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Curbing the Immorality of Insider Dealing

Insider trading is an act indulged in by select knowledgeable few for higher profits. As the participation by investors in the stock markets is with the aim of garnering higher returns, insider dealing will always have supporters as well as critics. However, for the sake of propriety and giving a level playing field to all participants, as well as stability against volatility in the stock market, it is necessary to regulate greed.  A stock market will be vibrant and act as a barometer of the health of the economy only if the participation is all-encompassing. This is only possible if there is investor confidence in the market across the investor spectrum.

It is evident that laws pertaining to insider dealing are grossly inadequate but mostly act as a deterrent. Detection of offence and offenders indulging in it is also a complex process. Strict imposition of regulations to curb insider dealing besides being impractical would also not prove to be cost effective. Moreover, the makers of law are unsure of the fact that whether it is such a big offence, or to quote simply, even if it is an offence at all, other than the ‘immorality and unfairness factor”. It is true that business should be on the basis of fair principles, but it is also true that the market is not only about “morality”. It is about making use of the right information at the right time. However, having an unfair informational advantage over other market participants by virtue of being primary or secondary insiders does not give a level playing field to all participants but is also against the business ethics. Hence, the author opines that there should be a mid way so as to curb insider dealing while keeping in mind other factors.

 

Wittman, Carlton and Fischel, attach great importance to Coase’s analysis that, benefits of insider trading depends on the value attached to the information is more valuable to the manager of the firm or the investors of the firm. The maximum valuing user should have the property right of the information which is required to be worked out by both parties to ensure maximum value is accrued out of the information available. If the analogy of banning insider trading is justified it can be assumed that property right of information in the hands of the firm’s investors will benefit both the firm’s insiders and investors. However, the allocation of property right in information, to the maximum valuing user is not a physical negotiation process between insiders and investors. Investors need to be aware of the likelihood of insider trading and if a maximum value allocation is reached then both the managers’ compensation as well as the share prices will be higher.

The author suggests that there should be an autonomous monitoring agency to monitor the transactions of insiders. The members of the agency should be independent nominees of the investors. For the sake of transparency, a modality should be worked out wherein insiders are required to declare their financial gains pertaining to trades from their own and their associated firms. This would be a confidence building measure for investors knowing fully well that their representatives are monitoring insider transactions. However, it is easier said than done, hence, it is recognized that the requirement of a detailed feasibility of implementing has to be worked out.

 

Professor Brudney reflects on the principle that dictates the disclosure or refrain rule. He summarizes that, if, information parity is not available to all parties regardless of their source, such transactions must not be permitted.  The principle given by Professor Brudney is a good way to prohibit the insiders from trading on insider information, as it gives clear limitation to using this information by a select few.

 

If implemented “Pre-trading Disclosure” rule under which a corporate insider makes public his order to the broker before he places such order, is a cost effective way to rationalize profits of corporate insider trading. The information being in the public domain all parties including dealers, market makers, public investors would have the information to weigh this against other parameters available with them and arrive at a price they are willing to buy or sell. This will restrict corporate insider’s capability as a group to reap gains from insider trading, also this pre-disclosure will give the desired results at a nominal cost to the Government.

The main grounds of prohibiting insider dealing are based on the fact that it is immoral and unfair. Policies relating to prohibition of insider dealing have been a subject of debate since long. The academicians on either extremes of the debate have given their opinions on the subject of prohibiting insider dealings. However, if insider dealing is left completely unregulated it would be against business ethics and unfair to the small shareholders, who seen as a group bring in substantial wealth, investing their savings for higher returns.

In discussing the ills of insider dealing as is derived in various research , it is deduced that stock markets thrive with participation from all quarters, from the smallest individual investors to large investors, whose combined buying and selling activities create the demand and supply of stocks which ultimately drives the stock market and determines the price of stocks. An act of insider trading on inside information results in higher profits for the insider at the cost of outsiders. Insider dealing if prevalent and unchecked discourages and frightens away small investors / outsiders, which is against the grain of a healthy stock market.

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