The purpose of insider-trading laws is to prevent people who have information – ‘insider’ or ‘unpublished’ information – that is not available to all market participants from benefiting at the expense of others.
Parth J Shah (see References, below) writes:
‘The countries that have stringent insider-trading laws and stronger enforcement, like United States and Australia, have rather low rates of prosecution and even lower rates of convictions. There have been only six prosecutions in last ten years in Australia... Research by Professor Michael Adam of the University of Melbourne suggests that between five to 10 percent of securities trading in Australia would be classified as insider trading as per the existing laws and definitions.’
An indication of the difficulty in proving insider trading, as suggested by Professor Adam, is illustrated in a report in The Age on 3 June 2004:
‘Two brothers who made $10 million profit on derivatives based on AMP shares the day after National Australia Bank announced its bid for the insurer will not be pursued for insider trading and can keep the money, a parliamentary committee was told yesterday. The Australian Securities and Investments Commission said there was not enough evidence to bring an action, despite an intense joint investigation with NAB. The executive director of enforcement, Jan Redfern, told the Senate Committee on Economics: ‘I agree that the circumstances of the profits created some suspicion. However, we had to establish that there is possession of insider information and we could not establish that.’
On 9 July 2004 it was reported in the Herald Sun that two West Australian businessmen, who together face more than 300 counts of insider trading, plus counts of communicating inside information and money laundering, will defend charges brought against them by the Australian Crime Commission, claiming they are victims of a witchhunt.
Now read the following case study (drawn from the US Gitman site, see References, below) and answer the questions at the end.
Ethics: Insider trading over the Internet
You don't have to be a member of the Board of Directors to engage in illegal insider trading. John J. Freeman, a part-time temporary word processor at two investment houses, learned all he needed to know from the desks of co-workers, garbage cans, and from making copies of documents that discussed impending mergers and acquisitions. Even though the documents referred to the companies involved by code, Freeman was able to learn their true identity by piecing together their industry, historical stock prices, names of officers, and geographic location.
Once Freeman knew who and when, he disseminated the information to friends, family, and anyone who would listen via an Internet chat room under the name ‘TheBren’. What Freeman did not know is that among his many listeners were members of the Securities and Exchange Commission (SEC), the FBI, and federal prosecutors. In fact, at any given time, 100 specially trained SEC employees are surfing the Net, visiting chat rooms, and reading message boards looking for illegal inside traders. When they identify a red flag, they forward the information to the Office of Internet Enforcement, a special division of the SEC who helps build cases to pursue criminal charges and/or civil lawsuits.
The SEC is not the only surveillance group out in cyberspace. The exchanges monitor trading activity as well. In fact, the American Stock Exchange was the organisation who originally identified a problem when they noticed unusual trading patterns prior to the public announcement of these mergers and acquisitions. Once the SEC was notified, it was only a matter of time.
Freeman directly told at least 10 people, but as with any valuable secret, the information spread like wildfire. A friend of Freeman's, a waiter at a New York restaurant, made over $285 000. He told a patron who profited by at least $445 000, which was certainly more than he earned in his former career as a schoolteacher.
While his friends made millions of dollars, Freeman was more conservative and profited by only $70 000–$110 000, plus various non-pecuniary benefits such as cases of wine. This seems to be a small gain given the hefty fines and prison time that is certain to follow.
It seems the Internet is affecting the stock market in all sorts of ways, both good and bad. It remains to be seen if the perceived anonymity of the Internet acts as a breeding ground for the conveying of private corporate information. One thing is for certain, however, the SEC is readying itself by continual efforts and manpower devoted to policing cyberspace.