The Ethics and Laws of Insider Trading

Insider Trading

All of the individuals were engaged in insider trading. They all obtained their knowledge by way of an insider, in this case a member of the Board of Directors. Any trading based on knowledge acquired by an insider, regardless of the degrees of separation is considered to be insider trading. Thus, the ex-husband clearly knew of his ex-wife's position. He passed the information along to his dentist, who may or may not have known the source of the information. Certainly, the dentist's broker would have had pretty good reason to question what the source of the information was, knowing that this sort of information is not just randomly acquired.

All of the parties are culpable, though the degree might vary. The broker, Green, has a high level of culpability as an industry professional. Green would have known that such knowledge is not easy to come by and there was significant risk that such information came from an insider. Green stands to lose her SEC license as a result of this trade. But the others also stand to face penalties for their trading on this information as well. Martha Steward went to Sing Sing for the same offense -- she did not learn about ImClone from an insider, but from her broker who happened to know an insider. The SEC generally does not believe people when they claim they had no way of knowing what the source of the information was. Wilson knew he had insider information, Looney probably knew and Green definitely should have known.

The only person here who did not engage in insider trading, maybe, was Sara Wilson. She did not trade on the news herself, and it is not clear if her ex-husband did either . Normally, insider trading applies to family relations, not just the insider in question. Anybody close to Sara, including her ex-husband, would be forbidden from trading on the news. Whether Sara Wilson herself is going to be found culpable is trickier, as this would be determined on the basis of whether or not she is considered a de facto beneficiary of the trade, and that might depend on the nature of the legal relationship between her and her ex. If in fact neither Wilson traded, Brian at the least would be held accountable for leaking the news, but no insider trading charge would be brought up.

The parties would all be liable for criminal actions. The SEC can and will put people in prison for insider trading, though it is more likely that they will face fines. However, as the Stewart case showed people have been known to face prosecution and jail time for such trading. There might be other charges for Sara and Brian, but if they did not trade then they would not face insider trading charges. Looney most certainly would, as would Green. Looney could go to prison, and green could not only go to prison but could also lose her license with the SEC to tirade in securities, effectively ending her career in the business. Her clients would also see their trades reversed, as would all of the other actors in this scenario.

Nobody acted particularly ethically here. The ethics of insider trading are fairly clear, that the integrity of the securities markets requires that insider trading be forbidden. Otherwise, certain insiders would have advantages over other market participants. These advantages undermine the trustworthiness of the markets, and would discourage other people from participating in the capital markets, to the significant detriment of the economy as a whole. Thus, actions that threaten the ability of the public to trust in the capital market system are going to be view as illegal by regulators and unethical by society as a whole.

As such, all of these individuals behaved unethically, even the Wilsons, who may not have traded on the news. Even without trading, Sara Wilson likely did not need to tell her ex-husband about the pending deal. Brian in particular knew that he should not tell anybody because he would have known that this was privileged information. The same can be said for Looney and Green. Thus, they were all acting unethically, and against the best interest of the American economy and the sanctity of the capital markets.

Part II. The first case is the aforementioned Martha Stewart case. In this case, her stockbroker received an insider tip from one of this clients, who was an insider at ImClone. Based on this tip, the broker traded on the news and advised Ms. Stewart to do so as well. Securities fraud charges were filed against Stewart and the broker, Bacanovic (SEC.gov, 2004). The two were also charged with making false statements to regulators about these trades. Basically, Sam Waksal was head of ImClone and received news that the FDA was set to reject approval for a drug, and that this would naturally cause the stock to drop sharply in value. The broker traded on this information, and ordered his assistant to convey the information to Stewart. The information included the source of the information, who would have been known to both Stewart and Bacanovic as an insider.

The SEC has its own internal mechanisms for pursing such matters. The SEC pursued a reversal of the trades, so that Stewart and Bacanovic would face the losses that they otherwise would have faced had they not sold on their insider information. This is part of the SEC's policy of making people whole -- undoing the effects of insider trading. Further, the broker lost his license to trade, effectively ending his career. Stewart also faced sanction. She served time for the trade, but was also forced by the SEC to surrender her seat as a director of a publicly-traded company. The assistant also lost his license, as he would have knowingly conveyed the insider information. The SEC also pursued civic monetary payments -- damages essentially -- as a punitive measure. Stewart's activities as an office of a public company were also curtailed. She served a sentence of a few months in prison for her crimes, which was actually a fairly high level of punishment, no doubt exacerbated by her lying during the original SEC investigation into the matter.