According to a recent article in The Economist, incidents of insider trading continue to grow on Wall Street, despite attempts to curb such activity. The Economist report cites two academic studies; the first maintains that inside traders profited even during the global economic crisis; the second suggests that the entire share-trading system is rigged.
With concerns about insider trading dogging corporations around the world, business leaders find themselves in the position of trying to play defense against a number of tricky and unsavory possibilities that include the following:
- How do we guard against those moments when temptation proves too much?
- What warning signs might exist that flag certain trades or sales?
- How can we know who among our employees is in the possession of information that might be considered sensitive?
- How can we educate our employees so they know the letter of the law before they break it accidentally?
As reported by Brittany De Lea of Fox Business, insider trading 'carries potential penalties including a maximum prison sentence of up to 20 years, maximum criminal fine of up to $5 million, and maximum fine for corporations of up to $25 million.' In addition, civil penalties may rise as high as three times the amount of profits gained or losses avoided by the unlawful trades.
As steep as these penalties may seem, they do not take into account the reputational damage that insider trading does to the organization as a whole. More so than some other crimes, insider trading reflects back onto the culture of the entire organization, and can plant seeds of doubt within the minds of investors and clients, effectively tainting the entire brand through the actions of a single individual.
The Unfair Trade
When does trading in company stock cross the line into criminal activity?
The difference between insider trading and legal trading can sometimes be difficult to spot. For example, according to Andrew Sebastian of Investopedia, it is not illegal for a company's directors, employees or management to trade their company's stock, even if they have special knowledge that might affect the price of the stock or the overall value of the organization. All these company traders need to do is report those trades to the Securities and Exchange Commission (SEC). The SEC, in turn, reports those trades to the wider public.
What is illegal is when a company's employee or representative shares the nonpublic, material information with friends, family or fund managers for the purpose of influencing their stock trades and purchases. Likewise, when a non-company employee, such as a government regulator or an employee at an accounting firm, law firm or a brokerage, uses material, nonpublic information to take advantage of the market, this is insider trading. Material, nonpublic information is any information that may change a stock's value that is not disclosed to the general public. Such information may include the following:
- The intention to launch a takeover bid, auction, public offering or stock repurchase.
- A pending resignation or dismissal of a senior executive.
- A pending significant purchase or sale.
- A pending significant legal or regulatory proceeding or settlement.
- A pending earnings release that is inconsistent with expectations.
Defining the Insider
Within the context of insider trading, there are actually two types of insiders:
company insiders and temporary insiders. Company insiders might include corporate executives, general managers, public relations officers, brokers, bankers and corporate lawyers, who, through the execution of their duties, might be in the possession of material, nonpublic information.
Temporary insiders include the many individuals who might be connected to a company insider and learn of privileged company information that way. These might be spouses or other family members, or friends or associates of company employees. Regardless of how such an individual came into possession of material, nonpublic information, he or she is considered a temporary insider and is barred from trading on that knowledge.
Entity Management Technology Can Help By Tracking Insider Trading
Communication and Control. While it might be impossible to control the actions of temporary insiders, companies should do their best to keep track of all of their company insiders. Entity management technology can keep the wider organization informed of which individuals now have access to sensitive information and keep those individuals aware of which restrictions are now placed upon their trading activity. This can ensure that no trades are attempted due to a lack of understanding or miscommunication. Since employees change positions and directors change roles, keeping this list current is vitally important. With entity management technology, such changes can be made across the organization from a single, secure database.
Automating Pre-clearance. As we noted above, not every employee trade of company stock is considered insider trading. To ensure your employees retain their abilities to legally trade company stock, your organization can establish an automated pre-clearance system. Entity management technology will screen each trade for suspicious activity and block those that fall outside established parameters.
Instituting Blackout Periods. During periods of market sensitivity, many organizations establish a trade blackout, particularly for employees who have access to material, nonpublic information. These blackout periods might coincide with the release of quarterly results, the announcement of a major product change, or the settlement of any legal or regulatory proceedings. Entity management technology can be used to automate these blackout periods for specified employees.
Monitoring and Tracking Employee Trades. While it is not recommended to track all employee trades and purchases, it may be wise to monitor the trading records of key employees, particularly during times of market sensitivity. In the past, this sort of tracking was done manually, after the fact, and involved trying to match employee data to trading records and then trying to factor in changes in the market and possible losses and gains. This laborious process was less than exact and always time-consuming. Entity management technology can now monitor these situations as they happen, reporting on employee trading in light of changing market news and providing you with the information you need to determine whether or not such trading constitutes a risk.