The purpose of this paper is to review the phenomenon of illegal insider trading in the United States financial securities markets. The analysis section of this paper (a) defines illegal insider trading, (b) explains the enforcement of laws and regulations concerning illegal insider trading, (c) review the pattern of illegal insider trading from 1996 through 2005, and (d) compares the problem of illegal insider trading in the United States with the problem in other countries.
Consider this: "Imagine a boardroom of corporate executives, along with their lawyers, accountants, and investment bankers, plotting to take over a public company. The date is set; an announcement is due within weeks. Meeting adjourned, many of them phone their brokers and load up on the stock of the target company. When the takeover is announced, the share price zooms up and the lucky 'investors' dump their holdings for millions in profits." First things first - insider trading is perfectly legal. Officers and directors who owe a fiduciary duty to stockholders have just as much right to trade a security as the next investor. But the crucial distinction between legal and illegal insider trading lies in intent. As a result, two theories of insider trading liability have evolved over the past three decades through judicial and administrative interpretation: the classical theory and the misappropriation theory. The classical theory is the type of illegal activity one usually thinks of when the words "insider trading" are mentioned. What is insider trading? According to Section 10(b) of the Securities Exchange Act of 1934, it is "any manipulative or deceptive device in connection with the purchase or sale of any security." This ruling served as a deterrent for the early part of this century before the stock market became such a vital part of our lives. But as the 1960's arrived and illegal insider activity began to pick up, courts were handcuffed by this vague definition. So judicial members were forced to interpret "on the fly" since Congress never gave a concrete definition. There is a difference between insider trading and illegal insider trading. One of the major difficulties in dealing with the problem of insider-trading appears involves defining the practice. Some writers define insider trading as trading by a stockholder of a corporation who is also an officer or key executive. Other parties include professional traders as insiders, as opposed to the investing public. Legally, however, and insider is someone who has knowledge of facts that are relevant to the valuation of a publicly-traded company. The individual with such knowledge need not be a member of the company in question, nor is it necessary for the person to own stock in the company in question. It is legal for persons with knowledge of facts that are relevant to the valuation of a company to trade in the stock of that company if the information to which the person has knowledge also is available to the public. Insider trading becomes and illegal act when the trading is performed by persons who have knowledge the access to which is restricted to a narrow group of company insiders or to others to whom such information has been made available. For years, the Securities and Exchange Commission (SEC) applied a “strict constructionist view” of what was considered to be insider-trading. The following example illustrates this view of insider-trading: “… an airplane passenger who saw a factory in flames while aloft and rushed to the phone to short sell the stock when the plane landed violated … the … anti-fraud prohibition on which the SEC bases insider-trading prosecutions” (Muzea 19). For decades, the SEC operated within the context of the preceding illustration. Following rulings by the United States Supreme Court, and because of other incidents, the strict constructionist view was discarded...