Insider Trading Regulations Are

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					Insider Trading Regulations: Are They Effective?

                       Created by Christa
                       ECON 4353
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
    activities (SEC-laws).
   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.
                    Who benefits?

   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
    (SEC-laws 4).
   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).
               Intended Effects

   The intended effect is for insider trading to be
    reduced (Khan and Lamba 4).

   The program also strives to make the
    markets fair.
                 Unintended Effects

   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
    reduced (13-14).
           Recommendation 1

   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
    few employees?
            Recommendation 2

   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
    supposed to.
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).
             Recommendation 3

   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
    (WNBC-TV 2).
   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”
    (WNBC-TV 1).
   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
Coasean Solution
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

(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

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
   1999), p411-420.

 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.