This week, we had an interesting time in our Business Ethics class discussing on the topic of insider trading especially from the perspective of how it affects an organization. In this blog post, I will be sharing with you some thoughts about insider trading. We shall begin by looking at the meaning of insider trading and then conclude with the reasons why insider trading is an unethical practice.
By a way of definition, insider trading is the purchase or sale of stocks and securities by someone with information that is material and not in the public domain. Insider trading occurs primarily when a director or employee of a company buys or sells shares of that company on the basis of confidential information which, once it becomes public, is likely to have a significant impact on the price of the shares (Cf. Business Ethics, Technical Note, No 23, Insider Training). In other words, insider trading involves taking an undue advantage of a privileged or classified information that is not yet in the public domain. A good example of insider trading would be a situation where an employee with a telecommunication company for instance finds out that his company has won a huge multi-million contract. The employee immediately gives out the information to another person or buys shares in the company and when the news of the huge contract is made public, the shares of the company rise and he makes a huge profit. Such an action is both illegal and unethical.
The illegal and unethical nature of insider trading stems from the fact that the person who engages in the selling and buying of a security is in possession of material non-public information. Also, another thing that makes insider trading unethical is that it causes a great harm to the shareholders of the company, to whom the insider owes fiduciary obligations. A fiduciary is a person or an organization that makes financial decisions on behalf of another party who is legally obligated to act in their client’s best interest. Fiduciaries duties which companies owe their shareholders include duty of care, loyalty, good faith, confidentiality, prudence, and disclosure. Insider trading breaches these duties and roles and makes it unable for shareholders to trust a company.
Furthermore, insider trading also has a way of harming the company itself by disclosing through their actions the news that the company wanted to keep secret for the time being. This is likely to disrupt the plans of the company. Again, insider trading adversely hampers the efficient functioning of the stock market. It makes transaction cost higher and reduces the returns of the investors. When this is the case, investors will lack the needed motivation to invest more in such a company.
In all, insider trading is an unethical and illegal practice. It is an action against the law and the ethics of business. It is a kind of investment fraud as it violates the insider trading law (the law which exists to preserve trust and confidence in the securities markets), and undermines the trust of the public on financial system.
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