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Techniques used in insider trading on Wall Street

Question:

Discuss about the Comparative Business Ethics Of Galleon.

Insider trading calls into questions issues or legality and morality based on ethical considerations. The action taken when using insider information, should be analyzed from the perspective of whether the outcomes can lead to an illegality or not. The action could be legal but not ethical. It could also be illegal yet ethical. Regulators, executives and investors have an important role in reducing the use of insider information within their spheres of authority. Varied implications can arise when nonpublic information is used in trading company stocks. Investigations into cases involving insider trading require secrecy in order to reduce interference and tampering with the evidence. This is critical in successful prosecutions which serve as a deterrent for fund managers from taking similar paths and actions.

Insider traders in Wall Street use a number of techniques in order to gain information which is considered nonpublic (US SEC 2017).  These range from sifting through the garbage of the target company in which the information is being sought. Disgruntled employees are also used to give information about their companies either with financial inducement or out of malice. Moles are also planted within companies with the aim of collecting confidential information. Persons of high rank who are privy to confidential documents are also corrupted out of avarice in order to leak news before it is made public. The above techniques of collecting information are common in Wall Street. Regulator, investor and executives can undertake the following measures in order to reduce such practices.

The main regulator tasked under the law is the Securities and Exchange Commission. The regulator can push for the reform of the insider trading law as currently stated. The law is weak in setting out the penalties that can be meted out to those found to be culpable.  The law is weak in substance but expansive in theory. Defense lawyers capitalize on this shortcoming when representing offenders who have been found guilty of breaching its tenets. Eisenberg & Gates (2017) state that in the ruling of Salman v United States, the Supreme Court refused to accept the theories set out as having no basis in law. Strengthening the law would give the regulator more authority in successfully prosecuting such cases. Stiffer penalties and sentencing would act as the deterrent that would curb the illegal techniques of gathering information.

Regulatory measures to reduce insider trading

Investors often make choices to invest after receiving information from financial advisors who operate in Wall Street. Some of these entities are in actual fact nothing more than illegal information gathering shops. These advisors form part of the intricate labyrinth within Wall Street that propagates the continued use of techniques that are illegal when gathering information. Investors can help curb such practices by undertaking due diligence to establish how such financial advisors gather their information. Seeking the SEC in cases where they need confirmation is advisable before engaging such firms. This will help reduce the use of such practices and which is the basis of insider trading. This will also help to protect the funds they have been tasked with investing.

Executives can reduce this vice from two perspectives. The first perspective is where the executive is leading a firm engaged in trading shares or managing funds. Having a strong and clear organizational policy on insider trading is important. It should spell out the boundaries of trading together with penalties applicable for breaches. Sherwood (2012) states those blackout periods should be included in such a policy. This includes periods such as before companies release material information or the release of quarterly earnings. Limitations on how employees can dispose of their shares will also reduce the practice of insider trading by making it difficult to gain from selling their company stocks. Adopting share plans which are automatic by the executives is a good starting point.

The second perspective for executives is where they are leading companies that are actively traded on the stock exchange. To ensure that their employs are not enticed by external players to engage in such practices, creating a conducive working environment is encouraged. Providing leadership that promotes equity and fairness will ensure that no employees are disgruntled and who may decide to sell confidential company information. Promoting and instilling work ethics will also reduce the probability of such occurrences at the workplace. Regular screening of employees in order to identify moles should be encouraged. Improving security and ensuring confidential company documents are safeguarded or properly destroyed will also assist in reducing this vice in Wall Street.

One of the implications of sharing insider information is with regards to stocks which are traded. The information used to buy or sell shares on the stock exchanges distorts the true reality and value of the market and distorts market forces. The market forces are the fundamental stabilizing foundations that ensure stability in the market. Smith & Block (2016) assert that artificial manipulation of the market dynamics creates instability that can lead to market crashes. Artificial and inflated value is given to stocks without backing based on market fundamentals. Trading based on insider information can result in market crashes it is discovered that particular company shares are inflated artificially. Sabin (2009) states that a good example occurred in 1920, when the actions of J.P Morgan & Co precipitated the market crash that triggered the Great Depression.

How investors can help curb insider trading


Another implication of sharing confidential material information is that it has the potential to harm investors. In the event that the material facts being shared are false, making decisions based from that stand can lead to massive losses. This is the basis of ponzi schemes and scams within companies. Some information which is passed on is intentionally misleading. It is given with the aim of triggering a domino and cascading effect that is capitalized by a select few (Walsh 2017).  On getting such information and passing it on with cross checking is dangerous and unethical. It creates culpability on the person sharing such information. This is despite the person involved not gaining personally from such material facts. Overland (2017), posits that it therefore can lead to one being enjoined in civil and criminal proceedings despite having innocently passing on such facts off the cuff.

The other critical implication of sharing confidential knowledge about a stock is that it is intricately linked with the larger financial market and the economy at large (Witter 2016).  Third parties may take out a bank loan to purchase the stocks which they think will appreciate. In the case that the stock does not appreciate but plunges down puts the bank at risk as it holds stock which is not worth its value. When this occurs on a massive scale due to several thousand people buying at the same time, banks may ultimately fail and need to be rescued. The instability in the financial institutions may cause ripple effects that affect the whole economy. Thus insider trading has the implication of harming the economy of a nation at large.

Knowing information that is nonpublic changes the dynamics when one is trading a stock from three perspectives. The first reasoning that will guide the decision taken will be based on ethical grounds in not trading such a stock (Ferrel, Fraedrich & Ferrel 2017).  The ethical principle of rights and duties is appropriate in this particular situation (Xu & Ma 2016). The senior manager to whom I report to has the right to the information in my possession in order to give directions on how to proceed. I also have the right to privacy in controlling the way I control the material facts about the stock. I should exercise good judgment and discretion as a trader. With the rights come duties such as the duty to act truthfully, with integrity and to do justice. The concept of not causing harm to others will also guide me in handling a stock of which I am privy to confidential information.

How executives can reduce insider trading


The second reasoning that will guide my actions is based on institutional guidelines on such incidences. This will be in the form of the existing company policy that articulates the circumstances, sensitivity and size of outcomes of trading in such a stock (Governance Institute of Australia 2014).  The terms set out in the employment contract that spell out obligations of confidentiality should also contribute to the decision that will be made. Lenkey (2014) states that apart from the confidentiality agreements which are internal, similar arrangements with external stakeholders should be taken in consideration in making taking a holistic position. If the company whose stock is being traded actively and purposely leaked information to their advantage, the lack of a confidentiality agreement should not lessen the ethical position that may influence me.

The third perspective is that of trading the stock as a stock holder. In the event that selling the stock will substantially benefit me, I have to balance the outcome with ethical considerations. Based on the theory of consequentialism, weighing the outcomes of the action taken is critical. Will my action result in minimizing harm and maximizing benefit or the vice versa (Andric & Tanyi 2016).  The altruistic position would be ideal in this situation in that it will lead to benefiting others even at my personal cost. I may miss out in benefiting financially but will help in a small way in reducing the overall domino effect of selling simultaneously by similar stockholders. This action helps reflect the true value of the stock for other holders.

The employment of secret investigation by SEC is helpful in successful prosecutions that lead to convictions. The investigation which uses methods such as wiretaps and informers helps to keep the investigation confidential and minimizes interference (Chang 2012).  The principal persons being investigated may derail the investigation if a formal investigation is launched. They may tamper with the evidence by destroying incriminating documents in their possession. Witnesses who may testify against them stand to be intimidated or even eliminated. Witnesses are often forced to cooperate with the prosecutors in order to lessen their part in the case through plea bargaining. They may alternatively be coerced by monetary gain to refuse to testify. Secret investigations avail more material facts and information that leads to successful convictions.

Secret investigations help to reduce the propensity by fund managers and investors from divulging nonpublic information. The lack of knowledge as to whether they are being investigated helps to keep in such persons in check and to be in compliance with company policy and laws that regulate insider trading. This in effect makes everybody who can engage in such practices a target and potential suspect. The unspoken implications are clearly spelt out in the outcomes of cases that have been concluded. The penalties exacted coupled with the prison sentences serve as the deterrent that works to reduce the practice of insider trading. Friedrich (2016) asserts that the precedent set helps keep in check organizational malpractices when using nonpublic information.

Implications of insider trading on the stock market

The investigation that is secret also helps to reduce the bonds that are normally prevalent within Wall Street. The hedge fund industry is run by a tightly knit group of persons. Most of them attended the same schools for the elite and are family friends. Ahern (2017) states that the ability to penetrate such networks and circles is difficult due to the deep loyalties that holds toward each other. The only way that investigators can breach such loyalties is through the use of covert means such as wire tapping. Such persons within the group can quickly find out suspicious outsiders. Taking time to ingratiate moles in such situations is difficult and takes up too much invaluable time in the investigation. Thus secret investigations quicken the process, saves manpower and resources.

Conclusion

The Galleon case serves to present the potential outcomes that are associated with insider trading. Insider trading involves using nonpublic information to make personal gain when trading stocks. The investigator and regulator used secret means of investigating which yielded successful outcomes. Executives, investors and regulators can get engaged proactively in order to reduce this vice within organizations. Being privy to such confidential material information, calls for one to make decisions based on ethics and morality as well as company policy. The outcomes of this particular case set the precedent that deters future criminality in using insider information. This is based on the use of private investigations that considers fund managers as potential suspects to be investigated.

References

Ahern, KR,  2017, 'Information networks: Evidence from illegal insider trading tips', Journal of Financial Economics, vol. 125, no. 1, pp. 26-47. Available from: 10.1016/j.jfineco.2017.03.009, viewed 20 September 2017.

Andri?, V, & Tanyi, A, 2016, 'Multi-Dimensional Consequentialism and Risk', Ethical Theory & Moral Practice, vol. 19, no. 1, pp. 49-57. Available from: 10.1007/s10677-015-9658-5, viewed 20 September 2017.

Chang, A., 2012, Wall Street wiretaps: investigators use insiders’ own words to convict them, viewed 20 September, https://www.npr.org/2012/12/26/168021457/wall-street-wiretaps-investigators-use-insiders-own-words-to-convict-them>

Eisenberg, J., & Gates, L, 2017, Insider trading law after Salam, viewed 20 September, https://corpgov.law.harvard.edu/2017/01/18/insider-trading-law-after-salman/>

Ferrel, O., Fraedrich, J., Ferrel, L., 2017, Business Ethics: Ethical Decision Making & Cases (11 Ed), CEngage

Friedrich,  EK,  2016, 'Insider Trading After Newman : The Impact on Financial Institutions', Journal of Taxation & Regulation of Financial Institutions, vol. 29, no. 4, pp. 23-30.

Governance Institute of Australia, 2014, Handling confidential market-sensitive information: Principles of good governance, viewed 20 September, < https://www.governanceinstitute.com.au>.

Lenkey, SL, 2014, 'Advance Disclosure of Insider Trading', Review of Financial Studies, vol. 27, no. 8, pp. 2504-2537.

Overland, J 2017, 'Insider Trading, Materiality and the Reasonable Person: Who Must Be Influenced for Information to Have a "Material Effect"?', Australian Business Law Review, vol. 45, no. 3, pp. 213-228.

Sabin, G, 2009, 10 Folks who got rich during the Depression, viewed 20 September, < https://edition.cnn.com/2009/LIVING/08/20/mf.fortune.depression/>

Sherwood, M, 2012, How to prevent insider trading in your ranks, viewed 20 September, https://beta.theglobeandmail.com/report-on-business/careers/business-education/how-to-prevent-insider-trading-in-your-ranks/article4239232/?ref=https://www.theglobeandmail.com&>

Smith, T, & Block, W, 2016, 'The Economics of Insider Trading: A Free Market Perspective', Journal of Business Ethics, vol. 139, no. 1, pp. 47-53. Available from: 10.1007/s10551-015-2621-5, viewed 20 September 2017.

US SEC, 2017, Fast answers: Insider trading, viewed 20 September, https://www.sec.gov/fast-answers/answersinsiderhtm.html>

Walsh, J, 2017, '"LOOK THEN TO BE WELL EDIFIED, WHEN THE FOOL DELIVERS THE MADMAN": INSIDER-TRADING REGULATION AFTER SALMAN V. UNITED STATES', Case Western Reserve Law Review, vol. 67, no. 3, pp. 979-997.

Witter, N, 2016, 'Insider Trading and Newman Applied: Goldman Sachs', Review of Banking & Financial Law, vol. 36, no. 1, pp. 144-158.

Xu, Z, & Ma, H, 2016, 'How Can a Deontological Decision Lead to Moral Behavior? The Moderating Role of Moral Identity', Journal of Business Ethics, vol. 137, no. 3, pp. 537-549. Available from: 10.1007/s10551-015-2576-6. [20 September 2017].

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