Challenges of Investigating and Prosecuting Inside Traders
Following the stock market crash of 1929, former President Franklin D. Roosevelt signed into law the Securities Exchange Act of 1934. It was under this action that the SEC was created to regulate and monitor U.S. securities markets and create rules to establish a level playing field for all investors. Under The Code of Federal Regulations pertaining to and agreed upon by the SEC, rule 10b5-1 states;
“…the purchase or sale of a security of any issuer, on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the ...view middle of the document...
Thus the Insider Trading Sanctions Act of 1984 was established to prevent the “undermining of the public’s expectations of honest and fair securities market” so that all investors can “play by the same rules”.
Assessing who is participating in insider trading, however, can be a difficult task. Certain forms of insider trading are actually perfectly legal. For example, if company insiders start snatching up shares of stock because they feel strongly about their company, they may do so legally by informing the SEC of their activities. However, this activity can only take place so long as it’s not based on material non-public information. If this activity is not reported, it can also become especially illegal.
This is precisely what happened in the case of Martha Stewart. In 2001, Stewart dumped 4,000 shares of ImClone after having received word from her broker that the company’s CEO was liquidating his shares of company stock (Hoffman, 2007). The SEC caught on to this activity and launched an investigation which culminated in Stewart being convicted of conspiracy, making false statements, and obstruction of justice (“AP: Martha Stewart Convicted on All Four Counts”, 2004).
In the end, Martha Stewart’s punishment greatly exceeded the financial losses she would have incurred had she not been a participant in insider trading; “jail time and hefty fines, which were 4 times greater than the losses Stewart would have incurred had she kept her shares of the ImClone stock, were primarily a result of the court action related to the perjury and collusion charges of which Stewart was ultimately found guilty” (Rawls, 2009 as cited by Hoffman, 2007).
It’s important to note, however, that Martha Stewart was not convicted of insider trading. As noted by Rawls (2008), “in an interesting legal technicality, Martha Stewart did not necessarily breach a fiduciary duty to the other investors, since she had no real obligation to inform other investors, which would be the case if she were an officer with the company”. Martha narrowly escaped by means of this ethically murky maneuver; however her deception to investigators and her cover-up activities were separately illegal and enough to prosecute and convict her.
Insider trading, with the modern day technology enabling instantaneous information exchange, is increasingly becoming a problem. In 2006, the SEC filed more than a dozen insider trading cases which numbered more than the entire amount collected through the 90’s (Rodier, 2007). In an effort to prevent such unethical behavior, the FBI and SEC have been doing their best to crack down on insider trading. The FBI has moved beyond court-authorized wire taps to catch insider trading activities. Investigative branches have become more and more tech-savvy and implemented complex event processing (CEP) software which can monitor and detect suspicious activity through advanced algorithms (Roider, 2007). The FBI, SEC, and Department of Justice (DOJ) all work...
