Insider Trading

Introduction
All the business activities require a certain environment to carry out called the Financial System.
It is the process that transfers the money of the savers to the business smoothly. One of the
most important element of the Financial Systems are the Financial Markets, which provide you
the place to park, invest and transact money and are the most regulated sector of the
economy, but still they face several issues out of which the most serious one is called Insider
Trading.

Insider trading refers to the practice of purchasing or selling a publicly-traded

company’s securities while in possession of material information that is not yet public
information. Material information refers to any and all information that may result in a
substantial impact on the decision of an investor regarding whether to buy or sell the security.

By non-public information, we mean that the information is not legally out in the public domain
and that only a handful of people directly related to the information possess. An example of an
insider may be a corporate executive or someone in government who has access to an
economic report before it is publicly released.

Hypothetical Examples of Insider Trading

 The CEO of a company divulges important information about the acquisition of his
company to a friend who owns a substantial shareholding in the company. The friend
acts upon the information and sells all his shares before the information is made public.
 A government employee acts upon his knowledge about a new regulation to be passed
which will benefit a sugar-exporting firm and buys its shares before the regulation
becomes public knowledge.
 A high-level employee overhears some conversation about a merger and understands its
market impact and consequently buys the shares of the company in his father’s account.

Insider trading was not considered illegal at the beginning of the twentieth century; in fact, a
Supreme Court ruling once called it a “perk” of being an executive. After the excesses of the
1920s, and the resulting shift in public opinion, it was banned, with serious penalties being
imposed on those who engaged in the practice.
Securities and Exchange Commission of
Pakistan
The Securities and Exchange Commission of Pakistan (SECP) was setup in pursuance of the Securities and
Exchange Commission of Pakistan Act, 1997 and became operational on January 1, 1999. It has
investigative and enforcement powers.

The current mandate of SECP includes following:

 Regulation of Corporate Sector and Capital Market

 Supervision and Regulation of Insurance Companies
 Supervision and Regulation of Non-Banking Finance Companies and Private Pension Schemes

The vision of the institution is the development of modern and efficient corporate sector and capital
market, based on sound regulatory principles that provide impetus for high economic growth and foster
social harmony in the Country.

The mission is to develop a fair, efficient and transparent regulatory framework, based on international
legal standards and best practices, for the protection of investors and mitigation of systematic risk
aimed at fostering growth of a robust corporate sector broad based capital market in Pakistan.

Ethical Issues with Insider Trading

Breach of Fiduciary Duty
A fiduciary duty is an obligation to act in the best interest of another party. For instance, a
corporation's board member has a fiduciary duty to the shareholders, a trustee has
a fiduciary duty to the trust's beneficiaries, and an attorney has a fiduciary duty to a client. So in
the case of Insider Trading the fiduciary (one who leaks the private information) violates the
fiduciary duty conduct.

Breach of Contract
When employee of an organization shares some sort of confidential information with outsiders
to provide them an edge over others when making a decision, at this point the employee
violates the contract made with the organization.
Endangers Transparency
One of the principal tenants of capital markets is transparency, meaning that all investors have
access to the same information. Think of capital-markets transparency this way. Chances are
you would not like it if, as a shareholder of a company, the company provided only half its
investors with quarterly earnings updates while keeping the numbers a secret from the other
investors. Insider trading is wrong for a similar reason: Why should only a small amount of
market participants be privy to information that many more could benefit from?

Thievery
In some examples of insider trading, the illicit and unethical act is perpetrated by a person or
parties associated with a particular company exploiting nonpublic information for their benefit.
In many of these examples, it is information the company intended to make public at some
point, but the important theme is this: The information is property of the company. When
insider traders make public information the company has not yet approved for release, the
resulting act is akin to a home burglary. Moreover, it could endanger the company and its
investors.

No Level Playing Field

Among all the people in the market for dealing and looking for information, only a chosen few
are given special treatment which damages other players in the market.

Unfair/Inequality
It may sound like two young children arguing with each other, but the fact of the matter is
insider trading is not fair. To start with, making money in capital markets is a difficult endeavor,
one that is made even more difficult by the fact that small investors compete against large,
deep-pocketed institutions. At the very least, some semblance of equality is needed to ensure
orderly capital markets that encourage broad-based participation.

Damages Confidence
On a related note to the previous point, insider trading can shake the confidence of ordinary
investors. Too many insider trading scandals in a condensed period of time could leave
investors frustrated and wondering how they can make any money in stocks if they are
consistently being put at a disadvantage by unscrupulous insiders. What insider traders, the bad
type, don't realize is that the more investors are driven from the market, the more the market
will suffer from liquidity issues. And that is bad for all market participants.
Against Work Ethics
The necessary information shared with the people working in the organizations, is a liability to
them and they should show loyalty to the firm and keep the information and details
confidential that is also a need out of work ethics.

Selfishness over Selflessness

The ethical code of conduct directs us to act what is in the favor of the society as a whole rather
than acting out of our self-interest only. Insider Trading depicts a picture of severe selfishness,
where the committers only think of their material gain and ignore the effects it will impose on
investors, organization and market etc.

Example Cases of Insider Trading

Jahangir Tareen
Jahangir Tareen was found guilty of insider trading eight years ago as he violated the Insider
Trading Ordinance-1969 and the Companies Ordinance-1984 in the United Sugar Mills (USML)
acquisition, according to the SECP’s response.

He also made roughly Rs71 million gains but returned Rs73.1 million to the SECP — including
fines and legal cost that the regulator incurred on investigating the case.

Securities and Exchange Commission of Pakistan says that Jahangir Tareen Khan being
director of the JDW was authorized by its board of directors to negotiate the acquisition of
the USML. Hence, he was privy to all inside material/information during the acquisition of the
USML, and consequently made a hefty gain of Rs70.811 million in violation of Section 15A of
the Securities and Exchange Ordinance-1969.

The unusual trading pattern and price movement in the shares of the USML from November
2004 to November 2005 was observed by Jahangir Tareen Khan and investigation under
Section 29 of the SECP Act 1997 was ordered on December 12, 2006.
The investigation report revealed contravention of Section 15A of the Ordinance of -1969,
sections 214, 216, 217 and 222 of the Companies Ordinance-1984 and Section 4 of the
takeover Ordinance.

It was further revealed that Tareen acquired 341,780 shares through M/s Haji Khan and Allah
Yar and made a gain of Rs70.811 million through the sale of his shareholding in the USML, in
the stock market and under the public offer made by the JDW in October 2005.

Aijaz Rahim
Top Pakistani investment banker, Aijaz Rahim, earned more than $7.5 million in illegal profits
from an insider trading scheme that they say was run by a former Credit Suisse banker, also a
Pakistani.

In a 26-count complaint filed in the Federal District Court in Manhattan, the US District Attorney
charged Mr. Rahim, head of investment banking at a bank in Pakistan, of conspiracy and
securities fraud, said a report in the New York Times.

Mr. Rahim is accused of profiting from confidential information about nine deals, including the
$45 billion buyout of TXU, the Texas energy giant. Credit Suisse was an adviser on all nine deals.
Two weeks ago, the Securities and Exchange Commission amended its complaint to accuse Mr.
Rahim of securities fraud. Citing telephone and email records, prosecutors said that from April
to February, Mr. Rahim received confidential information from Hafiz Mohammad Zubair
Naseem, 37, at the time a junior associate in Credit Suisse’s global energy group.

The SEC said in its amended complaint that both men once worked for the American Express,
Lahore, the report said. Prosecutors and the SEC have accused Mr. Naseem of repeatedly
calling Mr. Rahim’s home and cellphone from his office phone at Credit Suisse, divulging
information about deals in which the bank was an adviser. Shortly after the calls, Mr. Rahim
would buy shares in companies involved in the transactions.

Altogether, prosecutors said Mr. Rahim earned more than $7.5 million from the nine
transactions. More than $5.1 million of that stemmed from trading in TXU alone.

According to the complaint, last spring Mr. Naseem opened an account at an unnamed
brokerage in Pakistan, authorizing Mr. Rahim to manage it. Citing email messages obtained
from Credit Suisse, the complaint says that Mr. Naseem told Mr. Rahim that he could do
whatever he wanted in the account. In one email message, Mr. Naseem concluded: “Let the fun
begin.”

Mr. Naseem, who was arrested at his office on May 3, has been charged with conspiracy and
securities fraud. He posted bond and is under house detention.
Martha Stewart
In December 2001, the Food and Drug Administration (FDA) announced that it was
rejecting ImClone's new cancer drug, Erbitux. As the drug represented a major portion of ImClone's
pipeline, the company's stock took a sharp dive. Many pharmaceutical investors were hurt by the drop,
but the family and friends of CEO Samuel Waksal were, oddly enough, not among them. Among those
with a preternatural knack for guessing the FDA's decision days before the announcement was
homemaking guru Martha Stewart. She sold 4,000 shares when the stock was still trading in the high
$50s and collected nearly $250,000 on the sale. The stock would plummet to just over $10 in the
following months.

Stewart claimed to have a pre-existing sell order with her broker, but her story continued to
unravel and public shame eventually forced her to resign as the CEO of her own company,
Martha Stewart Living Omnimedia. Waksal was arrested and sentenced to more than seven
years in prison and fined $4.3 million in 2003. In 2004, Stewart and her broker were also found
guilty of insider trading. Stewart was sentenced to the minimum of five months in prison and
fined $30,000.

R. Foster Winans: The Corruptible Columnist

Although not high-ranking in terms of dollars, the case of Wall Street Journal columnist R.
Foster Winans is a landmark case for its curious outcome. Winans wrote the "Heard on the
Street" column profiling a certain stock. The stocks featured in the column often went up or
down according to Winans' opinion. Winans leaked the contents of his column to a group
of stockbrokers, who used the tip to take up positions in the stock before the column was
published. The brokers made easy profits and allegedly gave some of their illicit gains to
Winans.

Winans was caught by the SEC and put at the center of a very tricky court case. Because the
column was the personal opinion of Winans rather than material insider information, the SEC
was forced into a unique and dangerous strategy. The SEC charged that the info in the column
belonged to the Wall Street Journal, not Winans. This meant that while Winans was convicted
of a crime, the WSJ could theoretically engage in the same practice of trading on its content
without any legal worries.

Brian D. Jorgenson
The SEC alleges that Brian D. Jorgenson, who lives in Lynwood, Wash., obtained confidential
information about upcoming company news through his work in Microsoft’s corporate finance
and investments division. Jorgenson tipped Sean T. Stokke of Seattle in advance of the
Microsoft announcements, the most recent occurring in October. After Stokke traded on the
inside information that Jorgenson provided, the two equally split the illicit profits in their
shared brokerage accounts. They made joint trading decisions with the goal of generating
enough profits to create their own hedge fund.

Jorgenson and Stokke made a combined $393,125 in illicit profits in their scheme, which began
in April 2012.

Jorgenson and Stokke are charged with violating Section 10(b) of the Securities Exchange Act of
1934 and Rule 10b-5, both directly and pursuant to 20(d) of the Exchange Act. The SEC seeks
permanent injunctions, disgorgement of ill-gotten gains plus prejudgment interest, and
financial penalties against Jorgenson and Stokke as well as an officer-and-director bar against
Jorgenson.

Amazon Case
A former Amazon financial analyst was found guilty of insider trading for tipping a former
college fraternity brother about the retailer’s quarterly results before they were made public.

Authorities said Brett Kennedy gave fellow University of Washington alumnus Maziar Rezakhani
nonpublic information from Amazon’s database, showing that the retailer would lose less
money and report higher revenue for the first quarter of 2015 than Wall Street expected, in
exchange for $10,000 cash.

Kennedy, 26, of Blaine, Washington, faces up to 20 years in prison at his Dec. 8 sentencing, but
prosecutors will recommend that he serve no more than a year and a day. He agreed to pay
$10,875 to settle with the SEC.

The SEC also charged Rezakhani and his former investment adviser Sam Sadeghi, who the
regulator said discussed the tip with Kennedy and Rezakhani, and hoped to eventually start a
New York hedge fund with Rezakhani.

Sadeghi, 28, agreed to pay $24,215 to settle with the SEC, without admitting wrongdoing.
Contact information for his lawyer was not immediately available.
 Literature Review (1)
Introduction
The topic of my research paper is “The Ethical Dimension of Insider Trading in Australia”. Insider
trading is the illegal practice of trading on the stock exchange to one's own advantage through
having access to confidential information. This is a severe problem faced by the Securities and
Exchange Commissions of different countries and is very difficult to point out and file
complaint. Insider trading is increasing day by day and the number of complaints registered by
the SEC is also increasing as compared to previous times.

Summary of the Article

The purpose of this paper is to explore the attitude of different players of the securities market
towards ethics of Insider Trading. The research was conducted through a series of interviews of
lawyers, accountants and different people involved in the activities of securities market.

The real issues concern such factors as the culture of tolerance of insider trading, the casino
mentality, peer-group support for insider traders, the low stigma attaching to insider trading,
and the largely symbolic role of law and regulation in this area. There are obviously different
ethical values at play within the industry.

Conclusion
When researching the extent and effects of insider trading, the researcher came across
observations which reflected upon the nature of business ethics in the securities industry. As he
found, Insider Trading is commonplace in Australia.

One way of assessing ethical attitudes to insider trading is to seek to assess the perceived
effects of such conduct. Most interviewees made the expected "motherhood" statements such
as that insider trading is unfair to those who do not have the inside information or that it was
desirable to seek to achieve "a level playing field", but these views were almost invariably
qualified by some other statements. As one lawyer saw it, "the law has a role to inhibit it, but
not to stop insider trading entirely". One explanation of this qualification was offered by
another lawyer when he said that "the degree of harm depends upon the circumstances of a
particular stock". Once again, this was usually seen in terms of unfairness and resort was often
made to a currently fashionable metaphor, such as the "level playing field". One regulator
described insider trading as "unfair in the same way as a fixed horse race is unfair; it gives the
Australian market a bad image". At one level, the philosophy of the level playing field is based
upon the ethical principal of fairness of opportunity. Self-interest comes first for many brokers".
Similarly, another broker remarked that insider trading "is tolerated as long as it is not too
blatant. The market would not work without insider trading". Another added that "the industry
tries to promote it - it has a vested interest in insider trading". This situation may be described
as "Casino Capitalism".

There is a culture of tolerance of Insider Trading in the market. One financial adviser answered,
when asked about the attitude of his professional colleagues to insider trading, that "no one
will ever say so, but we tolerate it". Lawyers and accountants were seen to have the highest
ethical standards. A financial adviser told us that "respectable professionals would not risk their
career or reputation to insider trade". Many brokers sought to give the impression that "there
is a genuine distaste for people who indulge in it", but there were other brokers who took a
more critical attitude to their colleagues. One broker said of his professional colleagues that
"they know it happens and there is a degree of acceptance of its prevalence". This same view
was put most bluntly by a leading Sydney broker, when he exclaimed that "we are all thieves in
this industry" and that there would be no damage from a person being known as an insider
trader. Another broker noted that "while you would not have dinner with him, somebody will
deal with him".

The low risk of detection and prosecution for insider trading has helped to entrench an easy
morality in the securities industry. Insider traders tend to fall into two broad groups. There are
those who are ignorant of the law against insider trading and there are those who are aware of
the law against it but believe, nevertheless, that the risk is worth taking. Some of the latter are
quite sophisticated in the ways in which they execute their insider trading transactions.

It is clear that the stigma attaching to insider trading is only likely to be meaningful when it is
coupled with the possibility of imprisonment. One lawyer explained that "it comes down to
making people sit up and take note. A criminal prosecution brings with it a stigma. This is an
important thing for management to avoid". Nevertheless, there is a widespread view, as put by
one regulator and perhaps shared by the general community, that "magistrates just won't send
prominent businessmen to goal". So, we might ask what the social purposes of criminalizing
insider trading actually are. Three suggested goals of insider trading regulation were put to
those interviewed. We asked interviewees: "which of the following purposes do you see as
being the most realistic goal of insider trading regulation: punishment, orderly marketing or
symbolic reassurance". It was quite clear to almost everyone that punishment was not
considered in the industry to be a realistic goal of regulation, due simply to the lack of any
convictions.
 Literature Review (2)
Purchasing or selling of a security by someone who has right of entry to material nonpublic

information about the security is called insider trading. Insider trading can be illegal or legal

depending on when the insider makes the trade. It is illegal when the material information is

still nonpublic.

The ethical issue in finance has received increasing attention from academic researchers,

government agencies and business communities; it is neither well researched nor understood.

The growing importance of ethics in finance has undoubtedly been recognized by people from

all disciplines. Even among academic researchers, however, there is still no consensus on what

kinds of conduct should be regarded as unethical.

Opponents of insider trading seem simply to believe that insider trading is inherently immoral.

Proponents, on the other hand, assert that insider trading is viable and efficient economic

means and can be used to serve the best interest of shareholders and the economy at large. For

example, Manne (1966) is clearly the most quoted on discussions of the benefits of insider

trading and correspondingly, why ITR should not be adopted. Manne put forth two primary

arguments in support of insider trading. He argued that insider trading helps to gradually move

the price of a stock closer to its fair value since insiders’ trade on the basis of MNPI. He asserted

it prevents abrupt adjustment shocks in the share price when the news turns public, which he

contended could adversely affect investors. Manne also argued that IT is the best means to

reward entrepreneurship and promote innovation. He believed this would be an effective

solution to tackle the agency problem between shareholders and managers, as it rewards
producers of information and encourages them to produce more information and add to the

value of the firm.

Researchers have found evidence of abnormal returns earned by both the narrower and

broader groups of insiders. From an empirical standpoint, most of them have restricted

themselves to the narrower scope given the richness of data availability. Finnerty (1974) notes

that insiders, who during 1969-72 bought their own company shares listed on the NYSE,

managed a cumulative abnormal return (CAR) of 8.61% over an 11-month holding period. Pratt

and DeVere (1970), Jaffe (1973), Seyhun (1986) and Jeng et al (2002), among others have

validated the earning of abnormal returns by registered insiders. A few have attempted to

target the wider group too, basing their study on prosecutions by regulatory authorities. For

instance, Muelbroek (1992) based her analysis on individuals charged with insider trading by

the US Securities and Exchange Commission (SEC) in civil or administrative cases during 1980-

1992. The author estimated that CAR for an insider trading episode to be 6.85%.

They argue that insiders who are also shareholders have the same rights as ordinary
shareholders to trade based on their information and judgment. Thus, expropriating value from
insiders by prohibiting insider trading is both senseless and immoral.

Methodology
Sample cases were taken from internet from reliable sources. Both, local and international
cases are taken into consideration. Ethical issues are pointed out after reading the cases and
relating them with the lectures of the class and personal understanding. Each member of the
group has written a literature review on the articles taken from internet. Solutions of Insider
Trading are presented through research and individual thought process. In the findings section
of the report, the cases are linked with the theories studied during the course.

Findings
After careful examination, our group members have reached to the conclusion that Insider Trading is
and should be illegal everywhere with strict laws enforcing it. At the same time, we think that it is also
an unethical act due to several reasons, out of which some are mentioned below:

 Unfair: A very small proportion is given advantage over a large population of people by
providing them with confidential information.
 Against Work Ethics: There are certain guidelines which define the work ethics that include
being loyal to your workplace and confining with the defined ethics.
 Fiduciary Breach: When the employee of the organization, passes on confidential information to
outsiders, this act is considered as unethical because it violates the contract between the
employee and the organization.
 No Level Playing Field: Any sector grows when there is a strong competition in the sector, and
strong competition develops when numerous players are present and there are equal
opportunities for everyone. As in the case of Insider Trading one party is given special treatment
which violates the conditions required for healthy competition.
 Damages Market: Insider trading reduces the confidence of the people in the whole process,
which damages the market in the long run because either the people distance themselves from
the process completely or keep a very small share in it.

Kantian Ethics
Kantian ethics refers to a deontological ethical theory ascribed to the German
philosopher Immanuel Kant. The theory, developed as a result of Enlightenment rationalism, is
based on the view that the only intrinsically good thing is a good will; an action can only be
good if its maxim – the principle behind it – is duty to the moral law. Central to Kant's
construction of the moral law is the categorical imperative, which acts on all people, regardless
of their interests or desires. Kant formulated the categorical imperative in various ways. His
principle of universalizability requires that, for an action to be permissible, it must be possible
to apply it to all people without a contradiction occurring.

When relating Kantian Ethics to Insider Trading, it can be seen that Insider Trading cannot be
applied to all the people as only few have such opportunities and according to Kant, only those
actions are permissible that can be applied to all the people without a contradiction, so Insider
Trading is not permissible according to Kantian Ethics.

Utilitarianism
Utilitarianism is an ethical theory that states that the best action is the one that
maximizes utility, which is usually defined as that which produces the greatest well-being of the
greatest number of people. Jeremy Bentham, the founder of utilitarianism, described utility as
the sum of all pleasure that results from an action, minus the suffering of anyone involved in
the action. Utilitarianism is a version of consequentialism, which states that the consequences
of any action are the only standard of right and wrong. Utilitarianism considers the interests of
all beings equally.

As in the case of Insider Trading only a very small proportion of people are benefited and
Utilitarianism emphasizes on maximum utility attained by maximum people, so Bentham’s
theory completely rejects Insider Trading and does not consider it as the best action.

Egoism
Ethical egoism is the normative ethical position that moral agents ought to do what is in their
own self-interest. It differs from psychological egoism, which claims that people can only act in
their self-interest. Ethical egoism holds, therefore, that actions whose consequences will
benefit the doer can be considered ethical in this sense.

From Egoist point of view, Insider Trading is considered ethical because they consider those
acts as ethical which benefit their self-interest, and in the case of Insider Trading, few people
act out of their self-interest and get benefitted.

Conclusion