Analysis of public policy
The need for public policy with regards to insider trading can easily be understood by looking at the case of Mitchel S. Guttenberg. The 42 year old was an executive director at UBS. He and his wife lived quite nicely on his salary, an apartment in Manhattan, and a $1 million home in the Hamptons. The Gutenberg’s were top donors to Learning Leaders, a charity that provides tutoring services for New York City public school children. However, while living his life as the model banker, Guttenberg has been accused of padding his $300,000 annual salary with the proceeds of selling confidential stock research.
On March 1, 2007, federal prosecutors charged him with masterminding the insider trading scheme in which he allegedly tipped of traders to upcoming ratings changes on hundreds of stocks, while allowing them to trade ahead of the news. Authorities say that Guttenberg received his inside information from his position on a committee at UBS that signed off on all upgrades and downgrades. (Business Week, 3/26/07, p40-40) Another global insider trading case comes from a Hong Kong firm, Blue Bottle, who is accused of netting over $2.
7 million in trading on information that it gathered by hacking directly into computers in order to view press releases before they were published. However, this is not the most egregious case of recent days. That title goes to a ring of 13 bankers and fund managers, who according to the SEC were trading illicitly ahead of mergers and analysts’ stock-tips. The bankers come from such firms as UBS, Bear Stearns and Morgan Stanley. According to some in the industry, this is the biggest bust since 20 years ago when Ivan Boesky was jailed and fined $100 million.
(Economist. 10 March 2007. Vol 382. p71-72) Insider trading usually falls under the jurisdiction of the federal government, most notably the SEC, but also involves state and local governments as well as other governments from other countries. For instance, in Singapore, a Bill was passed in Parliament in January of 2000 in a move to combat insider trading and to level the playing field in the securities industry. The Bill however, it has not been approved by the President and as a result has not been put into force. The Bill includes provisions that will:
1. to enhance the penalties which may be imposed on a person convicted of insider trading; 2. to allow the imposition of a civil penalty on a person who has contravened section 103 within six years of the contravention; 3. to extend the time limit within which a civil action for compensation must be brought from two to six years from the time of the contravention; 4. to allow recovery of compensation and penalties without having to first secure a criminal conviction; and 5. to allow contemporaneous traders to claim compensation.
When the Bill comes into force the penalties in section 104 of the Act will be enhanced from S$50,000 and S$100,000 to S$250,000 and S$500,000 respectively. (http://www. lawgazette. com. sg/2000-2/Feb00-40. htm) The SEC has also moved to amend the current laws with regards to insider trading. They have also passed new rules as mentioned before that will make it more difficult for insiders to actually get away with trading on proprietary information. The new regulations that have been put into place by the SEC provide for increased benefits with relation to insider trading.
The Regulation FD provides benefits to investors and the securities market as a whole. First, by forcing the issuer to publicly disclose material nonpublic information, it keeps investor confidence high. Another benefit of Regulation FD is that of actually keeping transaction costs down and will make investors more willing to commit their capital. Economic theory and empirical studies have shown that stock market transaction costs actually increase when certain traders may be aware of material, undisclosed information.
(SEC Final Rule, p28) Finally this ruling will place all analysts on the same playing field with respect to competition for access to material information. (SEC Final Rule, p28) Although the new regulation has substantial benefits for the issuers, it does come at a cost. Issuers will incur additional costs in making the public disclosures of material nonpublic information required by the regulation. Based on the approximate number of 13, 000 issuers which will be affected by the regulation, it can be estimated that each filing of disclosure will incur an additional $762. 50.
On an annual basis, it is approximated that the yearly cost will be between $34,937,500 and $49,562,500. (SEC Final Rule, p29) It is also predicted that the regulation will also lead to increased costs for issuers as a result of the new or enhanced systems and procedures that they must now follow. These increased costs come as a result of the issuers having to either develop new or enhance current systems in place which are designed to safeguard against selective disclosures that are not intentional, which will ensure prompt public release when these disclosures do occur.
Another cost that may or may not actually materialize is the cost of overall market efficiency and capital formation. This cost of efficiency would come to fruition in the case of corporate individuals chilling as to their disclosures to analysts, investors, and the media. With regards to Rule 10b5-1, there are two significant benefits that are anticipated. The first benefit is that it should increase investor confidence in relation to the fairness and integrity of the market as the rule clarifies and strengthens the existing insider trading law.
Secondly, the rule will benefit corporate insiders, by providing greater clarity on how they can structure securities transactions in the future. (SEC Final Rule, p32) Rule 10b5-2 provides additional benefits with regards to insider trading. The first benefit is that the rule will provide much more clarity to the law of when a family relationship will create a duty of trust. In addition, the rule will address an issue with the current law when a family member receives material nonpublic information and they may exploit it without violating the prohibition against insider trading. (SEC Final Rule, p33).
There are significant issues that have been raised by the public with relation to insider trading. The SEC has requested comments on three certain issues regarding: (1) the number of small entity issuers that may be affected by the proposed regulation and rules; (2) the existence or nature of the potential impact of the proposed regulation and/or rules on small entity issuers discussed in the analysis; and (3) how to quantify the impact of the proposed regulation and rules. (SEC Final Rule, p35). The comments that were received however only pertained to Regulation FD and not to Rule 10b5-1 and Rule 10b-2.
The comments that were received regarding small entities were the method by which the “public disclosure” occurred. The comments were centered on the fact that there are certain circumstances of the issuer that should be recognized. This commenter noted that it may be difficult for small entities in obtaining coverage in the public domain. This individual recommended that public disclosure should welcome website posting as a legitimate way of disclosing information. Recommendations In looking at the entire capital market as a whole, it is imperative that the recommendations of the new SEC rulings be put into place and further enhanced.
In enhancing these rules further with regards to insider trading, it will continue to bolster investor confidence on the global level and also on a more local level. With banks continuing to tighten their internal checks, they must always be leery of the individuals who are chosen to “watch the store” so to speak. An example of this goes back to the ring of 13 bankers and other employees who were recently arrested for their major insider trading behavior. As a pundit explained it, it was “like the head of the CIA turning over secret info to Osama bin Laden.
” (Economist, 10 March 2007, Vol 382, p71-72) To clarify, banks and other corporations should continue to enhance the internal procedures that they have been place, but they must also remember that the procedures are only as effective as the people who put the procedures into practice. In order to move forward with tightening the ability for individuals to pursue insider trading, we, as a community, must understand that insider trading is extremely hard to quantify. Although it is hard to quantify, we must not be under the illusion that it is uncommon; on the contrary, it is extremely common.
The increase I mergers has provided more opportunities to make a dishonest buck ahead of these mergers. According to the SEC, suspect trading patterns that have been filed have doubled over the past two years. While the issue of insider trading is unclear and filled with grey, it can be regulated. In order to regulate insider trading, fine lines must be drawn. For instance, when does asking for feedback on interest among institutional clients for an upcoming financial deal become something more sinister? The SEC relies on algorithmic programs in order to see unusual peaks and valleys in trading transactions.
Although these programs are cutting edge, proving intent requires good old-fashioned detective work. (Economist, 10 March 2007, Vol 382, p 71-72) Conclusions Insider trading has become one of the biggest white collar crimes that not only the United States has had to deal with but the world as a global community. Through research it has been demonstrated that no one, nor one country is safe from insider trading at any level. Insider trading is a global issue and all countries must form a united front against these individuals who deem it necessary to pad their own pockets, while the average individual must work even harder to make ends meet.
The penalties that are imposed must be stricter on all fronts with regards to insider trading and corporations must adhere to policies and procedures to stop this disease from spreading further.
References Business Week. Article. Markets: Still Jittery. 19 March 2007. Issue 4026, p34-35 Datamonitor. Industry Profile. Global Capital Markets. 2006 April. www. datamonitor. com. Economist. Article. Hints, tips, and handcuffs. 10 March 2007. Vol. 382 Issue 8519, p71-72. Goldstein, M. UBS: Notes on a Wall Street Scandal. Business Week. 26 March 2007. Issue 4027, p40.
Investment Dealers’ Digest. Keeping Tabs on the Hedgies. Vol. 73. Issue 10. p4-11. Roberts, B. Electronic Business. Growing Pains. 2002 May. Rosen, R. ,C. The CPA Journal Online. An Accountant’s Guide to the SEC’s New Insider Trading Regulations. (Accountant’s Liability). 2 April 2007. http://www. nysscpa. org/cpajournal/old/13808667. htm. U. S. Securities and Exchange Commission. Final Rule: Selective Disclosure and Insider Trading. Release Nos. 33-7881, 34-43154, IC-24599, File No. S7-31-99. 2 April 2007. http://www. sec. gov/rules/final/33-7881. htm.