Introduction to Economics                                                   Lesson 18 / 07



The announcement on Friday by BHP-Billiton, the world’s biggest mining company, that it had made an offer for its rival Rio Tinto, the worlds fourth biggest miner, made news around the globe.  If successful it would create the world’s fourth biggest company, behind PetroChina, ExxonMobil, and General Electric. 

Rio's shares in Australia rose 15% on the day.  More interesting to some however was the news that its price had begun to rise steeply on international stock markets, several hours before the official public announcement in London, suggesting strongly that the news had been leaked and that there had been significant insider trading.  The Australian Stock Exchange was reported as looking into this aspect, as a matter of course.


What is Insider Trading?

Insider trading is a concept which is easy to describe and define generally but which can be difficult to do specifically or precisely. Although a large number of countries, probably the majority, have laws against insider trading, a significant number do not.  Amongst those who do, the definition of what is insider trading varies, as does the seriousness with which it is viewed, and the effort put into such law’s enforcement.  Thus, for example, in the UK, negative insider trading, ie where a person acquires information that would be considered insider information, but which information such person then uses not to make a trade which he or she otherwise would have done, is not considered illegal.  This is presumably because of the added difficulty of proving a negative.  Other countries make no such distinction.

The USA and the Anglo-Saxon countries generally, including Australia, are amongst the leaders in opposition to insider trading.  In Australia, the provisions relating to it are found in the Corporations Act, which devotes a considerable number of pages to it and provides a definition of sorts.  Many institutions and major companies have their own formal Insider Trading Policy.  The Monash University Insider Trading Policy, for example, summarises the definition of insider trading as follows;

“ Insider trading is improper trading in securities on the basis of price sensitive information that is not generally available to others.”  It goes on to note that “It includes procuring or inducing another person to buy or sell securities about which insider information is known.”

One does not have to be a lawyer to see the potential judicial problems inherent in such definition.  What is, for example, “improper trading”?   Or “price sensitive information” or “ insider information”?   Since the potential penalties are fines up to $200,000 and five years imprisonment these are serious questions.

It follows that insider trading as such is concerned with trading in or of a corporation’s stock or other securities.  The ASX maintains a special unit to monitor the market.  If unusual activities occur it will conduct an inquiry and can refer the matter to the Australian Securities & Investment Commission, which has broad powers of investigation.  It is suggested that the ASX will conduct a routine investigation if there is a one-day price movement in a security of 10% or more.

If a person is charged with an offence of insider trading, the problem widens from one of definition to include questions of proof.   It is said that insider trading is easy to detect but difficult to prove.  Between 1985 and 2005, 32 persons were charged with insider trading but only 9 were convicted.  Earlier this year ASIC unsuccessfully brought a major charge in the Federal Court against Citibank, the world’s second biggest bank.  


Some cases of Not e

Perhaps indicative of the inherent difficulties in conducting a prosecution for insider trading, two of the more recent notable cases, often thought, by the public, to be insider trading cases, were in the event, not insider trading cases at all; these were the Steve Vizard case in Australia and the Martha Stewart case in the USA.

Steve Vizard was a successful TV entertainer and businessman.  It was alleged that in 2000 as a director of Telstra he had misused information he had acquired from his position as such to deal in shares in 3 public companies thereby making a relatively small profit.  However, to much criticism, the Commonwealth Director of Public Prosecutions declined to prosecute him criminally for insider trading.  He was subsequently tried in 2005, in a civil proceeding, for breach of his duties as a company director, and was fined $390,000 and disqualified from directing a company for 10 years.

In the Martha Stewart case in the USA, Stewart also, like Vizard, a successful TV personality and entrepreneur sold some shares she owned shortly before the company announced some devastating news which caused a steep drop in its share price.  Since Stewart was friendly with the president of the company it was assumed he had leaked the news to her beforehand.

Initially Stewart was sued for insider trading in a civil proceeding by the Securities & Exchange Commission, the American equivalent of ASIC, but this was dismissed.  However in the course of the proceedings Stewart made statements and did things for which she was subsequently charged with making false statements and obstructing the course of justice.

At the trial, the judge dismissed the principal charge; namely that she had publicly declared her innocence and hence had committed fraud.  However the jury convicted her of the other charges and she was sentenced to gaol.


Some Reasons why it should be Illegal

·         Insiders in a company have been implicitly entrusted by the company with access to information to be used by them for the benefit of the company and not for the benefit of the insider.  There exists an implicit duty not to breach such trust.  Any benefit derived by the insider trader belongs to the company, which has been fraudulently deprived of it by the insider.

·         It is dishonest and morally wrong, and hence a fraud, to engage in a trade when you are possessed of inside information, which you are aware, the other party does not possess.  Whilst asymmetric knowledge trading will always occur, the law should do what it can to prevent it.

·         Anti insider trading laws encourage investment in the market since it reassures investors and gives them confidence that the law will protect them from the ‘sharks’.


Some Reasons why it should not be Illegal

·         Insider trading facilitates the market process since it enables and encourages speedy dissemination of information.  It gives those most likely to have information, namely insiders, an opportunity to use and benefit therefrom.  The likelihood of major corporate disasters, such as HIH is much reduced since insiders will want to use the information of its likely occurrence, sooner rather than later, and hence will expose such potential major disasters before they occur.

·         Insider trading is a victimless act.  There is no way the law can preclude trading between parties with asymmetric knowledge and to purport to do so merely inhibits the working of the market to the ultimate detriment of all.

·         To make laws to prevent people from using the information they possess, in the absence of a readily discernible victim, is contrary to human nature and will merely bring the law into disrepute.

·         Similar activities such as insider trading in real estate or commodities are not burdened with such constraints.


                                     David Sharp

                                        12 November 2007







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