependant on crime.

Why is insider trading a disaster for the economy?

Contrary to popular belief insider trading is not a victimless crime, it is like throwing a bottle of glue into the gears of the economy. This slows down the economies growth heavily. This is as new investors are less likely to enter the market if it is known to be corrupt, this can lead to companies being abused and losing all credibility. Undermining this public confidence can lead to several impacts. The major one of these being an increased chance of recession. Less investors results in the slow down of growth and therefore GDP. Furthermore, insider trading also negatively impacts companies and businesses. These services usually place bonds and insurance claims which tend to become much higher so the costs to the company increase. This discourages companies from expanding and merging but also leave them with less positive turn over annually.

How can we stop insider trading?

The best and most effective way to stop this is through strict and firm monitoring of company books, audits and trades. This coupled with due diligence by companies as well as implementing training education and spreading knowledge and awareness. The larger proportion of employees and employers that are aware about these issues and can identify when this occurs can act as whistleblowers and prevent this crime from reoccurring. A common way the SEC monitors trades, to varying success, is through irregular trading patterns. For example if a company normally trades using 10-30x leverage , if a single outlying deal is conducted with 100x leverage and profit is bought in. This may result in investigation from the SEC or the HMRC in the United Kingdom.

To summarise, Insider trading, the trading of stocks using non public information, is a heinous crime. The amalgamation of each trade can lead to a much larger impact on the economy and businesses nationally, the leading governments usually identify and monitor trading however external companies can be bought in. A key way in which we can stop this is through awareness and stricter more detailed control of trading patterns.