Insider trading has been a controversial issue ever since the beginning of the stock exchange, and this ethical minefield has sparked many debates. Some people believe that having access to all kinds of information is just one way to make better decisions. For others, everyone should have a level playing field when it comes to buying and selling shares of stock. Over the years, many people have been caught and found guilty of insider trading, and some of them are even famous.
An Introduction to Insider Trading
Insider trading is simply the buying or sharing of a publicly owned company by people who have access to confidential information about said company. These insiders are often the company’s owners, officers, directors or business partners who know the company inside out. Insider trading can actually be both legal and illegal. It can be legal if the beneficial parties trade shares without using information that is non-public. After all, nobody is better qualified to gauge the health of the company, than those who are working in that organization. In the US, anybody who owns 10% of company’s stock is required to disclose any trades they make to the SEC.
Illegal insider trading is what comes to mind for most people when they think about insider trading. After all, cases of illegal insider trading have been sensationalized by the media.
Insider trading is against the law if the trader makes one’s buying or selling decision based on non-public information obtained while performing one’s fiduciary duty to the company.
This is considered a breach of trust and a failure of corporate governance. If the insider ends up stealing information, then corporate espionage can also be added to the list of crimes.
Raj Rajaratnam and the Galleon Group Insider Ring Scandal
Based in New York City, the Galleon Group was one of the biggest hedge fund management companies in existence. The firm, at one time, was managing more than $7 billion worth of investments. The company shared its name with one of the biggest classes of sailing ships used by Europeans hundreds years ago. Raj Rajaratnam was the captain steering the Galleon Group.
The investors of the Galleon Group were pleased because they were enjoying excellent returns. Unbeknownst to them, there were a number of illegal activities taking place without their knowledge. Raj Rajaratnam was participating in insider trading, and he had many informants providing him with tips and news that had the potential to earn him millions.
One of Rajaratnam’s most important informants was Anil Kumar, who worked at one of the top consulting firms in the world, McKinsey & Company. Kumar was able to provide a wealth of information gathered from McKinsey’s extensive client list. Another high-profile informant was Goldman Sachs director Rajat Gupta who provided Rajaratnam with insider information from the investment bank’s board meetings.
Suspecting the Galleon Group of insider trading, the authorities decided to wiretap the phones and listened in to Rajaratnam’s conversations with his informants. Ultimately, the various officers of the hedge fund were found guilty of fraud and insider trading. Over fifty people, some of them non-Galleon employees, have been found or have pleaded guilty. The Galleon Group closed in 2009, and Raj Rajaratnam was sentenced to eleven years in prison.
How to Avoid or Prevent Insider Trading
Of course, it is important to gather as much information as you can before you make the decision to buy or sell shares of stock. However, you sometimes end up getting more than you bargained for and might be innocently doing some insider trading. Here are some tips so that you can avoid any illegal insider trading activities.
- Double check your broker’s stock tips
Don’t take your broker’s advice as golden. You have to still do some research of your own to verify that your broker is steering you in the right direction. A simple web search will tell you whether the information he has passed on to you is available to the public.
- Take care in questioning potential insiders
If you know someone who works for the company you are investing in, be careful when it comes to asking questions about the company. You don’t want to probe so deep that they accidentally divulge confidential information.
- Ask the proper authorities
If you are not sure whether or not the stocks in your portfolio were obtained through insider trading, the best option is to report it to the proper authorities such as the SEC. That kind of goodwill can go a long way. It will give the impression that you do not have any sinister motives when you traded those stocks.
- Allow yourself to be audited
Being audited is the kiss of death for some people. However, auditors are definitely good at verifying information. If you considered to be an insider and are unsure about the stocks in your portfolio, have an auditor double check your trades.
- Enforce insider trading policies
You might not be trading illegally, but if one of your team members is, you might also be held responsible. You should create policies for dealing with information and make sure that everyone involved in your trades understands these policies and that no one trades outside what is considered legal by the regulating bodies.
What are your opinions on insider trading?