Insider Trading and Strategies to Combat the Menace

What is Insider Trading ?

In recent years, there has been a string of high profile convictions in the United States as part of the crackdown against insider trading. This has resulted in lot of media attention being given to the issue of insider trading. Before we launch into a fully-fledged discussion of the intricacies of the issue, it would be useful to define the term and understand what insider trading is all about.

Specifically, the term refers to the practice prevalent among corporate insiders who use the knowledge gained because of their contacts and position to trade in stocks and equities that would not have been otherwise possible if they did not have the inside information.

For instance, before a firm announces an acquisition or launches a new product line, several people within the firm have the knowledge beforehand. As the stock might go up in value once the news is made public, there are chances for these insiders to use their knowledge to trade in the stock. This is the barebones version of insider trading. The other aspect of insider trading refers to the practice wherein these insiders share the knowledge with their peers and acquaintances in other firms who might profit from this knowledge. This aspect has been the subject of the recent crackdown on insider trading in the United States.

Examples from Companies around the World

Having said that, it must be understood that many companies prohibit trading in their stocks by their employees before the quarterly and annual results are announced. This is done to ensure that they do not profit from the inside information. However, many corporate insiders have found ways and means to circumvent this by sharing the knowledge with others outside the company and hence, share in the profits made in such trading activity. This aspect of insider trading is hard to detect as the number of people and the trading involved in such cases cannot be detected easily.

The recent crackdown on insider trading in the US, which saw leading executives like Rajat Gupta, the former head of McKinsey implicated in the case, was done after regulators started tapping the phones of many corporate honchos who they suspected were involved in insider trading.

Further, the fact that insider trading is rampant in the corporate world is an open secret which not many people would acknowledge in public. This is the reason why it is more the reason for stringent action against insider trading as it not only harms the reputations of the companies but also gives the people involved in the activity an unfair advantage that the ordinary investors would not have.

Insider Trading by the Investing Community

Apart from these aspects, insider trading is an activity that is also done by stock traders and many investors who use their contacts within the industry to gain advance information about the stock movements and the upcoming announcements.

In Asian countries, it has been the case that the market regulators have been lenient insofar as insider trading is concerned because of the magnitude and the scope of the issue, which extends its tentacles into virtually every company. However, the recent crackdown has brought to the fore the need for stringent action in other countries as well which has translated into many companies seeking non-disclosure agreements from their employees about the knowledge they might have about inside information.

Concluding Thoughts

Further, the other ways and means to curb insider trading would be for companies to restrict the number of people with access to privileged information and at the same time, monitoring the activities of those who they suspect could be indulging in insider trading.

Finally, many companies are now asking their employees not to trade in the stocks of their companies without prior permission from the compliance department and this is seen as a move to have control over insider trading by employees. It is hoped that these moves along with other strategies would restrict if not eliminate the menace of insider trading.