Insider Trading Regulations: Are They Effective?
Created by Christa
Purpose of Insider Trading Regulations
To halt the use of insider information to make stock
transactions (Seyhun 149). This includes buying or
selling securities while committing fraudulent
Insiders with this kind of information can make a
huge profit or save themselves from tremendous
loss, while the public cannot react to this information
because they don’t have access to it.
Insider trading regulations strive to make the
financial markets fair for everyone.
This program benefits the general public and anyone who
invests in the stock market. People do not want to be involved
in the market if it is biased towards insiders who use
information illegally (SEC-bounties).
Insider trading regulations put everyone on an equal level and
encourage full disclosure of all information important to the
market with acts such as the Sarbanes-Oxley Act of 2002
The bounty program benefits those who turn in insiders.
Though they do not always receive a bounty, they often get a
portion of the fines paid to the SEC (SEC-bounties).
Any law passed by Congress that governs the SEC (such as
the Sarbanes-Oxley Act of 2002) is a part of the program (SEC-
The bounty program through the SEC is included as well (SEC-
bounties). This program allows for people to apply for a bounty
when they turn in cases of insider trading.
Case law is also important to the program (Seyhun 151).
All companies must follow these laws or suffer severe
punishment if convicted by the SEC (SEC bounties).
Is the program justified?
The program is necessary to ensure equality in the markets.
The markets cannot be efficient if only a handful of those
involved know what is going on.
The stock market is an important part of the US economy. The
government is involved to make sure it is fair.
If insiders follow the private decision rule, and their costs are
lower than the costs to society, then a market failure will occur.
Therefore, it is justified for the government to make sure that
markets run efficiently and fairly (Mrozek 3).
The intended effect is for insider trading to be
reduced (Khan and Lamba 4).
The program also strives to make the
It is important to note that the intended effects are not achieved
through the trading regulations!
The most important unintended effect is the boost in frequency of
insider trading. It increased substantially (nearly 30%) during the
1980’s, when the SEC and Congress were coming down hard on
insiders (Seyhun 162).
Not only did the frequency increase, but the profitability did as well
(Seyhun 162). Insiders who chose to break the law were reaping the
benefits more than ever before.
Khan and Lamba also found that before and after the Insider Trading
Sanctions Act was passed in 1984, insider trading was not significantly
One way to improve the program is to
fine companies when their employees
are found guilty of insider trading. This
would encourage companies to
increase their awareness program and
prevent employees from breaking the
law (Bettis et al. 10).
The problem is . . .
Some would argue that this is unfair to
the company. Should they be held
responsible for the actions of one or a
The SEC could completely take away
the ability of insiders to trade (Bettis et
al. 10). This would ensure that no one
is using information that they are not
The problem is . . .
Although we could now ensure that insiders
are not taking advantage of information, it
would be discriminatory for them to not be
able to trade at all.
This solution would take away any
attractiveness about employee stock
inventive programs (Bettis et al. 10).
Require that companies have insider trading
awareness programs. This way, the companies
could better ensure that their employees are
following the law (Bettis and Chang 3).
The companies would not be creating programs just
because they had to pay a fine (reference to
recommendation 1). They would have to make sure
their employees are informed.
The problem is . . .
The most apparent problem with this
program is that companies might have to
take on some extra costs to implement the
program. However, if it saves them from
being fined due to employee insider trading
later down the road, these costs will be worth
The Martha Stewart Trial
Fortunately for Martha, the judge decided not to charge her with
insider trading (WNBC-TV 4).
However, it seems suspicious that Martha sold stock for
$228,000 the day before the FDA disapproved a cancer drug
made by ImClone Systems, in which she held a lot of stock
The CEO of ImClone Systems, Sam Waksal, was convicted of insider
trading and will spend 7 years in prison for it (WNBC-TV 2).
The Martha Stewart Trial
Juror Hartridge comments,“Maybe it’s a victory for the little guys who
lose money in the market because of these kinds of transactions”
Martha will likely spend anywhere from 10 to 24 months in prison for
her actions (Appleson 2).
During Hardball with Chris Matthews, the former Chairman of the SEC,
Harvey Pitt, talks about the implications of the Stewart trial, saying,”
The government’s going to go after you. That’s a positive” (Hardball
Though the end of the 20th century was not encouraging regarding
reductions in insider trading due to increased regulations, perhaps
after the popularity of this trial, more people will obey the law.
Negative Cost Externality
Positive Benefit Externality of Bounty Program
“The Laws That Govern the Securities Industry” U.S.
Securities and Exchange Commission website. Retrieved
on March 21, 2004 from
“Insider Trading: Information on Bounties” U.S. Securities and
Exchange Commission website. Retrieved on March 21,
2004 from http://www.sec.gov/divisions/enforce/insider.htm.
(2004) “Martha Stewart Guilty of All Counts In ImClone Case”
WNBC-TV. Retrieved on March 21, 2004 from
(2004) “Former SEC chair on the Martha Stewart verdict” MSNBC TV.
Transcript from Hardball with Chris Matthews. Retrieved on
March 22, 2004 from http://www.msnbc.msn.com/id/4466848/.
Appleson, Gail. “Experts say Martha Stewart faces tough appeal”
MSNBC Wire Services. Retrieved on March 22, 2004 from
Bettis, J. Carr and Stanley Y. Chang. “Insider Trading Regulations”,
Internal Auditor. Vol. 53, Issue 1, February 1996. p53-56.
Seyhun, H. Nejat. “The Effectiveness of Insider-Trading Sanctions” ,
Journal of Law and Economics. Vol. 35, No. 1 (April 1992), p149-
Mrozek, Janusz R. “Market Failures and Efficiency in the Principles
Course. Journal of Economic Education. Vol. 30, No. 4 (Fall
Bettis, J. Carr, et al. “The Effectiveness of Insider Trading
Regulations” , Journal of Applied Business Research.
Vol. 14, Issue 4 (Fall 1998).
Khan, Walayet A. and Asjeet S. Lamba. “The Effectivness
of Legal Sanctions in Curtailing Insider Trading:
Evidence from Exchange Listings”, Quarterly
Journal of Business and Economics. Vol. 40, Issue 1,
(Winter 2001). p3-16.