UNIVERSITY OF WEST LONDON

ASSESSMENT 1
COURSE: MS7SL82O
INSTRUCTOR: Mr. Dehan Senevirathna
STUDENT NAME: Ravindu Bentotahewa
UWL ID: 21598305
EMAIL: ravben50@gmail.com
SUBMISSION DATE: 12/10/2022
WORD COUNT: 2405
CONTENTS

UNIVERSITY OF WEST LONDON..........................................................................................................1

EXECUTIVE SUMMARY.........................................................................................................................3
BACKGROUND.........................................................................................................................................4
KEY ETHICAL DILEMMAS.....................................................................................................................4
CONTEXTUAL ANALYSIS......................................................................................................................5
STAKEHOLDER ANALYSIS...................................................................................................................5
NORMATIVE THEORIES.........................................................................................................................6
Consequentialist Theories........................................................................................................................6
Theory of Egoism:.............................................................................................................................6
Utilitarianism:......................................................................................................................................6
Non-consequentialist Theories................................................................................................................7
Ethics of duties...................................................................................................................................7
Ethics of Rights..................................................................................................................................8
Ethics of Justice.................................................................................................................................9
VIRTUE ETHICS.......................................................................................................................................9
TRIPLE FONT THEORY.........................................................................................................................10
RECOMMENDATIONS...........................................................................................................................10
CONCLUSION.........................................................................................................................................11
APPENDICES...........................................................................................................................................12
APPENDIX A: An in-depth Analysis on Key Ethical Dilemmas..........................................................12
APPENDIX B: Stakeholder Analysis....................................................................................................13
REFERENCES..........................................................................................................................................15
EXECUTIVE SUMMARY

The report attempts to explore different ethical facets pertaining to Insider trading. Initial an
overview is provided upon the financial and banking sector. Due to the immenseness of the
Sector and the primary objective being wealth creation, the report details major ethical issues
that is actively pursued in the financial industry.

The report shines the spotlight on Insider trading and move on to probe in to the ethical aspects
of it. The practice is analyzed through the lens of consequentialist theories such as Egoism and
Utilitarianism using real life case studies for more clarification. In addition, more ethical theories
are discussed such as ethics of duties, Rights and Justice theory and finally through virtue ethics

Insider trading is discussed briefly in the light of the Triple Font Theory. The report is concluded
by suggesting recommendations to deter the practice of insider trading.
BACKGROUND

The Financial and the Banking sector is an immense sector consisting of commercial banks,
investment banks, pension funds, mutual funds, insurance companies, and simply any
organization that provides financial services to the society fall into this sector. The financial
sector encompasses approximately an unfathomable $50 trillion in assets, with a growth rate of
8% per year. With this vast amount of assets, we are looking at a total of global business
transactions that are processed exceeding 100 billion per year. (Federwisch, 2021) Given the
huge scope of this industry, it is clear that the decisions and actions taken in the financial sector
reflects on every individual in a society either directly or indirectly. There is a chance that a
small percentage of decisions and actions are being implemented on the sole purpose of
maximizing profit margins of corporations that will likely raise ethical concerns. Even-though
the financial sector is highly regulated compared to other sectors, it is wise to keep in mind that
even a small percentage of unethical issues could be significant given the vastness of the sector.
(Federwisch, 2021) The following paragraphs discusses a few key ethical dilemmas that would
be common among most corporations related to the financial sector. (Federwisch, 2021)

KEY ETHICAL DILEMMAS

There are a number of ethical dilemmas attributed to the financial and banking sector

1. Financial statement fraud

2. Fraud in financial markets
3. Insider trading
4. Hostile takeovers
5. Window dressing
6. Money laundering

An in-depth breakdown of the key dilemmas can be found in Appendix A.

CONTEXTUAL ANALYSIS
Insider trading occurs when the management within a corporate entity uses information which is
not disclosed to the public to purchase and sell securities. This practice solely capitalizes on the
information asymmetry between the management and employees within the corporation and
other market participants. Insider trading is unethical because it violates investor principles such
as fairness and integrity. This has a huge impact on the securities markets because insider trading
attempts to erode investor confidence regarding the market overtime.

As per the Securities and Exchange Commission of United States insider trading is “Buying and
selling of a security, in breach of a fiduciary duty or other relationship of trust and confidence,
on the basis of material, nonpublic information about the security.” This illustrates that when
insider trading becomes commonly practiced, it has a significant impact on the market liquidity
which will likely increase transaction costs and cause the investor returns to suffer.

STAKEHOLDER ANALYSIS
The internal stakeholders that would be directly affected by insider trading are all market
participants that would experience a loss as a result of unequal access of information.

The external stakeholders would be employees, customers and other members that does not
directly own shares but would have an indirect impact as a consequence of insider trading. This
means that when firms face financial ruin as a result of insider trading, a company may go
bankrupt and employees may lose their jobs.

A further analysis is done on appendix B

NORMATIVE THEORIES
Consequentialist Theories
Theory of Egoism:
In Egoism an action takes form as morally right when an individual attempts to pursue his/her
respective long-term and short-term goals through free will (Anderson, 2014). As Adam Smith
stated, Egoism conveys an idea that an individual acting on behalf of its own self-interests bears
no harm but in turn would benefit for the society. A case study will be used to discuss Egoism in
regards to Insider Trading.
A prominent American retail businessperson Martha Stewart sold approximately 4000 shares of
the pharmaceutical firm ImClone, just days prior to FDA rejected a cancer drug known as
Erbitux (www.sec.gov, n.d.). Prior to the announcement the stock was selling around $60, but
plummeted down to $10. Despite the rapid drop Martha was able to raise suspicions by
capitalizing a whopping $240000 on the sale. It was later revealed through investigations that
Stewart was tipped by an insider named Peter Bacanovic. (www.sec.gov, n.d.)

The case of Martha Stewart clearly portrays how information asymmetry through insider trading
could be used for the pursuit of self-interest. Martha’s action of selling the stock based on the tip
that the share price would drop was made on her own free will and the obligation of service for
herself. By acting on superior information that the rest of the public did not have access to,
Martha becomes guilty for the charges on dishonesty and lack of integrity. As highlighted by the
above case it is clear that through insider trading it is possible for individuals to achieve their
personal endeavors while the rest suffer due to the information asymmetry.

Utilitarianism:

Utilitarianism also known as “The greatest happiness principle”, proposes that an action is
deemed to be morally right if the action creates the greatest good for the greatest number of
people.

To shed light upon Stuart Mill’s Utilitarian approach the report attempts to discern the biggest
insider trading scandal to date in America. The CEO Raj Rajaratnam of Galleon Group, one of
the largest hedge funds in the world, was found guilty of insider trading on 14 counts by the SEC
and FBI. Rajaratnam would go on to serve a jail term of 11 year (Cohan, 2011). In its prime, Raj
would build up close relationships with a network of top executives that represented large firms
such as Intel, McKinsey, Goldman Sachs and IBM (Cohan, 2011). These insiders would feed
Galleon with highly sensitive confidential non-public information that would enable Raj to
pursue aggressive investment strategies (Luhby, 2008).

Mill’s “greatest happiness” principle can be clearly demonstrated from this case because Raj
would pay handsomely the insiders to obtain the sensitive information (Lawson, 1988). The case
extends further to provide as a classic example of Utilitarianism in regard to “greater good” for
the “greatest number” empathizing the fact that during the period of time the rest of the
stakeholders of Galleon Group was not aware of Raj’s actions, the value of Galleon group
increased from $3.7 billion in 2008 to $7 billion by 2009. This caused excitement and happiness
for shareholders, the management and the employees of Galleon Group. This “greater happiness”
was only short lived as SEC and the FBI would later find Rajaratnam guilty and soon after
stakeholders would begin to experience loss and pain as Galleon Group took the downfall.
Therefore, it is evident that through insider trading a benefit for the society could be experienced
from market efficiency by price accuracies, and market smoothing (Lawson, 1988). However,
the short-term benefits to society would soon diminish as the frequency of insider trading
practices increases which will hurt investor confidence. This will impact the overall integrity of
markets as a result of information asymmetry.

Non-consequentialist Theories
Ethics of duties
Under the ethics of duties Kant identifies three core aspects in regard to ethics that every rational
being have to obey. These areas are collectively known as the categorial Imperatives (Mele,
2009).

1. Consistency:

The moral correctness of an action guided by the behavior that the action is implemented
consistently by everyone in all cases. Under maxim 1, the morality of insider trading would be in
question since insider trading is pursued by a minority in financial markets. In addition, insider
trading is not a practice that is carried out consistently. Therefore, insider trading cannot be
considered morally right under the first maxim (Mele, 2009).

2. Human Dignity:

The second maxim highlights the importance of treating others with respect and dignity thereby
they are treated as an end and never as means (Mele, 2009). As mentioned above, when
Rajaratnam formed a close network with the top executives of IBM, Intel and McKinsey, he was
using them as a means of achieving high profitability by feeding his company with sensitive
information. Therefore, it is clear that engaging in insider trading is totally against human dignity
(Mele, 2009).

3. Universality:
The final maxim, refers to the rules that guide actions of an individual has to accepted by all
rational beings. The modern finance theory assumes that investors act rationally and are
inherently risk averse (DeGeorge, 2010). When information asymmetry is actively pursued, it
enables the insider to solicit abnormal returns by the exploitation of non-public information.
Under such conditions, the assumptions of modern finance theory are violated, which is to say
that any rational investor would not accept the rules that guide insider trading. Therefore, it
conveys that insider trading fails to obey universality (DeGeorge, 2010).

Ethics of Rights

Locke’s Theory of Rights stresses the fact that individuals are entitled to unalienable rights that
is universally embraced and protected (Statman, 2009). It should be noted that the rights theory
is strongly encultured in the west. Based on the theory of rights, market participants have a right
for equal information. Insider trading succeeds in violating this right when certain individuals act
on superior information (Statman, 2009). The rights theory would be further infringed in a
scenario where insider trading is normalized. This is because rookie investors would no longer
feel “protected” in participating in the market and as a result would be left alienated. A further
clarification can be drawn using the case of Mark Cuban (Norris, 2008). He was charged by the
SEC for alleged insider trading with the CEO of web company (mamma.com) (Norris, 2008).
Mark would gain the upper hand by the knowledge that the firm was planning to execute a
secondary equity offering in the future. He sold his shares decreasing the value of mamma.com’s
price by 10%. The case proves that gaining advantage on non-public information helped Mark to
avoid a financial loss which violated the rights of other investors for equal information (Norris,
2008).

Ethics of Justice

Theory of Justice revolves around fair treatment to people in a given society so that everyone
gets what they rightfully deserve. In the financial realm, “fair treatment” is achieved through
when all market participants have access to equal relevant information to make informed
decisions (A, 2009). As a result, “everyone gets what they deserve” in the sense that wealth
would be distributed in a just and proportionate manner attempting to satisfy their respective
financial goals. The practice of Insider trading conflicts with ethics of justice since information
asymmetry is unfair. Insider trading will create an environment in the financial market where
investing would not be deemed as a “fair game of skill” with winners and losers, but as
something of a non-skill-based edge on trading (Jean Eaglesham, 2011).

VIRTUE ETHICS

As an early advocate of virtue ethics, Aristotle quotes “The virtue of a man will also be the state
of character which makes a man good and which makes him do his work well (Peter-Jan
Engelena, 2006).” Virtue ethics proposes that morality is not constraint upon rules and guidelines
and therefore more of a goal that a rational individual would pursue. Virtue is a character trait
that has to be consistently exercised through sound judgements integrity, trust, fairness, honesty
and self-control (Linda K. Trevino, 2010). Rajat Gupta’s case of insider trading can be used to
dig deeper in to the depths of virtue ethics. Rajat was the CEO of McKinsey & Co and in 2008 a
deal was settled with billionaire Warren Buffet to purchase $5 billion worth of preferred shares
with Goldman Sachs (Baldoni, 2012). A day before this information was about to go public,
Rajat tipped Rajaratnam regarding the deal. Rajaratnam acted on this information to realize a
profit of $1.2 million from the trade of Goldman Sachs shares (Baldoni, 2012). Rajat did not
have integrity since he was a board member of Golden Sachs and yet acted on personal benefits
(Anderson, 2009). Trust was tarnished between him and the other board members of Golden
Sachs. There was no fairness in Rajat’s action because he chose to disclose the sensitive
information entrusted to him to gain an unfair advantage before the news was made public. There
was lack of honesty in the action because there was an implicit promise to keep the information
confidential. Rajat lacked self-control since he was eager to leak this information (Ven, 2016).

Based upon the above study it is clear that inside trading fails to exhibit the values of a virtuous
character.

TRIPLE FONT THEORY

  Intent:
The intention of the parties involved in insider trading is to seek an unfair advantage in
order to gain abnormal profits (Mele, 2009).

 Object of action:

Insider trading is practiced using nonpublic information which will give an edge on
knowledge between the parties involved in the act and other investors who are unaware of
the information (Mele, 2009).

 Circumstances:
The outcome would be gradually investors would lose confidence creating market
inefficiencies which will lead to an illiquid market (Mele, 2009).

RECOMMENDATIONS
Tightening regulations on trading practices could be used to identify possible insider trading
activities. The SEC could have a closer eye in the market specially during special corporate
announcements such as acquisitions, earnings and other news that would influence the
fundamental value of the company.

Establishing harsh laws for individuals guilty of insider trading could act as a deterrent for future
protects who intend to capitalize on information asymmetry. This is because increased sentences
and having to pay huge fines would stress the severity of committing insider trading so that any
rational person would understand that the negatives far outweigh the positives regarding the
action.

Firms and business colleges could have special education programs highlighting the unfairness
and unethical nature of engaging in insider trading. This would help to create an enlightened set
of future leaders and managers that would look down on such bad practices and conduct their
businesses in an ethical manner. As a result, there would be a boost in confidence in the financial
market which will permit market liquidity.

CONCLUSION

The purpose of the report was to tap into the ethical sphere of insider trading and gouge into how
the action would influence the investment realm. This study successfully dissected the morality
of insider trading using a wide array of major ethical theories. The report was able to showcase
that lack of ethical decision making can lead individuals to exploit sensitive information in order
to gain an unfair advantage. Such bad practices are quite common in the investment world where
the core objective is profit maximization. However, the study makes it clear that through ethical
behavior all market participants will be able to reap the rewards of having trust in an efficient
market where everyone would get what they deserve.
APPENDICES
APPENDIX A: An in-depth Analysis on Key Ethical Dilemmas
1. Financial Statement Fraud:
Firms could deliberately add revenues to portray high profit margins. Corporations also
could conceal liabilities or expenses in the hope of conveying investors that the firm has a
favorable financial position for them to invest. Furthermore, corporations engage in
fraudulent asset valuation practices over value a firm’s assets to create a more positive
financial position.
2. Fraud in Financial Markets:
 Deception: Organizations try to get a better image for themselves by misrepresenting
relevant information.
 Churning: Individual investors normally invest and trade in the stock market with the
help of brokers. Brokers help their clients to trade in the stock market by trading
securities in the secondary market on behalf of their clients. (Bolch, 2021) Therefore, the
broker should always have the client’s best interest at heart. Churning occurs when
brokers misuse their duty by executing excessive and inappropriate trades for their clients
in the hope of generating higher commissions for themselves. (Bolch, 2021)
3. Insider Trading:
when managers or employees in a corporation capitalize on material information that has
not been exposed to the general public, it is known as insider trading. They may use this
information to seek personal gains such as the purchase/sale of stocks and other
securities.
 4. Hostile Takeovers:
A company (acquirer) forcefully takes over a target firm by meeting with the
shareholders or by replacing the management that would operate according to the
acquiring firm’s interests. Since hostile takeovers occur without the consent of the
management, this is an ethical dilemma. (Akshatha, 2021).

5. Window Dressing:
It is an unethical practice specially used by Fund managers and Portfolio Managers to
exaggerate the performance and value of their portfolios in order to attract potential
investors. Fund managers do this by selling securities that tend to have large losses and
purchasing dynamic stocks just prior to potential investor presentations.
6. Money Laundering:
It is the process of presenting large sums of money generated through illegal activities to
be legitimate. Money laundering is considered to be a financial crime and it is quite
common in the financial industry.

APPENDIX B: Stakeholder Analysis

The Mendelow’s Matrix is used to dissect how different stakeholders are impacted by Insider
Trading.

Key players: The Key players would be the market participants who are directly impacted by
information asymmetry. Market participants have high interest and high power because they
trade through financial instruments, stocks, diverse portfolios and mutual funds. Due to
information asymmetry, market participants have to bear significant losses since the expectations
of returns are disturbed.

Keep Satisfied: Government Regulatory authorities should be kept satisfied. This is because
although the portray a low interest in the act of trading, regulatory authorities have high power to
intervene in conditions where the laws and rules concerning investing have been breached.
Insider trading violates laws enforced by the SEC.

Keep Informed: Prospective investors should be kept informed regarding the efficiency of
financial markets. Prospective investors exhibit a high degree of interest and a low degree of
power. This means that if they feel that true and equal information is not being delivered in
financial markets, they may lose the trust and confidence to invest. As a result, they may lose
interest which will drive financial markets to illiquidity overtime.

Minimal Effort: The public who have no interest and no power can be considered to be under
minimal effort. These may be consumers of products and employees who have no interest in
trading. These parties may be affected indirectly if may structure is threatened through insider
trading which could create price inaccuracies and inflations.

REFERENCES

Anderson, J., 2014. Greed, Envy and Criminalization of Insider trading. Utah Law Review,
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