Insider trading is a threat to public confidence and a serious violation of the public trust. Congress was quite correct to have banned insider trading and quite justified in more recently increasing penalties and sanctions for insider trading transgressions. This is because insider trading can lead to an extraordinary amount of social problems and because confidence in our economic institutions demands transparency and fair dealing. The argument advanced by some, that self-policing through the Securities and Exchange Commission is an attractive alternative approach to an outright congressional ban, is both disingenuous and self-defeating.
This is because the Security and Exchange Commission is often administered by the same corporate insiders whom most often engage in insider trading. Self-policing is not an option. This analysis paper will define what is meant by insider training, advance the arguments in favor of a congressional ban on insider trading, and rebut the contention that self-policing is better than congressional intervention. Insider Trading: Defined and Policy Goals
As a preliminary matter, in order to understand why a congressional ban of insider trading is necessary in order to prevent substantial abuses, it is first necessary to understand what is meant by insider trading and the policy underlying its ban. As a general rule, a corporate insider (1) may not buy or sell a corporation's securities while that insider is in possession of material, nonpublic information relating to that corporation's securities. This is the so-called "disclose or abstain" rule, embodied in Rule 10b-5(2) promulgated under Section 10(b)(3) of the Securities Exchange Act of 1934 (the "1934 Act").
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A corporate insider is broader than a mere employee; in fact, both congressional legislation and court cases have defined an insider expansively to include, for example, corporate employees, corporate agents such as accountant or lawyers, and even outsiders whom happen to come into contact with the relevant type of insider information. Once it has been established that a person or an organization constitutes an insider, then it must be further established that the information is both nonpublic and material. The nonpublic requirement means that the general public is unaware of the information.
The material requirement means that this nonpublic information will in all probability, when it is in fact made public, result in an increase or decrease in the value of the corporation’s securities. Information that is commonly considered material includes such things as “the pendency of an acquisition or divestiture of the corporation's substantial business or division, a major change in the corporation's dividend policy, a sharp decline or increase in the corporation's projected earnings, significant unexpected losses by the corporation, or significant new products or services offered by the corporation.
” Thus, when a corporate insider is in possession of nonpublic and material information a number of legal prohibitions apply. First, the corporate insider may not purchase or sell that corporation’s securities until the information has been released to the public for a certain amount of time. Second, the inside person may not attempt to circumvent these prohibitions by leaking the information to a third party. The violation of these prohibitions can result in civil and criminal penalties.
In the past, these prohibitions were largely enforced by the Securities and Exchange Commission and constituted a sort of self-policing mechanism where corporate insiders were vested with oversight authority over other corporate insiders. When this incestuous relationship resulted in weak oversight and lax enforcement, such as in the highly publicized Ivan Boesky case, Congress was compelled to act. Congress acted by significantly increasing the penalties and sanctions for insider trading.
Under the provisions of this new law, "a district court may now impose civil penalties of up to three times the profit gained or losses avoided by any person who has violated the 1934 Act by purchasing or selling a security while in possession of nonpublic information. " In sum, because Congress deems insider trading a serious threat to public trust and to corporate transparency it has not only banned insider trading but continuously increased penalties and sanctions because of continued abuses and attempts to circumvent the letter of the law. Why Congress Should Ban Insider Trading: Claim, Reasons and the Ivan Boesky Case
There are many reasons why Congress was correct to have banned insider trading and why it is correct for Congress to remain diligent with respect to a variety of attempts to circumvent the insider trading prohibitions. First, and most importantly, insiders are more than merely corporate employees. They serve shareholders. This means that, although they are compensated for their efforts, they are paid to produce results for investors in the corporation. They have a duty to perform in the best interests of the corporate organization rather than in self-interest.
Second, insiders have a duty to the public. Because corporations are the products of state laws, publicly chartered business entities, the public has an interest in corporate governance. To this end, for instance, states create many laws regarding corporate taxes, corporate liability, and corporate record-keeping. The trading of securities nationally, however, implicates important federal interests and concerns. The public invests in corporate securities and they require a transparent system. If insiders are using nonpublic information then the public will be at a continuous disadvantage.
It is important to note that the public may include state pension funds as well as individuals. Because the corporations at issue are state creations, that is publicly created entities, they must operate in ways that are fair and transparent to the public which allowed their creation. In short, Congress has rightly recognized that insiders occupy a position of trust. This position of trust extends to the separate corporate enterprise, to the corporate shareholders, and to the public more generally. The Ivan Boesky case illustrates a few additional reasons why a congressional ban is necessary.
First, as his paper will discuss, lax regulatory enforcement by the Securities and Exchange Commission created a false sense of confidence in which corporate insiders felt like they could circumvent regulatory prohibitions with impunity. Congress, therefore, had to step in because the Securities and Exchange Commission was too connected with corporate insiders to function as an effective deterrent to insider trading. Second, the aggressiveness of the insider trading, and the complicity of multiple types of insiders, led to a loss of confidence in the securities markets.
Who, after all, would feel comfortable investing their life savings in a securities market riddled with self-dealing and non-transparent corporate dealings? The implications could become quite significant and damaging. Investors could pull their money out of the securities markets, corporations could become devalued or insolvent, and bankruptcies could result in the loss of jobs, lower tax revenues for local governments, and a crisis in confidence. Congress has an interest in avoiding all of these problems. Rebuttal: The Security and Exchange Commission is not Neutral
Congress is the sole legitimate arbiter in such cases because, as one scholar has remarked in reference to the Boesky case, "in the past, insider trading was often met with a wink of the eye from those on Wall Street and the SEC. " This is the essential reason why Congress must be directly involved. The self-policing approach is defective in several respects. First, there are built-in conflicts of interest. Wall Street regulators are no more likely to seriously question their colleagues and former business partners than farmers in Alabama would have questioned the Alabama governor’s defense of racial segregation in the past.
It is the proverbial case of the fox guarding the chicken coop. Second, because of these incestuous relationships, insider trading prosecutions are less likely to be initiated and penalties are more likely to be moderate. This is precisely what compelled Congress to increase the civil and criminal sanctions because corporate insiders could simply engage in a cost benefit-analysis with respect to insider trading; more specifically, if a inside trade yielded a greater long term-benefit than the short term penalty took away, then insider trading was still a valuable course of action despite the prohibitions.
Finally, the Securities and Exchange Commission could water down the legal prohibitions against insider trading, so to speak, by issuing vague or overly generous regulations. This interpretive function could usurp the intent of the congressional directives and allow certain types of insider trading which Congress had intended to prohibit altogether. In sum, any suggestion that self-policing is adequate, through an agency such as the Security and Exchange Commission, is self serving to corporate insiders and hinders more than aids congressional efforts to reign in this type of destructive corporate behavior.
Conclusion In the final analysis, Congress should under no circumstances allow insider trading nor should it delegate an overly broad self-policing function to the Securities and Exchange Commission. Corporate insiders are vested with an extensive set of duties and must behave in a transparent manner at all times. These duties extend not only to shareholders but to the public and the very systemic integrity of our economic institutions.
The violation of such duties must be dealt with harshly because the effects over time could have several negative implications such as job losses, decreased tax revenues for local governments, devalued and insolvent corporations, and a generalized crisis of confidence in our corporate governance. Because of the potential and actual conflicts of interest inherent in any self-policing proposal, Congress must articulate and regulate more directly the ban against insider trading itself.
Works Cited Dalley, Paula J. "From Horse Trading to Insider Trading: The Historical Antecendents of the Insider Trading Debate. " William and Mary Law Review 39. 4 (1998): 1289-1353. Questia. 12 Apr. 2009 ;http://www. questia. com/PM. qst? a=o;d=5001343688;. Spencer, Margaret P. , and Ronald R. Sims, eds. Corporate Misconduct: The Legal, Societal, and Management Issues. Westport, CT: Quorum Books, 1995. Questia. 12 Apr. 2009 ;http://www. questia. com/PM. qst? a=o;d=27237195;.
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