In your view is insider trading a serious moral problem? Explain why or why not.
ID: 470254 • Letter: I
Question
In your view is insider trading a serious moral problem? Explain why or why not. Should we legalize insider trading, as some argue, and simply let different companies decide how they want to deal with the issue? (At least 500 word reply)
Please read the below case to answer this question:
“Insider Trading or Astute Observers?”
In 2009, Federal authorities broke up The biggest insider-trading ring ever. Originally focused on the Galleon Group hedge fund, the investigation soon unraveled a complicated network of nearly two dozen traders, analysts, and lawyers at several different companies who were engaged in a criminal conspiracy to buy insider information, usually about pending corporate acquisitions. Using throw-away cellphones to avoid detection, they had netted $20 million in illegal profits. Allegedly at the center of it all was ringmaster Zvi Goffer of the Schottenfeld Group and later Galleon, nick- named “Octopussy” because his arms reached out to so many sources of information. Among those caught up in the federal dragnet was a senior vice-president at IBM, Robert Moffat, who had been induced by his lover into divulging confidential information, which she then passed on to the head of Galleon Group.
Since that case, the Securities and Exchange Commission (SEC) has been pushing hard against securities fraud in general and insider trading in particular, using informants, wiretaps, and sophisticated software tools to make a num- ber of prominent arrests. “Illegal insider trading is rampant and may even be on the rise,” says Preet Bharara, the U.S. attorney in Manhattan. A main target of recent investigations has been the so-called “expert network firms” that arose in response to an SEC rule in 2000 that banned companies from selectively divulging significant information, such as upcoming earnings reports, to favored analysts. These firms purport to offer “independent investment research” but routinely deliver inside information on revenue numbers and sales forecasts. In Bharara’s view, however, it’s not just about the prosecuting the big fish on Wall Street: “The people cheating the system include bad actors not only at Wall Street firms, but also at Main Street companies.” However, some think the SEC is now pushing too hard and too far.
Take the case of Gary Griffiths and Cliff Steffes, who worked in a rail yard owned by Florida East Coast Railways in Jacksonville, Florida. The SEC charged them with making more than $1 million by trading on inside information, specifically, on the information that their company was going to be sold. How did they do it? After all, one of them is a mechanical engi- neer, the other a trainman—not your usual corporate insiders. The answer is simply that they were observant. According to the SEC, the two noticed that “there were an unusual number of daytime tours” of the rail yard with “people dressed in busi- ness attire.” Although they were not told anything, officially or unofficially, Griffiths and Steffes had a hunch that something was up. Along with members of their families, they bet that a deal was in the works by buying tens of thousands of call options on the company’s stocks. That gave them the right to buy the stock at its current price at some future date. (Purchasers of call options make money if the stock increases in value because they can then buy it at its earlier, lower price. If the stock decreases in value, then the buyers simply don’t exercise the options; they’re out only whatever they paid for the options.) In this case, when Fortress Investment Group acquired Florida East Coast Railways, the value of the latter’s stock shot up, and Griffiths, Steffes, and their families were able to cash in big-time.
Critics of the SEC say that it is going beyond making sure that insiders are not abusing their positions or violating their fiduciary duties. Joel M. Cohen, a partner at the law firm of Gibson, Dunn & Crutcher, has written that the SEC is moving from “deterring and punishing those who abuse special relation- ships at the expense of shareholders into a murkier area . . . [of] policing general financial unfairness.” Other business observers agree with him that the SEC shouldn’t focus on trying to make the markets “feel” fair to everyone.
For its part, the SEC contends that Gary Griffiths and Cliff Steffes were more than just observant. After the tours began, they had heard “rail yard employees . . . expressing concerns that [it] was being sold, and that their jobs could be affected by the sale.” It also claims that Griffiths was asked to make a list of all the locomotives, freight cars, trailers, and containers owned by the company, along with their current value, something he had never been asked to do before. “Is all of that material information?” asks New York Times business columnist Andrew Ross Sorkin. “Clearly, it is nonpublic. But without being told directly that a deal was in the works, did the men actually have inside information? What would have happened if there had been no deal? Or if the company was later sold for a price below its prevailing stock market value?” And as Joel Cohen points out, in most cases, “if you overhear something and divine from the conversation that Party A is about to buy Party B, and you buy Party B, that’s fine. You can do that.”
On the other hand, both Griffiths and Steffes had signed the company’s code of conduct, which states that employees can- not trade on or disseminate material nonpublic information. So maybe they breached a fiduciary duty after all. Or maybe they were just alert employees, who happened to be good guessers and—until the SEC showed up, anyway—very lucky.
Update
After the SEC charged Griffiths, Steffes, and four members of Steffes’s family with insider trading, Griffiths and one of Steffes’s relatives signed agreements with the SEC to avoid prosecution. Although neither admitted guilt, they agreed to pay fines of $120,000 and $240,000, respectively. The other defendants went to trial in 2014 but were acquitted by a jury.
Explanation / Answer
Insider trading can be defined as the act of conducting a transaction (buy or sell) in a company’s share on the basis of material information with regards to the company. An important thing to remember here is that the material information on the basis of which shares of an organization is being bought and sold should be nonpublic information and confidential information. For example, if a stock broker has bought large number of shares of a pharmaceutical company on the basis of information that the company would be purchased by a larger pharmaceutical company. This information is still non-public and the broker got this confidential information from one of the directors of the company. When the company was bought by the larger company, the stock price rose by 20% and the broker made substantial profits.
Now, in the above case the act of the broker is illegal as he had purchased the shares on the basis of a piece of information that has not yet been made public. Had the broker bought the shares after the deal was announced by the company his actions would not have been considered illegal.
I firmly believe that insider trading is a serious moral problem, besides being illegal. The person who is indulging in insider trading is doing so for the sole purpose of profiting from a piece of material information that is still undisclosed.
Having said that it is important to note here that all insider trading is not illegal. Insiders like employee of an organization can engage in legal trades in the stocks of the company in which they are employed. However, these trades will have to be reported to the SEC.
The basic principle of insider trading is that any person who is in possession of a material and undisclosed information should not indulge in trading on the basis of such information. If insider trading is legalized it would be unfair to the public at large as they will be in a position of disadvantage when compared to the position that the insiders are in. This makes for a strong case against legalizing insider trading. However, the SEC should be careful in dealing with cases of insider trading. Not all trades being made by employees are illegal. In the case of Gary Griffiths and Cliff Steffes, they were not tipped or were informed about the possible sell off of Florida East Coast Railways. They merely observed and analyzed that there is a possibility that their company will be sold in the future. They purchased call options of Florida East Coast Railways and profited from the rise in the stock’s price after the company was sold off. This cannot be considered as an insider trading. One of them worked as a mechanical engineer and the other as a trainman. They were not privy to any undisclosed information and their decision was based on their hunch.
I would reiterate that insider trading is both a moral and a legal problem and it should never be legalized. Legalizing it would be unfair to the public at large who do not have access to undisclosed information. Having said that, the SEC has to determine the facts on a case basis and should judge each case on its merits and facts.