tag:theconversation.com,2011:/fr/topics/insider-trading-1440/articlesInsider trading – The Conversation2023-08-24T12:34:06Ztag:theconversation.com,2011:article/2102422023-08-24T12:34:06Z2023-08-24T12:34:06ZInsider trading − the legal kind − is a lot more profitable if you work for a multinational company<figure><img src="https://images.theconversation.com/files/543824/original/file-20230821-27-r6197f.jpg?ixlib=rb-1.1.0&rect=119%2C83%2C7821%2C5214&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The most in-the-know insiders earned three times as much as the typical investor in any given month.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/photo/close-up-of-hands-of-businesswoman-analyzing-stock-royalty-free-image/1330143303?phrase=stock%20trading">Witthaya Prasongsin/Moment via Getty Images</a></span></figcaption></figure><p>Corporate insiders who trade stocks based on the information they gain on the job earn a lot more if they work at multinational corporations than their peers at U.S. companies with no sales abroad. That’s the <a href="https://doi.org/10.1111/eufm.12415">main finding of our new peer-reviewed research</a>. </p>
<p><a href="https://www.law.cornell.edu/wex/insider_trading">Insider trading</a> happens when a director or employee trades their company’s public stock or other security based on important or “material” information about that business. Insider trading isn’t illegal as long as the person <a href="https://www.sec.gov/Archives/edgar/data/1164964/000101968715004168/globalfuture_8k-ex9904.htm">reports the trade to the Securities and Exchange Commission</a> and the information is already in the public domain. </p>
<p>We wanted to know if multinational insiders stand to make more money because of the complexity of the information they could possess relative to outsiders. </p>
<p>So we examined returns from <a href="https://www.sec.gov/dera/data/form-345">over 2.5 million trades</a> reported to the SEC from 1987 to 2019 by insiders at over 10,000 companies. This is only a subset of all insider trades reported during the period because we focused on only those transactions most likely to be informed by the employee’s insight. We then compared monthly returns for insiders at multinational and domestic companies with those for a typical investor. </p>
<p>We found that all insiders beat the market, but those at multinationals did better – especially if they were on the highest rungs of the corporate ladder. While insiders at domestic companies typically obtained a return of 2.4% in the month following a stock purchase, those at multinational corporations reaped 2.8%. That may not sound like a lot, but, assuming consistent returns, it could amount to earning $170,000 more if an insider traded $1 million over several months. And it’s triple the <a href="https://pages.stern.nyu.edu/%7Eadamodar/New_Home_Page/datafile/histretSP.html">typical stock market monthly gain of 0.9%</a></p>
<p>The most in-the-know insiders – executives and others with the most intimate knowledge of the company and its operations – at multinationals got an even bigger advantage, earning 3.6% per month vs. 2.7% at domestic companies. </p>
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<figcaption><span class="caption">Gordon Gekko may be the most famous (fictional) inside trader.</span></figcaption>
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<h2>Why it matters</h2>
<p>Insider trading is familiar to most people from movies that portray it in criminal terms, such as <a href="https://www.investopedia.com/terms/g/gordon-gekko.asp">Gordon Gekko</a> of “Wall Street.” In the film, he makes millions off others’ inside information. </p>
<p>But even when it is legal, insider trading is very profitable. That’s because insiders <a href="https://doi.org/10.1016/j.jfineco.2014.09.005">trading on public information</a> are more knowledgeable about their industry and process information more effectively than outside investors. </p>
<p>With global companies, the advantage of being an insider increases. Since multinational companies generate earnings in foreign countries, with different currencies, <a href="https://doi.org/10.1016/j.jcorpfin.2021.101917">cultures</a>, economies and <a href="https://doi.org/10.1093/rfs/hhv039">operating environments</a>, it can be hard for an outsider or analyst to <a href="https://doi.org/10.1093/rof/rfw070">accurately value the company</a> and its stock price. This is especially true when the company does business in regions that are culturally and linguistically distinct from the U.S. This helps insiders trade more efficiently, by buying underpriced stocks at a bargain and selling them later for a windfall. </p>
<p><a href="https://doi.org/10.1016/0304-405X(76)90026-X">Companies often motivate their employees</a> to work harder by offering them a stake in their success, but if insiders seem to be getting an unfair advantage over ordinary investors, it may undermine trust in financial markets. The size and profitability of such trades – particularly in light of our data – mean regulators and policymakers may want to consider whether new restrictions on insider trading are needed, such as placing additional limits on the timing or frequency of trades. </p>
<h2>What other research is being done</h2>
<p>Scholars, including us, are pursuing many avenues of research on insider trading, such as <a href="http://dx.doi.org/10.2139/ssrn.3844986">how insider trading restrictions are determined</a> and <a href="https://doi.org/10.2308/TAR-2020-0799/11072">how insider trades inform markets when news is limited</a>. We’ve recently conducted research on how insider trades by colleagues at the same company <a href="https://www.doi.org/10.1111/jfir.12172">tend to cluster together</a>, and we are currently looking at how innovation affects insider trading.</p>
<p>Another recently published project relates to how information is incorporated into stock market prices and <a href="https://doi.org/10.1287/mnsc.2022.4332">how investors underreact to news</a> that may affect insiders’ ability to trade profitably. Similarly, ongoing research uses a GPT language model to assess the complexity of business regulatory filings and financial statements by <a href="http://dx.doi.org/10.2139/ssrn.4480309">analyzing technical jargon that can confuse investors</a>, which could also affect how outside investors understand stock prices compared with insiders.</p>
<p><em>The <a href="https://theconversation.com/us/topics/research-brief-83231">Research Brief</a> is a short take about interesting academic work.</em></p><img src="https://counter.theconversation.com/content/210242/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Executives and other high-level inside traders at US companies with global sales earned about three times as much in a month as the average investor, a new study found.D. Brian Blank, Assistant Professor of Finance, Mississippi State UniversityDallin Alldredge, Assistant Professor of Finance, Florida International UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2051802023-05-08T12:19:57Z2023-05-08T12:19:57ZWhat is insider trading? Two finance experts explain why it matters to everyone<figure><img src="https://images.theconversation.com/files/524789/original/file-20230507-15-rcy73r.jpg?ixlib=rb-1.1.0&rect=140%2C126%2C4548%2C2952&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Financier Ivan Boesky was the real-life inspiration for Gordon Gekko of 'Wall Street.'</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/le-financier-ivan-boesky-en-avion-au-dessus-de-new-york-le-news-photo/999012440">Yves Gellie/Gamma-Rapho via Getty Images</a></span></figcaption></figure><p><a href="https://www.investopedia.com/terms/i/insidertrading.asp">Insider trading</a> is the term used to describe the illegal act in which someone relies on market-moving, nonpublic information to decide whether to buy or sell a financial asset.</p>
<p>For example, say you work as an executive at a company that plans to make an acquisition. If it’s not public, that would count as inside information. It becomes a crime if you either tell a friend about it – and that person then buys or sells a financial asset using that information – or if you make a trade yourself. </p>
<p>Punishment, if <a href="https://www.investopedia.com/articles/investing/021815/how-sec-tracks-insider-trading.asp">you’re convicted for insider trading</a>, can range from a few months to over a decade behind bars.</p>
<p>Insider trading became illegal in the U.S. in 1934 after Congress passed the <a href="https://www.investopedia.com/terms/s/seact1934.asp">Securities Exchange Act</a> in the wake of the <a href="https://www.investopedia.com/terms/s/stock-market-crash-1929.asp">worst sustained decline in stocks in history</a>. </p>
<p>From Black Monday 1929 through the summer of 1932, the <a href="https://www.federalreservehistory.org/essays/stock-market-crash-of-1929">stock market lost 89% of its value</a>. The act was meant to prevent a whole litany of abuses from recurring, including <a href="https://www.investopedia.com/articles/stocks/09/insider-trading.asp">insider trading</a>. </p>
<p>While insider trading typically involves trading stocks of individual companies based on information about them, it can involve any kind of information <a href="https://www.cnbc.com/2023/05/05/jobs-report-april-2023-job-growth-totals-25300-in-april.html">about the economy</a>, a commodity or anything else that <a href="https://www.cnbc.com/2022/02/09/stock-market-futures-open-to-close-news.html">moves markets</a>.</p>
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<figcaption><span class="caption">Insider trading was dramatized in Oliver Stone’s 1987 classic movie “Wall Street.” Here, ruthless financier Gordon Gekko explains why information is so valuable.</span></figcaption>
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<h2>Why insider trading matters</h2>
<p>Insider trading is not a victimless crime. People trading on inside information benefit at the expense of others.</p>
<p>A key characteristic of well-functioning financial markets is high liquidity, which means it is easy to make large trades at low transaction costs. But when traders fear losing money to counterparts with inside information, <a href="http://dx.doi.org/10.2139/ssrn.276179">they charge higher transaction costs</a>, which leads to less liquidity and lower investor returns. And since a lot of people have a stake in financial markets – <a href="https://www.federalreserve.gov/publications/files/scf20.pdf">about half of U.S. families own stocks</a> either directly or indirectly – this behavior hurts most Americans.</p>
<p>Insider trading also <a href="https://ssrn.com/abstract=249708">makes it more expensive</a> for companies to issue stocks and bonds. If investors think that insiders might be trading bonds of a company, they will demand a higher return on the bonds to compensate for their disadvantage – increasing the cost to the company. As a result, the company has less money to hire more workers or invest in a new factory.</p>
<p>There are also broader impacts of insider trading. It <a href="http://dx.doi.org/10.2139/ssrn.3645579">undermines public confidence</a> in financial markets and feeds the common view that the odds are stacked in favor of the elite and against everyone else. </p>
<p>Furthermore, since inside traders profit from privileged access to information rather than work, this makes people believe that <a href="https://ethics.org.au/wp-content/uploads/2019/02/The-Ethics-Centre_180410-on-trust-and-legitimacy.original.pdf">the system is rigged</a>. </p>
<figure class="align-center ">
<img alt="Martha Stewart, flanked by U.S. Marshals, leaves court" src="https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=533&fit=crop&dpr=1 600w, https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=533&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=533&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=669&fit=crop&dpr=1 754w, https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=669&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=669&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Martha Stewart was found guilty of insider trading in 2004.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/EnronMirageEconomy/3101174e18964ced96e4e87edc376790/photo?Query=Martha%20stewart%202004&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=7&currentItemNo=6">AP Photo/Bebeto Matthews</a></span>
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<h2>Hard to prove</h2>
<p>Research shows that <a href="https://dealbook.nytimes.com/2014/06/16/study-asserts-startling-numbers-of-insider-trading-rogues/">insider trading is common and profitable</a> yet <a href="https://knowledge.wharton.upenn.edu/article/why-insider-trading-is-hard-to-define-prove-and-prevent/">notoriously hard to prove and prevent</a>. </p>
<p>A recent study estimated that <a href="https://dx.doi.org/10.2139/ssrn.3764192">overall only about 15% of insider trading</a> in the U.S. is detected and prosecuted but suggested more of it is coming to light in recent years because of increased enforcement.</p>
<p>One of the more famous – and few – examples of insider trading being prosecuted was the <a href="https://www.chicagotribune.com/sns-ap-martha-stewart-chronology-story.html">2004 conviction</a> of businesswoman and media personality Martha Stewart for <a href="https://www.sec.gov/news/press/2003-69.htm">selling shares based on an illegal tip</a> from a broker.</p>
<p>The sudden collapse of several banks in 2023 <a href="https://www.forbes.com/sites/nicholasreimann/2023/05/05/first-republic-bank-executives-reportedly-under-investigation-for-possible-insider-trading/">has also caught the attention of authorities</a>. The Securities and Exchange Commission is reportedly investigating executives at both Silicon Valley Bank and First Republic Bank, which was seized and sold on May 1, for potential insider trading. </p>
<p>And, so, the cat-and-mouse game between regulators and those who want to game the system continues.</p>
<p><em>This is an updated and shortened version of an <a href="https://theconversation.com/link-176940">article that was originally published</a> on Feb. 18, 2022.</em></p><img src="https://counter.theconversation.com/content/205180/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The SEC is investigating whether executives at First Republic Bank, which was seized by regulators and sold to JPMorgan Chase, improperly traded on inside information.Alexander Kurov, Professor of Finance and Fred T. Tattersall Research Chair in Finance, West Virginia UniversityMarketa Wolfe, Associate Professor of Economics, Skidmore CollegeLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1928522022-11-09T19:00:10Z2022-11-09T19:00:10ZFor richer, for poorer: how married CEOs are less prone to risky investing and insider trading<figure><img src="https://images.theconversation.com/files/494008/original/file-20221108-18-f3jkre.jpg?ixlib=rb-1.1.0&rect=10%2C0%2C6699%2C4466&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>They say marriage teaches patience and understanding, but might it also be good for business ethics?</p>
<p>Apparently, yes. As our <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3991991">recent study found</a>, a chief executive’s home life can be a good indicator of whether or not they’ll engage in opportunistic insider trading. Married CEOs seem to take fewer risks with their investment decisions and are less likely to bend the rules than their unmarried counterparts. </p>
<p>Insider trading can be legal or illegal, depending on whether the trades are based on public or non-public company information. But profiting from insider trading can invite serious litigation if outside investors suspect executives have taken advantage of inside knowledge.</p>
<p>Understandably, then, there is a lot of interest in how executives’ personal characteristics and experiences might affect their management style. </p>
<p>Earlier <a href="https://pubsonline.informs.org/doi/abs/10.1287/mnsc.2014.1926">research has documented</a> how the marital status of CEOs relates to various aspects of their jobs, such as encouraging corporate social responsibility, the quality of financial reporting, and portfolio investment strategies. </p>
<p>However, these activities and outcomes may not be entirely driven by CEO decisions alone. In our study, we focused on identifying CEOs’ trading activity in their own companies’ shares. </p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/could-better-regulation-reconcile-trading-and-ethics-180442">Could better regulation reconcile trading and ethics?</a>
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<h2>Invested in their own business</h2>
<p>Corporate executives can invest a significant proportion of their personal wealth in their companies, and may be remunerated in company stocks on top of their own salaries. </p>
<p>Although CEO stock ownership has decreased over time in the US, on average, CEOs still hold 12% of company shares. This means managers sometimes have to trade stocks in their own firms, for a variety of reasons. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/an-ethical-workplace-culture-can-prevent-corporate-fraud-by-aiding-whistleblowers-191998">An ethical workplace culture can prevent corporate fraud by aiding whistleblowers</a>
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<p>But despite regulations designed to discourage insider trading, it is still hard for regulators and other investors to interpret those reasons: are the trades motivated by a legitimate need for liquidity or diversification, or are they informed by non-public information about the stock?</p>
<p>At the same time, the legal ambiguity and uncertainty about what constitutes an illegal trade also affects the decisions of would-be insider traders. Even when insider trading is technically legal, it still carries a threat of litigation from the US Securities and Exchange Commission (SEC).</p>
<figure class="align-center ">
<img alt="New York Stock Exchange trading floor" src="https://images.theconversation.com/files/494009/original/file-20221108-17-mi4wf.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/494009/original/file-20221108-17-mi4wf.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/494009/original/file-20221108-17-mi4wf.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/494009/original/file-20221108-17-mi4wf.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/494009/original/file-20221108-17-mi4wf.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/494009/original/file-20221108-17-mi4wf.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/494009/original/file-20221108-17-mi4wf.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">The trading floor of the New York Stock Exchange: trading on inside information disadvantages other investors.</span>
<span class="attribution"><span class="source">Getty Images</span></span>
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<h2>Marriage and insider trading</h2>
<p>Our study provides new insights into whether the marital status of a CEO has any bearing on their behaviour when trading company stock.</p>
<p>Looking at the trading behaviour of 1,100 heads of publicly listed companies in the US between 1996 and 2019, we found marital status seemed to have a significant influence on insider trading patterns. Overall, we found that:</p>
<ul>
<li><p>married CEOs earned significantly lower insider trading profits than their unmarried counterparts</p></li>
<li><p>married CEOs were less likely to engage in opportunistic trades (as opposed to routine trades) than unmarried CEOs</p></li>
<li><p>unmarried CEOs earned higher insider trading profit when they worked for firms with poorer corporate governance mechanisms or information quality. </p></li>
</ul>
<p>One possible explanation for this is that married CEOs are simply more likely to avoid insider trading because they don’t want to risk their jobs and let down their families by being prosecuted. </p>
<p>In other words, our findings suggest a CEO’s commitment to married life correlates with a lower appetite for risk. </p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/corporate-directors-dont-see-stopping-wayward-ceos-as-their-job-contrary-to-popular-belief-165788">Corporate directors don't see stopping wayward CEOs as their job – contrary to popular belief</a>
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</em>
</p>
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<h2>Marriage as regulator</h2>
<p>Insider trading can clearly be a path to increased personal wealth for CEOs because they can convert their equity shares into cash. </p>
<p><a href="https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.2012.01740.x">Research shows</a> insider traders can earn, on average, a 10% higher return compared to an average investor in a stock market index.</p>
<p>CEOs who use inside information for personal gain obviously create an uneven playing field that disadvantages other investors and stakeholders. So it’s useful to be able to identify characteristics that might predict an increased propensity for opportunistic behaviour.</p>
<p>If married CEOs display less opportunistic behaviour than unmarried CEOs, it suggests the social institution of marriage plays a positive – if under-examined – role in regulating trading behaviour at both an individual and corporate level.</p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/corporate-leadership-why-the-tone-at-the-top-has-moral-consequences-172134">Corporate leadership: Why the tone at the top has moral consequences</a>
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</em>
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<h2>Only one indicator</h2>
<p>While our study suggests a causal connection between CEO marital status and insider trading, it is not the sole indicator of likely behaviour. </p>
<p>Marriage merely helps determine an executive’s potential appetite for taking risks. In this context, it can be viewed as one of the traits (similar to education level or personality type) that correlates to such behaviours.</p>
<p>Our findings should not be interpreted as a prescription for corporate hiring policies. Risk-taking behaviour can also fuel innovation, drive momentum and help enhance company performance. </p>
<p>However, our study does provide evidence that marital and family commitment can be a good indicator of a CEO’s risk preferences – specifically as it applies to opportunistic insider trading and the subsequent risk of litigation.</p><img src="https://counter.theconversation.com/content/192852/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>New research suggests being married influences a CEO’s appetite for opportunistic insider trading and the subsequent risk of prosecution.Prasad Hegde, Lecturer in Finance, Auckland University of TechnologyNhut (Nick) H. Nguyen, Professor of Finance, Auckland University of TechnologyRui (Mary) Ma, Lecturer in Finance, La Trobe UniversityShushu Liao, Assistant Professor of Finance, Kühne Logistics UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1804422022-04-04T19:16:43Z2022-04-04T19:16:43ZCould better regulation reconcile trading and ethics?<p>For 30 years, financial scandals have been making front-page news. Among the most memorable were the fraud committed at <a href="https://www.cairn.info/revue-l-economie-politique-2015-4-page-89.htm">Barings Bank in 1995</a>, <a href="https://www.lemonde.fr/archives/article/1996/06/15/sumitomo-corp-est-victime-d-un-operateur-indelicat-sur-le-marche-du-cuivre_3729989_1819218.html">Sumitomo Bank in 1996</a>, <a href="https://www.nouvelobs.com/economie/20110919.OBS0651/ubs-kweku-adoboli-le-jerome-kerviel-de-l-annee-2011.html">UBS in 2011</a> and <a href="https://www.lemonde.fr/economie/article/2015/09/08/a-londres-bruno-michel-iksil-echappe-aux-poursuites_4681260_3234.html">JPMorgan in 2012</a>.</p>
<p>In France, the most notorious affair remains the scandal at Société Générale, which on 24 January 2008, announced a loss of 4.9 billion euros through unauthorised transactions by a young trader, Jérôme Kerviel. This loss is one of the biggest incurred by a single trader in financial history.</p>
<p>However, since the <a href="https://theconversation.com/fr/topics/jerome-kerviel-22012">“Kerviel affair”</a>, the behaviour of traders on stock exchange floors seems scarcely to have changed at all, despite increased regulation of markets and financial institutions.</p>
<p>Their behaviour has attracted much attention from the media, financial markets, universities, managers, and a general public unfamiliar with the trading world. Some observers characterise the behaviour of investment bank traders as unethical.</p>
<p>In a <a href="https://www.researchgate.net/publication/353194509_Organized_Decoupling_of_Management_Control_Systems_An_Exploratory_Study_of_Traders%27_Unethical_Behavior">July 2021 academic article</a>, we show the importance of the organisational and sectoral contexts in this (un)ethical behaviour.</p>
<h2>Lack of scruples perceived as an “asset”</h2>
<p>Most research into financial ethics adopts a quite narrow perspective on unethical behaviour that focuses on conformity and compliance with legal and moral standards. This perspective concentrates on individual actions and fails to grapple with the broader institutional context of investment banking.</p>
<p>Moreover, some <a href="https://www.taylorfrancis.com/chapters/edit/10.4324/9781315548067-5/irrelevance-ethics-alasdair-macintyre">researchers</a> argue that traders are by nature unethical people drawn to an industry, which itself is devoid of any sort of ethics. They indeed suggest that moral virtues are in fact contrary to what is demanded of traders in the sector.</p>
<p>It seems important not to be restricted by these two perspectives and, on the one hand, to study the context beyond that of investment banking, and, on the other, to think about the conditions encouraging unethical behaviour among traders. Investment banking is effectively a sector that is conducive to unethical behaviour. What is seen as unethical outside the banking sector is considered an asset or a <a href="https://journals.sagepub.com/doi/abs/10.1177/0018726718799404">desirable quality within it</a>.</p>
<p>In line with this view, we suggest that if the regulatory system does not seem to work despite being continually strengthened, this might be because it is not in fact intended to regulate traders’ behaviour.</p>
<p>According to our research, the monitoring systems have three design faults that prevent them from being able to control trader behaviour. We define these obstacles as physical, technical, and social distance.</p>
<p><strong>Physical distance</strong> refers to the fact that those monitoring traders are physically distant from them, in accordance with the principles of separation of duties, and of independence. There is also a <strong>technical distance</strong> between traders and financial regulators because the latter rarely master the technical aspects of the formers’ activity. Finally, the <strong>social distance</strong> between regulators and traders arises from the fact that the regulators’ social status (prestige, remuneration and legitimacy) is seen within investment banks as inferior to that of the traders.</p>
<p>Our research shows that the very design of the regulatory systems does not allow them to control trader behaviour effectively but instead creates an illusion of internal and external regulation. Our conclusions raise doubts about the role of such systems in surveying trading activities.</p>
<h2>Unworkable systems</h2>
<p>While this state of affairs exists despite the strengthening of regulations and assurances by banks that such deviations belong to the past, there are some ways we can try to improve the situation.</p>
<p>The first is to better distinguish the different kinds of regulation. We propose to make a distinction between those we might call “primary” and those that are “secondary” regulatory features.</p>
<p>The primary forms combine the three factors mentioned above – physical, technical, and social distance. The secondary forms present one or two of these distances at a time. In investment banking, they include <a href="https://www.investopedia.com/terms/r/riskmanagement.asp#:%7E:text=In%20the%20financial%20world%2C%20risk,of%20uncertainty%20in%20investment%20decisions.">risk management</a> and <a href="https://www.investopedia.com/terms/c/compliancedepartment.asp">compliance</a>. These secondary forms have little impact on either operations or trader behaviour. Changes to the rules are mainly aimed at secondary forms of monitoring.</p>
<p>Other regulatory features are less legal and formalistic, and more social. These primary checks are exercised at the heart of market activities, on the stock exchange floor itself. They involve desk officers and other traders and how they behave toward one another.</p>
<p>However, all ethnographic studies of the trading floor underscore that the social checks carried out there are mainly based on principles of <a href="https://www.dukeupress.edu/liquidated">competition and financial performance</a>, with little thought for the risks they entail.</p>
<p>The Kerviel affair is a perfect example of the importance of this kind of regulation. In this case, a first-line manager discovered the trader’s fraud and called him to order. This goes to show how important recent steps to strengthen the role of desk officers have been. Overseeing financial operations, these employees act not only as experts and peers but also as managers in physical proximity to traders. Their technical literacy and sense of authority empower them to keep dealers in check.</p>
<p>Nevertheless, technical supervision is insufficient when the manager does not have the expertise required to understand and directly supervise trading. This was the case of the manager in charge of the desk where Kerviel worked, who failed to grasp the anomalies’ nature or magnitude.</p>
<h2>Peer monitoring?</h2>
<p>Another important element is the permissive culture of trading floors, which values profitability and risk-taking more than respect for the rules and ethics. Thus, strengthening primary regulation requires that traders are adequately trained and socialised – in other words, a shift in the culture of stock exchanges. This would allow the sector to develop another primary check, exercised not by immediate superiors but by peers.</p>
<p>At present, such regulation exists in the sense that traders who watch one another are exercising social control. However, this mutual monitoring mainly has to do with the capacity of each trader to generate greater profits than the next. Indeed, this collective supervision permits and even pushes traders toward crime. Instead of prompting moderation, it encourages traders to take greater and greater risks, for themselves and others. This has everything to do with boasting, which often means showing fewer scruples than others, as evinced by the example of the former Goldman Sachs banker, Fabrice Tourre.</p>
<p>Tourre, who liked to go by the nickname of <a href="https://www.reuters.com/article/us-goldmansachs-sec-tourre-idUSBREA2B11220140312">“Fabulous Fab”</a>, sold structured securities to clients while hiding the fact that the creator of the stocks, Paulson & Co., had taken up <a href="https://www.sciencedirect.com/science/article/abs/pii/S0007681319300254">positions against the portfolio</a>. This desire to shine also partially explains the behaviour of Jérôme Kerviel, who was working in relatively low-return derivatives – a source of scorn among traders dealing in more profitable products.</p>
<p>Shifting such attitudes toward a less frenetic search for profit would have a decisive effect on the risks that traders create for their employers, their clients and the economy in general when the sums in question constitute a systematic risk, as was the case with the subprime loans.</p>
<p>What is at stake here is not just the internal culture of one bank or investment fund in particular, but more likely, a professional <a href="https://www.edhec.edu/fr/edhecvox/economie-finance/apres-milken-keating-madoff-kerviel-revisiter-l-ethique-dans-l-industrie-financiere">culture</a> shared by actors across the industry who put the pursuit of profit above all else and despite the risks involved. Therefore, the desired shift implies going beyond consideration of the individuals involved – the banks themselves must be encouraged to change. That change is still a long way off.</p><img src="https://counter.theconversation.com/content/180442/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Les auteurs ne travaillent pas, ne conseillent pas, ne possèdent pas de parts, ne reçoivent pas de fonds d'une organisation qui pourrait tirer profit de cet article, et n'ont déclaré aucune autre affiliation que leur organisme de recherche.</span></em></p>The regulatory apparatus designed to oversee investment banking is structurally flawed. To spawn ethical behaviour within traders will require nothing less than a sector-wide cultural change.Aziza Laguecir, Professeur, EDHEC Business SchoolBernard Leca, Professeur en sciences de gestion, ESSEC Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1769402022-02-18T13:07:37Z2022-02-18T13:07:37ZWhat’s insider trading and why it’s a big problem<figure><img src="https://images.theconversation.com/files/447130/original/file-20220217-6550-cyk6ud.jpeg?ixlib=rb-1.1.0&rect=17%2C28%2C1180%2C777&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Gordon Gekko of ‘Wall Street’ may be the fictional face of insider trading. </span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/gaynoir/5305214442/in/photolist-95NBqw-8eZzB4-2gaXVpL-s2fCsr-nFPuiD-ePa76m-sjMYy-e6jgdi-MRVMs6-5RK9Tv-XKREac-5RK9Mc-81RGna-auj3wz-5RK9H2-68vXMh-cYpQN7-Mz8LB4-97yw6Q-5p1xpr-7AHWLs-tzMsB-8hihSo-eH7ZqQ-eH1Vdz-5MUVGL-326JuL-5mEuYn-5a7HTp-4oursp-2jPZoFt-7KYrHv-2jP3Ezy-RNTZR-4ourhz-5J3hnY-2jMURif-2j1a7Sy-9zDy2t-2ge2gmQ-3ntYAr-darCBc-7BCEAG-nF4U7c-2jsS2ty-2jF4jgE-aDCTxL-byMpbz-Rc4DsU-5BZth">Ilona Gaynor/flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc-sa/4.0/">CC BY-NC-SA</a></span></figcaption></figure><p>There’s a <a href="https://www.vox.com/2022/2/12/22930385/congress-bipartisan-stock-trading-ban-lawmakers-pelosi-schumer">growing bipartisan push to prohibit</a> members of Congress from buying or selling stocks. The shift follows news reports that <a href="https://www.nytimes.com/2020/05/26/us/politics/senators-stock-trades-investigation.html">several senators sold stocks</a> shortly after receiving coronavirus briefings in early 2020 and that at least 57 lawmakers <a href="https://www.businessinsider.com/congress-stock-act-violations-senate-house-trading-2021-9">have failed to disclose financial transactions</a> since 2012 as required by law.</p>
<p>Congress passed that law – the <a href="https://www.congress.gov/112/plaws/publ105/PLAW-112publ105.htm">Stop Trading on Congressional Knowledge Act</a>, also known as the STOCK Act – in 2012 to fight insider trading among lawmakers with increased transparency. But a <a href="https://www.businessinsider.com/congress-stock-act-violations-penalties-consequences-2021-12">chorus of legislators</a> and <a href="https://www.cnbc.com/2021/10/28/sec-probes-possible-insider-stock-trades-by-sen-richard-burr-relative.html">governance watchdogs</a> argue that it didn’t go far enough and isn’t working. </p>
<p>All this raises two important questions: What exactly is insider trading and what’s the big deal?</p>
<p>We are a <a href="https://scholar.google.com/citations?user=JfUEmSUAAAAJ&hl=en&oi=ao">finance professor</a> and <a href="https://scholar.google.com/citations?user=dnCoKIUAAAAJ&hl=en&oi=ao">an economics professor</a> who have been studying financial markets and how investors try to take advantage of access to information for their personal gain. Our research shows it’s very common but difficult to stop.</p>
<h2>What is insider trading?</h2>
<p><a href="https://www.investopedia.com/terms/i/insidertrading.asp">Insider trading</a> is whenever someone uses market-moving nonpublic information in the act of buying or selling a financial asset.</p>
<p>For example, say you work as an executive at a company that plans to make an acquisition. If it’s not public, that would count as inside information. It becomes a crime if you either tell a friend about it – and that person then buys or sells a financial asset using that information – or if you make a trade yourself. </p>
<p>Punishment, if you’re convicted for insider trading, can range from a few months to over a decade behind bars.</p>
<p>Insider trading became illegal in the U.S. in 1934 after Congress passed the <a href="https://www.investopedia.com/terms/s/seact1934.asp">Securities Exchange Act</a> in the wake of the <a href="https://www.investopedia.com/terms/s/stock-market-crash-1929.asp">worst sustained decline in stocks in history</a>. From Black Monday 1929 through the summer of 1932, the <a href="https://www.federalreservehistory.org/essays/stock-market-crash-of-1929">stock market lost 89% of its value</a>. The act was meant to prevent a whole litany of abuses from recurring, including <a href="https://www.investopedia.com/articles/stocks/09/insider-trading.asp">insider trading</a>. </p>
<p>The issue <a href="https://slate.com/culture/2007/09/how-wall-street-s-gordon-gekko-inspired-a-generation-of-imitators.html">was dramatized</a> in Oliver Stone’s 1987 classic movie “Wall Street,” in which ruthless financier Gordon Gekko makes millions of dollars by trading on inside information on several companies obtained from his protege, Bud Fox.</p>
<p>“The most valuable commodity I know of is information,” <a href="https://www.youtube.com/watch?v=2WDBI4nLtXQ">declares Gekko</a>, who by the end of the film is convicted of insider trading and sent to jail.</p>
<figure>
<iframe width="440" height="260" src="https://www.youtube.com/embed/2WDBI4nLtXQ?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
<figcaption><span class="caption">Gordon Gekko explains why information is so valuable.</span></figcaption>
</figure>
<h2>‘Informed trading’</h2>
<p>While insider trading typically involves trading stocks of individual companies based on information about them, it can involve any kind of information about the economy, a commodity or anything else that <a href="https://www.cnbc.com/2022/02/09/stock-market-futures-open-to-close-news.html">moves markets</a>. </p>
<p>For instance, the monthly consumer price index figures <a href="https://www.cnbc.com/2022/02/04/fresh-inflation-data-could-fuel-further-market-volatility-in-the-week-ahead.html">have a huge impact on financial markets</a> at the moment because of concerns about inflation and how it will affect the pace of Federal Reserve interest rate hikes. That data is collected and then closely guarded, but a small number of people have access to it before it’s officially released, making the information extremely valuable if any of them wanted to profit off it. </p>
<p>Our own research on financial trading ahead of the release of U.S. economic data <a href="http://dx.doi.org/10.2139/ssrn.2637528">shows that financial markets tend to move</a> in the “correct” direction in the minutes before it’s released. That is, if the new data would be a positive for stocks, we saw patterns of stocks rising before that information becomes publicly available – something known as “<a href="http://www.labex-refi.com/wp-content/uploads/2017/04/Informed-Trading-and-Its-Regulation-mbf-2-24-17CLR.pdf">informed trading</a>.” We also found this to be the case on data released <a href="http://dx.doi.org/10.2139/ssrn.2339825">in China</a> and <a href="http://dx.doi.org/10.2139/ssrn.3502748">the U.K.</a>. This suggests that some traders may have advance knowledge of information in economic announcements.</p>
<p>Of course, alternative explanations could be that some traders are simply more skilled at collecting and analyzing available data that correctly predicts the economic announcements. For example, <a href="https://www.statestreet.com/content/dam/statestreet/documents/pricestats/PriceStats_productprofile_4PAGE.pdf">online prices</a> collected in real time can be used to predict inflation levels. Also, <a href="https://ssrn.com/abstract=3446701">satellite imagery</a> and <a href="https://ssrn.com/abstract=2826684">analyst forecasts</a> can be used to predict crude oil and natural gas inventory levels.</p>
<figure class="align-center ">
<img alt="Martha Stewart, flanked by U.S. Marshals, leaves court" src="https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=533&fit=crop&dpr=1 600w, https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=533&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=533&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=669&fit=crop&dpr=1 754w, https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=669&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/447122/original/file-20220217-23-1xrykmz.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=669&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Martha Stewart was found guilty of insider trading in 2004.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/EnronMirageEconomy/3101174e18964ced96e4e87edc376790/photo?Query=Martha%20stewart%202004&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=7&currentItemNo=6">AP Photo/Bebeto Matthews</a></span>
</figcaption>
</figure>
<h2>Common, profitable and hard to prove</h2>
<p>Research shows that <a href="https://dealbook.nytimes.com/2014/06/16/study-asserts-startling-numbers-of-insider-trading-rogues/">insider trading is common and profitable</a>, yet <a href="https://knowledge.wharton.upenn.edu/article/why-insider-trading-is-hard-to-define-prove-and-prevent/">notoriously hard to prove and prevent</a>. A 2020 study estimated that <a href="https://dx.doi.org/10.2139/ssrn.3764192">only about 15% of insider trading</a> in the U.S. is detected and prosecuted. </p>
<p>One of the more famous – and few – examples of insider trading being prosecuted was the <a href="https://www.chicagotribune.com/sns-ap-martha-stewart-chronology-story.html">2004 conviction</a> of businesswoman and media personality Martha Stewart for <a href="https://www.sec.gov/news/press/2003-69.htm">selling shares based on an illegal tip</a> from a broker. Another came in 2016, when billionaire Steven Cohen and his now-defunct SAC Capital Advisors hedge fund <a href="https://www.reuters.com/article/us-usa-insidertrading-sac-capital/cohens-sac-capital-in-135-million-settlement-with-elan-investors-idUSKBN13P2X0">entered into a US$135 million settlement</a> over <a href="https://www.newyorker.com/magazine/2017/01/16/when-the-feds-went-after-the-hedge-fund-legend-steven-a-cohen">insider-trading allegations</a>. The hedge fund also <a href="https://money.cnn.com/2014/04/10/investing/cohen-sac-capital-point72/">paid a fine of $1.8 billion</a> in 2014 over similar charges. </p>
<p>And in 2020, former U.S. Rep. Chris Collins <a href="https://www.washingtonpost.com/business/2020/01/17/former-rep-chris-collins-be-sentenced-insider-trading-case/">was sentenced to 26 months in prison</a> for passing on a confidential tip to his son and then lying about it to the FBI.</p>
<p>More recently, <a href="https://www.npr.org/2021/09/27/1041059924/2-top-federal-reserve-officials-retire-after-trading-disclosures">two Fed officials stepped down</a> in September 2021 after disclosures showed they were trading extensively in 2020 at the same time the U.S. central bank was spending trillions saving the economy from the effects of the pandemic. And Sen. Richard Burr and his brother <a href="https://www.cnn.com/2021/10/28/politics/burr-sec-investigation-stock-trades/index.html">remain under investigation</a> by the Securities and Exchange Commission over stock trades they made in February 2020 shortly after the North Carolina Republican received closed-door briefings on the pandemic. </p>
<h2>Why it matters</h2>
<p>Insider trading is not a victimless crime. By throwing sand in the gears of financial markets, people trading on inside information benefit at the expense of others.</p>
<p>A key characteristic of well-functioning financial markets is high liquidity, which means it is easy to make large trades at low transaction costs. Insider trading <a href="http://dx.doi.org/10.2139/ssrn.276179">adversely affects market liquidity</a> and makes transaction costs higher, reducing investor returns. And since a lot of people have a stake in financial markets – <a href="https://www.federalreserve.gov/publications/files/scf20.pdf">about half of U.S. families own stocks</a> either directly or indirectly – this behavior hurts most Americans.</p>
<p>Insider trading also <a href="https://ssrn.com/abstract=249708">makes it more expensive</a> for companies to issue stocks and bonds. If investors think that insiders might be trading bonds of a company, they will demand a higher return on the bonds to compensate for their disadvantage – increasing the cost to the company. As a result, the company has less money to hire more workers or invest in a new factory.</p>
<p>There are also broader impacts of insider trading. It <a href="http://dx.doi.org/10.2139/ssrn.3645579">undermines public confidence</a> in financial markets and feeds the common view that they odds are stacked in favor of the elite and against everyone else. </p>
<p>Furthermore, since inside traders profit from privileged access to information rather than work, this makes people believe that <a href="https://ethics.org.au/wp-content/uploads/2019/02/The-Ethics-Centre_180410-on-trust-and-legitimacy.original.pdf">the system is rigged</a>. </p>
<figure class="align-center ">
<img alt="Chris Collins arrives at a federal court as cameras record him" src="https://images.theconversation.com/files/447121/original/file-20220217-13070-azm93l.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/447121/original/file-20220217-13070-azm93l.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/447121/original/file-20220217-13070-azm93l.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/447121/original/file-20220217-13070-azm93l.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/447121/original/file-20220217-13070-azm93l.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/447121/original/file-20220217-13070-azm93l.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/447121/original/file-20220217-13070-azm93l.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Former U.S. Rep. Chris Collins pleaded guilty to insider trading and lying to the FBI. He was sentenced to 26 months in jail in 2020.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/CongressmanStockIndictment/d1a8f9fa60ff4b858db505d5daf1d3de/photo?Query=Insider%20trading&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=796&currentItemNo=6">AP Photo/Seth Wenig</a></span>
</figcaption>
</figure>
<h2>Curbing insider trading</h2>
<p>The odds of Congress prohibiting lawmakers from trading stocks got a boost when House Speaker Nancy Pelosi <a href="https://www.npr.org/2022/01/20/1074387320/pelosi-opens-the-door-to-stock-trading-ban">recently said she may support the idea</a> – though she’d like to see a ban also apply to the Supreme Court, which currently has no rules governing the practice. At least some Republicans, such as <a href="https://www.bloomberg.com/news/articles/2022-01-11/mccarthy-eyes-ban-on-lawmakers-trading-individual-stocks">U.S. Rep. Kevin McCarthy</a> and <a href="https://thehill.com/homenews/senate/593613-stock-trading-ban-gains-steam-but-splits-senate-gop">Sen. Ben Sasse</a>, also say they support a ban.</p>
<p>For its part, the Fed reacted to trading by its two former officials by <a href="https://www.federalreserve.gov/newsevents/pressreleases/other20211021b.htm">banning bank policymakers and senior staff</a> from buying individual stocks or bonds. </p>
<p>There are also less heavy-handed ways to curb insider trading. In recent years, policymakers <a href="https://abcnews.go.com/Politics/wireStory/labor-stop-giving-reporters-early-economic-data-70775151">in the U.S.</a> and <a href="http://theconversation.com/in-a-victory-against-spin-ministers-lose-pre-release-access-to-statistics-79793">the U.K.</a> have tightened procedures governing the release of economic data. In the U.K., for example, dozens of public officials used to get market-moving economic data 24 hours before the public release. After the practice stopped in 2017, we found evidence of <a href="http://dx.doi.org/10.2139/ssrn.3502748">significantly less informed trading</a> ahead of the release – suggesting it effectively prevented a lot of insider trading.</p>
<p>Surveys show widespread bipartisan public support for Congress to ban lawmakers from trading financial securities, with a <a href="https://conventionofstates.com/over-75-percent-of-voters-say-members-should-not-trade-stocks-while-serving-in-congress">recent poll showing 75% in favor</a>. While that doesn’t mean a law will get passed, it does put pressure on lawmakers of both parties to do something about the problem.</p>
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<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A bipartisan group of US lawmakers is pushing for a ban on active trading by members of Congress following accusations that some of their colleagues may have engaged in insider trading.Alexander Kurov, Professor of Finance and Fred T. Tattersall Research Chair in Finance, West Virginia UniversityMarketa Wolfe, Associate Professor of Economics, Skidmore CollegeLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1711122021-11-18T19:07:14Z2021-11-18T19:07:14ZAustralia’s insider trading laws might not apply to super – here’s why they should<figure><img src="https://images.theconversation.com/files/432557/original/file-20211118-27-xz449m.jpg?ixlib=rb-1.1.0&rect=179%2C23%2C3682%2C1682&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>Insider trading is something that only happens in companies listed on the stock exchange, right?</p>
<p>It could be happening in Australian superannuation funds. </p>
<p>The Australian Securities and Investments Commission suspects so. </p>
<p>It has examined the behaviour of <a href="https://asic.gov.au/about-asic/news-centre/find-a-media-release/2021-releases/21-282mr-surveillance-of-investment-switching-by-super-fund-executives-identifies-concerns-with-trustees-conflicts-arrangements/">23</a> members of the trustee boards of Australian super funds (both retail and industry) during the early days of the pandemic.</p>
<p>Super funds hold assets which are only revalued on its books <a href="https://www.afr.com/companies/financial-services/super-fund-trustee-snouts-in-the-trough-20211031-p594mz">from time to time</a>, sometimes monthly, sometimes quarterly.</p>
<p>When asset values were falling sharply last year, it meant super fund trustees had early access to information about valuation decisions and the ability to influence those decisions.</p>
<h2>Using information ‘for personal gain’</h2>
<p>ASIC wanted to find out whether some trustees were “using this information for personal gain” by switching their own personal super investment options based on their knowledge of the timing of the revaluations yet to be announced.</p>
<p>It says the conduct it uncovered “fell below ASIC’s expectations”.</p>
<p>The investigation follows an inquiry by the <a href="https://www.afr.com/politics/federal/super-execs-questioned-over-fund-switches-during-pandemic-turmoil-20201117-p56f8d">parliament’s economics committee</a> that found executives at AustralianSuper, NGS Super, Rest, First State, Hostplus and Intrust Super had switched their own personal super out of options exposed to revaluations at the start of the pandemic.</p>
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<strong>
Read more:
<a href="https://theconversation.com/insider-trading-has-become-more-subtle-142981">Insider trading has become more subtle</a>
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</em>
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<p>It’s behaviour that seems to have a lot in common with <a href="http://www5.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s1043a.html">insider trading</a>, in which insiders use inside information for their own benefit at the expense of other investors.</p>
<p>But while insider trading in relation to financial products is illegal, the definition of financial products used in the Australian legislation excludes superannuation products that are not provided by a “public offer entity”. </p>
<h2>Not caught by the law</h2>
<p>This means that the laws do not apply to some industry super funds, but might apply to others that are open to all members of the public regardless of the industry they work in.</p>
<p>As well, “trading” in financial products is held to only occur where a person applies for, acquires, or disposes of those products, or enters into an agreement to do so. </p>
<p>This means that insider trading laws might apply when a person first joins a public superannuation fund, but not when they switch their investment options within a fund.</p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/insider-trading-is-greedy-not-glamorous-and-it-hurts-us-all-60792">Insider trading is greedy, not glamorous, and it hurts us all</a>
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<p>ASIC has conceded this result in its announcement, saying the activity it has detected might not be caught by the insider trading prohibition, but is “similar to insider trading and may contravene other provisions of the law”.</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/432554/original/file-20211118-26-1nz8poa.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/432554/original/file-20211118-26-1nz8poa.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/432554/original/file-20211118-26-1nz8poa.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=969&fit=crop&dpr=1 600w, https://images.theconversation.com/files/432554/original/file-20211118-26-1nz8poa.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=969&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/432554/original/file-20211118-26-1nz8poa.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=969&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/432554/original/file-20211118-26-1nz8poa.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1218&fit=crop&dpr=1 754w, https://images.theconversation.com/files/432554/original/file-20211118-26-1nz8poa.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1218&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/432554/original/file-20211118-26-1nz8poa.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1218&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Not always glamourous.</span>
<span class="attribution"><a class="source" href="https://www.20thcenturystudios.com/movies/wall-street-money-never-sleeps">20th Century Studios</a></span>
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<p>When insider trading laws were last amended two decades ago under the 2002 <a href="https://www.legislation.gov.au/Details/C2005C00498">Financial Services Reform Act</a>, the financial products to which the laws applied were expanded to include “functionally similar” products – but not to all super funds. </p>
<p>At the time super funds held less than <a href="https://www.apra.gov.au/superannuation-australia-a-timeline">A$500 billion</a>. </p>
<p>They now hold more than <a href="https://www.apra.gov.au/news-and-publications/apra-releases-superannuation-statistics-for-june-2021">$3 trillion</a>, which is much more than the entire Australian economy turns over in a year, and constitute for most Australians their biggest financial investment outside the family home.</p>
<p>The restriction, especially the distinction between some kinds of industry funds and others, no longer makes sense.</p>
<p>The <a href="https://www.alrc.gov.au/inquiry/review-of-the-legislative-framework-for-corporations-and-financial-services-regulation/">Australian Law Reform Commission</a> is currently undertaking an inquiry into financial services regulation, which includes the provisions of the Corporations Act prohibiting insider trading. </p>
<h2>We invest more in super than in shares</h2>
<p>It would be timely to amend insider trading laws so that they catch the switching of superannuation investment options within funds and eliminate the distinction between different types of funds. </p>
<p>Australians invest more money in super than in the <a href="https://www.rba.gov.au/publications/rdp/2019/pdf/rdp2019-04.pdf">Australian share market</a>.</p>
<p>There is no obvious reason why it shouldn’t be as well regulated.</p><img src="https://counter.theconversation.com/content/171112/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Juliette Overland does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>ASIC suspects some super fund trustees of using inside information for personal gain, but they might not be caught by the insider trading laws.Juliette Overland, Associate Professor, Corporate Law, University of Sydney Business School, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1429812020-08-11T20:13:14Z2020-08-11T20:13:14ZInsider trading has become more subtle<figure><img src="https://images.theconversation.com/files/352123/original/file-20200811-16-wlmz2d.jpg?ixlib=rb-1.1.0&rect=280%2C178%2C2223%2C1045&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Michael Douglas in Wall Street: Money Never Sleeps (2010)</span> </figcaption></figure><p>Insider trading comes in two main forms: arguably legal and clearly illegal. </p>
<p>But, as with drugs in sport, it’s hard to tell when arguably legal ends and clearly illegal begins.</p>
<p>It is generally accepted that it is wrong to buy shares in the company you run when you know something about it that the market does not.</p>
<p>It’s especially wrong to buy shares when you are telling the market that things are much worse for the company than you know them to be.</p>
<p>But what about suddenly sharing everything – an avalanche of information – in the lead-up to a share purchase in order to muddy the waters and create enough uncertainty to lower the price?</p>
<p>Chief executives have enormous discretion over the tone and timing of the news they release, generally answering to no one.</p>
<p>A linguistic analysis of twelve years worth of news releases by 6764 US chief executives just published by myself and two University of Queensland colleagues in the <a href="https://www.sciencedirect.com/science/article/abs/pii/S0378426620300881">Journal of Banking and Finance</a> suggests they are using this discretion strategically.</p>
<p>Not clearly illegal (how can oversharing be illegal?) their behaviour can have the same effect as talking down their share price while buying, something that is clearly illegal.</p>
<h2>Spreads matter, as well as signs</h2>
<p>Earlier analyses of insider trading have looked at only the “sign” of the information released to to the share market. On balance was the tone of one month’s news releases positive or negative?</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=971&fit=crop&dpr=1 600w, https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=971&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=971&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1220&fit=crop&dpr=1 754w, https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1220&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1220&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Spreads matter as well as signs.</span>
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<p>We have looked at the “spread”, the range from positive to negative as well as the net result. </p>
<p>It doesn’t make sense to treat as identical a month’s worth of releases which are all neutral tone in tone (sending no message) and a month’s worth of releases of which half are strongly positive and half are strongly negative (stoking uncertainty).</p>
<p>Our sample of discretionary (non-required) news releases is drawn from those lodged with <a href="https://web.stevens.edu/hfslwiki/index.php?title=Thomson_Reuters_News_Analytics">Thomson Reuters News Analytics</a> between January 2003 to December 2015. It includes firms listed on the New York Stock Exchange, the AMEX American Stock Exchange and the NASDAQ technology-heavy exchange.</p>
<p>The archive scores the tone of each release as positive, negative or neutral.</p>
<p>We used the <a href="https://www.thomsonreuters.com/en/press-releases/2014/thomson-reuters-starmine-model-predicts-us-stock-performance.html">Thomson Reuters Insiders Filing Database</a> to obtain information on chief executive buying, limiting our inquiries to significant purchases of at least 100 shares.</p>
<h2>Strategic uncertainty</h2>
<p>About 70% of the chief executives proved to be opportunistic traders in the sense that they bought with no particular pattern, rather than at the same time every year.</p>
<p>We found that news releases by these chief executives increased information uncertainty by 5.8% and 3.6% in the months before they bought and in the month they bought.</p>
<p>In the months following their purchases, the positive to negative spread of their news releases returned to the average for non-purchase months.</p>
<p>The unmistakable conclusion is that their behaviour is strategic.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/insider-trading-is-greedy-not-glamorous-and-it-hurts-us-all-60792">Insider trading is greedy, not glamorous, and it hurts us all</a>
</strong>
</em>
</p>
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<p>We obtained similar results when we used other measures of buying and the tone of news releases.</p>
<p>Our results provide no evidence to support the contention that chief executives behave in this strategic way when selling shares. This is consistent with other findings suggesting that the timing of sales is often out of the hands of the sellers.</p>
<p><a href="https://scholar.google.com/scholar_lookup?title=Insider%20trading%20and%20voluntary%20disclosures&publication_year=2006&author=Q.%20Cheng&author=K.%20Lo">Previous studies</a> have found only <a href="https://scholar.google.com/scholar_lookup?title=Voluntary%20disclosures%20and%20insider%20transactions&publication_year=1999&author=C.F.%20Noe">weak links</a> between executive share purchases and the news they release to the market. This might be because those studies have looked for more easily detected (and more clearly problematic) negative news releases.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/to-protect-markets-we-need-strict-penalties-for-insider-trading-70191">To protect markets we need strict penalties for insider trading</a>
</strong>
</em>
</p>
<hr>
<p>But that’s an old and (with the advent of linguistic analysis) increasingly risky approach.</p>
<p>Our research suggests that by saying many things at once chief executives can achieve much the same thing.</p><img src="https://counter.theconversation.com/content/142981/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Barry Oliver receives funding from the Australian Government</span></em></p>Chief executives have moved on from buying while spreading bad news. They’re buying while spreading uncertainty.Barry Oliver, Associate Professor, The University of QueenslandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1348752020-04-02T12:33:07Z2020-04-02T12:33:07ZDOJ drops investigation into three senators for insider trading; Burr probe continues<figure><img src="https://images.theconversation.com/files/324691/original/file-20200401-23157-rot7tg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Justice Department is investigating stock trades made by Sen. Richard Burr (R-NC) after a briefing on the coronavirus.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/sen-richard-burr-and-acting-deputy-homeland-security-news-photo/1208602773?adppopup=true">Getty/Mark Wilson</a></span></figcaption></figure><p>The Department of Justice has notified three U.S. senators – Kelly Loeffler, R-Ga., James Inhofe, R-Okla. and Dianne Feinstein, D-Calif. – that it is <a href="https://www.axios.com/senators-insider-trading-loeffler-burr-a7876ff3-06a2-415e-a8f9-f20a942c6958.html">closing its investigation into insider trading allegations</a> without any charges. </p>
<p>The move to close these three investigations into whether laws were broken by members of Congress who traded stock in the midst of the COVID-19 pandemic represents at least a tacit recognition of the legal difficulties in prosecuting lawmakers for insider trading.</p>
<p>The department’s investigation involving Sen. Richard Burr, R-N.C., apparently continues. It has already affected Burr’s work in Congress; <a href="https://www.washingtonpost.com/nation/2020/05/14/fbi-richard-burr-warrant/">he temporarily stepped down May 14</a> as chair of the Intelligence Committee the day after the FBI seized his cellphone as part of its investigation into whether lawmakers who had sold stocks before the coronavirus pandemic tanked the stock market <a href="https://www.nytimes.com/2020/03/20/us/politics/coronavirus-richard-burr-insider-trading.html">engaged in illegal “insider trading</a>.”</p>
<p>Successfully prosecuting such cases is very difficult. Even federal judges struggle with writing clear instructions to lay jurors in insider trading cases. Often, verdicts are reversed on appeal due to errors in explaining complicated legal terms.</p>
<p>There are two different provisions of law that could apply to the trading activity of senators and congressional staff. </p>
<p>Members of Congress and staff could run afoul of either or both of these laws. But proving a violation and convicting them is not likely.</p>
<h2>Stock Act and securities law</h2>
<p>The first provision is a rule <a href="https://consumer.findlaw.com/securities-law/securities-and-exchange-act-rule-10b.html">known as Rule 10(b)(5)</a> after the section of the securities law under which it was issued by the SEC.</p>
<p>The rule makes it illegal for anyone who has nonpublic information about a company – including corporate officers, employees, brokers or security analysts, but also including members of Congress – to use that information to trade in the company’s stock before that information is available to the public. This provision applies to members of Congress because it applies to everyone.</p>
<p>The other provision applies only to members of Congress and staff. That’s the <a href="https://www.investopedia.com/terms/s/stop-trading-on-congressional-knowledge-act.asp">STOCK Act</a>, passed in 2012, which bars Congress members and staff from taking advantage of nonpublic information, gained from their positions in the performance of their duties, by trading on that information before it is public.</p>
<p><a href="https://www.nytimes.com/2019/10/01/nyregion/chris-collins-guilty-congress.html">Recently, Rep. Chris Collins of New York pled guilty</a> to violating Rule 10(b)(5) and was sentenced to several years in jail. </p>
<p>His crime: trading in a pharmacy company stock on whose board he served after receiving inside information regarding failed drug trials. He passed on that information to his son and his son’s father-in-law, who were also charged as “tippees,” or people who got insider tips.</p>
<p>This case was not difficult to prosecute under the first provision as the U.S. Attorney’s office had evidence – the defendants’ incriminating telephone call records. The activity had nothing to do with Rep. Collins’ official duties.</p>
<p>In the current cases involving trading by senators, successful prosecution under either provision will likely be substantially more complicated than the Collins case.</p>
<p>The STOCK Act’s defines nonpublic information as <a href="https://www.ethics.senate.gov/public/index.cfm/files/serve?File_id=8C923399-2DC0-4EF6-A0D2-9EF564FC7038">confidential and not widely disseminated to the public</a>. That’s a hard standard to prove. </p>
<p>Then there’s the problem that there’s lots of talking by, and information flowing from, multiple sources within Congress. How can it be proven that the lawmakers used only information they got in a confidential briefing to inform their decision to sell stocks?</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/324695/original/file-20200401-23095-vbgslv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/324695/original/file-20200401-23095-vbgslv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/324695/original/file-20200401-23095-vbgslv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/324695/original/file-20200401-23095-vbgslv.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/324695/original/file-20200401-23095-vbgslv.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/324695/original/file-20200401-23095-vbgslv.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/324695/original/file-20200401-23095-vbgslv.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/324695/original/file-20200401-23095-vbgslv.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">When the Founders signed the U.S. Constitution in Independence Hall (reflected here), they included a provision for immunity for Congress members.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/photo/constitutional-reflections-royalty-free-image/657130564?adppopup=true">Getty/Phil Roeder</a></span>
</figcaption>
</figure>
<h2>Constitution provides immunity</h2>
<p>There is another defense a lawmaker might raise, or that might prevent formal charges in the first place. </p>
<p>The <a href="https://www.law.cornell.edu/constitution-conan/article-1/section-6/clause-1">Constitution’s Speech or Debate Clause</a> gives members of Congress <a href="https://fas.org/sgp/crs/misc/R45043.pdf">immunity for acts they take</a> when performing their legislative duties. </p>
<p>The clause says that “for any speech or debate the [Senators and Representatives] shall not be questioned in any other place.” It may make prosecution impossible for certain types of information received officially in committee or other legislative settings. </p>
<p>The clause has been interpreted by the Supreme Court to cover <a href="https://books.google.com/books?id=Zp4qAAAAMAAJ&pg=PA42&lpg=PA42&dq=%E2%80%9Cgenerally+done+in+a+session+of+the+House+by+one+of+its+members+in+relation+to+the+business+before+it%E2%80%9D&source=bl&ots=7m-KbiwEMV&sig=ACfU3U2VMiw9MLn-JQGWThB_moKfUXkdmA&hl=en&sa=X&ved=2ahUKEwij2JSipcXoAhUvl3IEHdlqDhEQ6AEwAHoECAIQAQ">more than literal speech or debate and include anything</a> “generally done in a session of the House by one of its members in relation to the business before it” including voting, holding hearings, writing reports or gathering information from outsiders. </p>
<p>The Speech or Debate Clause was added to the Constitution to reinforce the separation of powers, which is part of the structure of government laid out in the Constitution. But as the Supreme Court has stated, the clause “<a href="https://books.google.com/books?id=pjUrAAAAIAAJ&pg=PA124&lpg=PA124&dq=has+enabled+reckless+men+to+slander+or+even+destroy+others+with+impunity,+but+that+was+the+conscious+choice+of+the+Framers&source=bl&ots=Ml6pZQadAA&sig=ACfU3U2anfy__KuBqvkAsKVpmfWLQjqR1g&hl=en&sa=X&ved=2ahUKEwi_xOHUqMXoAhVxmXIEHW_zAVsQ6AEwAHoECAwQAQ">has enabled reckless men to slander or even destroy others with impunity, but that was the conscious choice of the Framers.</a>”</p>
<p><a href="https://blogs.wsj.com/washwire/2014/01/13/gaming-the-capital-profiting-from-washingtons-secrets/">George Canellos, the co-chief of the SEC’s enforcement division, told The Wall Street Journal</a> during an earlier insider trading scandal that cases involving information from publicly traded companies are different from cases in which a member of Congress sells stock. </p>
<p>When it comes to information that could affect a company’s stock price coming from Congress, Canellos <a href="https://www.wsj.com/articles/insidetrading-probe-of-height-securities-over-decision-on-medicare-payments-hits-wall-in-capital-1385003329">said</a>, “The lines aren’t quite as bright and the opportunities for arguments by the defense are greater.”</p>
<h2>Is it public?</h2>
<p>An example of this problem occurred in a 2014 case involving <a href="https://www.nytimes.com/2014/11/15/business/tip-on-medicare-spurs-insider-trading-investigation.html">Height Securities</a>, a stock brokerage. </p>
<p>A confidential decision by Medicare to raise certain reimbursement rates in 2013 was leaked by a congressional staff member to a Height lobbyist. The lobbyist then passed it on to his clients, setting off a flurry of trading in health care stock before the Medicare decision was known to the general public. </p>
<p>During the insider trading investigation into these transactions, the FBI discovered that dozens of officials – potentially as many as 400 – at the Medicare agency knew about the decision before it was made public. That so many people within the government knew about the change made it difficult to determine whether the lobbyist based his conclusion on his own analysis, or on publicly available information. </p>
<p><a href="https://www.ethics.senate.gov/public/index.cfm/files/serve?File_id=8C923399-2DC0-4EF6-A0D2-9EF564FC7038">Guidance from the Senate Ethics Committee on the STOCK Act’s insider trading prohibition</a> acknowledges how common this problem can be.</p>
<p>“While Senators and staff are prohibited from using non-public information for making a trade, a great deal of Congressional work is conducted on the public record or in the public realm during committee hearings, and markups, floor activity, and speeches.” Whether a lawmaker gets information in a nonpublic briefing or in public proceedings is hard to determine.</p>
<p>Burr <a href="https://www.propublica.org/article/senator-dumped-up-to-1-7-million-of-stock-after-reassuring-public-about-coronavirus-preparedness">heard from intelligence officials</a> about how foreign nations were responding to the World Health Organization’s declaration of a global health emergency. </p>
<p>The session was not classified, but drawn instead from diplomatic wires and publicly reported sources. The senators in the briefing could have gotten the same information elsewhere. </p>
<p>So proving that the information received by senators constituted “insider” information – which in a criminal case would require proof beyond a reasonable doubt – could be very difficult for the government. </p>
<h2>Pentagon Papers relevant</h2>
<p>The <a href="https://www.law.cornell.edu/constitution-conan/article-1/section-6/clause-1">Constitution’s Speech or Debate Clause’s immunity provision</a> doomed previous prosecutions that depended on actions taken during a legislative hearing or related to that hearing.</p>
<p>In 1972, <a href="https://www.democracynow.org/2014/12/16/former_senator_mike_gravel_on_putting">Sen. Mike Gravel placed a purloined copy of the highly classified Pentagon Papers</a> into the hearing record of his committee. The Department of Justice began a criminal inquiry into his release of that Vietnam War study. </p>
<figure class="align-left zoomable">
<a href="https://images.theconversation.com/files/324692/original/file-20200401-23100-zruei5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/324692/original/file-20200401-23100-zruei5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/324692/original/file-20200401-23100-zruei5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=758&fit=crop&dpr=1 600w, https://images.theconversation.com/files/324692/original/file-20200401-23100-zruei5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=758&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/324692/original/file-20200401-23100-zruei5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=758&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/324692/original/file-20200401-23100-zruei5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=952&fit=crop&dpr=1 754w, https://images.theconversation.com/files/324692/original/file-20200401-23100-zruei5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=952&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/324692/original/file-20200401-23100-zruei5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=952&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">A case involving former Sen. Mike Gravel, D-Alaska, illustrates the problems of prosecuting when the Constitution grants lawmakers immunity.</span>
<span class="attribution"><a class="source" href="https://bioguideretro.congress.gov/Home/MemberDetails?memIndex=G000388">U.S. Senate</a></span>
</figcaption>
</figure>
<p>When the <a href="https://supreme.justia.com/cases/federal/us/408/606/">case ultimately got to the Supreme Court</a>, the court – relying on the Speech or Debate Clause – said Gravel was absolutely immune for anything done at the hearing or communications with his staff before the hearing. </p>
<p>In the Height Securities case, when the <a href="https://www.leagle.com/decision/infdco20151117c14">Security and Exchange Commission subpoenaed records</a> from the House Ways and Means Committee to determine how the confidential information leaked, the court upheld the Speech or Debate Clause protection for committee documents. That made prosecution for insider trading impossible. </p>
<p>These same problems would make prosecuting the insider trading cases difficult. </p>
<p>And while the Speech or Debate Clause would not bar the Senate Ethics Committee from getting at the evidence – because it is “the place” where members may be questioned – senators would still be able to defend by showing that the information was based on publicly available nonconfidential sources.</p>
<p><em>Editor’s note: This story is an update to the original story published on April 2, 2020.</em></p>
<p>[<em>Get the best of The Conversation, every weekend.</em> <a href="https://theconversation.com/us/newsletters/weekly-highlights-61?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=weeklybest">Sign up for our weekly newsletter</a>.]</p><img src="https://counter.theconversation.com/content/134875/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Stanley M. Brand is Vice-President of MiLB, governing body of Minor League Baseball. </span></em></p>Did members of Congress illegally sell stocks after getting inside information about the pandemic from federal officials? A former lawyer for the House says proving such cases is very difficult.Stanley M. Brand, Distinguished Fellow in Law and Government, Penn StateLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1012972018-08-08T21:04:38Z2018-08-08T21:04:38ZWhat is insider trading, the crime Rep. Chris Collins was charged with?<p>The <a href="https://www.cnn.com/2018/08/08/politics/chris-collins-indicted-insider-trading/index.html">arrest</a> of Congressman Chris Collins shines light on one of the sexier crimes that the securities laws has to offer: insider trading. </p>
<p>It’s the subject of many iconic movies like “Wall Street,” television shows like “Billions” and <a href="http://articles.latimes.com/2013/jan/19/business/la-fi-sec-celebs-20130119">real-life scandals</a> involving celebrities, politicians and others.</p>
<p>But despite all the media attention, <a href="http://fortune.com/2013/08/15/the-gray-art-of-not-quite-insider-trading/">very few people</a> actually know what insider trading is under the law and how it gets people into trouble. As finance <a href="https://scholar.google.com/citations?user=y_ViJ7oAAAAJ&hl=en&oi=ao">experts</a>, <a href="https://theconversation.com/profiles/karen-kunz-340855">we</a> are here to fill that gap.</p>
<h2>What is insider trading?</h2>
<p>As its most basic, insider trading is when someone – usually a corporate insider – buys or sells securities such as a stock or bond based on “non-public information.” </p>
<p>For instance, Martha is a board member at Company X and learns of an incredible breakthrough at her company that hasn’t been disclosed to the public. If she then uses that information to buy her company’s stock – knowing that the stock price will go up after the announcement – Martha is likely guilty of insider trading. </p>
<p>Under current laws, the insider can also get into trouble if he or she shares that information with others – who could face prosecution as well if they make a trade using the information.</p>
<figure>
<iframe width="440" height="260" src="https://www.youtube.com/embed/rM7TW_O0YCs?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
<figcaption><span class="caption">‘Billions’ on insider trading.</span></figcaption>
</figure>
<h2>Why is it illegal?</h2>
<p>For much of the 20th century in the U.S., insider trading <a href="http://www.sechistorical.org/museum/galleries/it/counterAttack_d.php">was not generally considered illegal</a>. It was only in the 1950s that various court rulings strengthened the power of Wall Street’s beat cop – the Securities and Exchange Commission – to go after inside traders under federal securities law. </p>
<p>Under the classical legal theory for insider trading, an insider – whether an employee or a corporate director – has a fiduciary obligation to a company to keep secret information secret. Insiders who breach that duty by either trading on the information or sharing it for personal benefits violate that duty. This appears to be the case with <a href="https://drive.google.com/file/d/1KSIMuRjRNOJ4WK5WuSguKEnoxSHwpYQt/view">Collins</a>. </p>
<p>But what if the stock you traded wasn’t from a company to whom you owed a fiduciary duty? </p>
<p>That was at the heart of a <a href="https://www.oyez.org/cases/1996/96-842">1997 Supreme Court case</a> that spawned something known as the misappropriation theory, which broadened what was considered illegal insider trading. In that case, attorney James O’Hagan used information he gained from his position at his firm to trade in another company’s stock. Since it wasn’t O’Hagan’s client, he argued, there was no duty and, hence, no breach.</p>
<p>The court disagreed. Since O'Hagan used confidential information that was given to him to perform his job and instead used it for his personal gain, he breached his duty and was therefore found guilty of insider trading. </p>
<p>Since then, prosecutors have used this theory to find <a href="https://caselaw.findlaw.com/us-1st-circuit/1030702.html">wives</a> who trade based on marital secrets, <a href="https://www.marketwatch.com/story/sec-charges-therapist-with-insider-trading-on-confidential-patient-disclosures-2017-12-14">therapists</a> who trade based on therapy sessions and even <a href="https://www.reuters.com/article/us-trading-cyber-plea/ukrainian-hacker-gets-prison-in-u-s-insider-trading-case-idUSKBN18I2DF">hackers</a> who trade based on computer theft all to be guilty of insider trading.</p>
<p>As for Collins, he sat on the board of biotechnology company Innate Immunotherapeutics. He was also the Australian company’s largest shareholder. When Collins learned that a trial involving a new multiple sclerosis drug failed, he allegedly sold shares in the company – to avoid significant losses – and passed along that information to his son, who in turn, shared it with others.</p>
<p>Not quite the plot of a “Billions” story line, but, give it a year and we’re sure that Hollywood can come up with something.</p><img src="https://counter.theconversation.com/content/101297/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Insider trading, like what Rep. Chris Collins is accused of engaging in, is one of the sexier crimes in securities law.Jena Martin, Professor of Law, West Virginia UniversityKaren Kunz, Associate Professor of Public Administration, West Virginia UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/701912016-12-09T06:11:32Z2016-12-09T06:11:32ZTo protect markets we need strict penalties for insider trading<figure><img src="https://images.theconversation.com/files/149355/original/image-20161209-31364-1c2zcry.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Insider trading has a reputation of being hard to spot and prosecute.</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>In the first ever case in which a corporation has been found liable for insider trading, German construction company Hochtief has been <a href="http://www.smh.com.au/business/markets/german-owner-of-cimic-hochtief-fined-400000-for-insider-trading-after-asic-probe-20161208-gt78kf.html">fined A$400,000 for insider trading</a> and required to make donations to the Australian Shareholders Association and First Nations Foundation.</p>
<p>This is also the first case where the market itself was expressly recognised as a victim of insider trading.</p>
<p>The Federal Court’s decision coincides with the <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/White_collar_crime">Senate Inquiry</a> into the adequacy of penalties for white collar crime. Insider trading is a complex, controversial offence with a <a href="http://www.abc.net.au/news/2016-06-09/insider-trading-cases-tip-of-iceberg/7497236">reputation</a> for being under-detected and under-prosecuted, but the Hochtief case recognises that significant penalties are appropriate to protect markets. </p>
<h2>What is insider trading?</h2>
<p>Insider trading occurs when a person or company trades in a financial product (such as shares) while they possess price-sensitive information that is not publicly available.</p>
<p>The Hochtief case is a set of civil proceedings arising from the 2014 takeover of Leighton Holdings. At the time, a number of Hochtief executives held positions on Leighton’s board and had access to inside information concerning Leighton’s financial results. </p>
<p>Because those executives possessed this information when Hochtief was purchasing Leighton shares, Hochtief was considered to possess inside information and to have engaged in insider trading, in breach of the Corporations Act. </p>
<h2>We are all victims</h2>
<p>Insider trading is <a href="https://theconversation.com/insider-trading-is-greedy-not-glamorous-and-it-hurts-us-all-60792">not a victimless crime</a>. The person on the other end of a trade with someone who possess inside information is potentially missing out on a profit or the opportunity to avoid a loss. They are a victim of insider trading. </p>
<p>But Australians collectively have <a href="http://www.apra.gov.au/MediaReleases/Pages/16_47.aspx">more than A$2.1 trillion</a> invested in superannuation funds, of which <a href="https://www.superannuation.asn.au/resources/superannuation-statistics">about 20%</a> is allocated to publicly traded shares. This means almost all of us are shareholders in some form, even if we don’t directly trade on the stock exchange. We could all be unknowing victims of insider trading as a result of the trades undertaken on our behalf by our superannuation funds.</p>
<p>But there is also another victim - the market itself. If investors believe that share trading is weighted in favour of insiders, and that only insiders can profit from trades, they lose confidence in the integrity of the market. This means investors are more likely to seek investments outside the stock exchange, <a href="http://repository.law.umich.edu/cgi/viewcontent.cgi?article=1053&context=articles">withdrawing their capital from the market</a>. </p>
<p>So insider trading can reduce liquidity and increase the cost of capital for all companies and investors. Almost all countries with well-developed securities markets prohibit insider trading. In countries that don’t, or are perceived to have lax regulation or enforcement, the cost of capital is greater and the level of investor participation lower. </p>
<h2>The Hochtief decision</h2>
<p>That the market is a victim in this case was <a href="http://asic.gov.au/about-asic/media-centre/find-a-media-release/2016-releases/16-430mr-construction-company-hochtief-ag-fined-for-insider-trading-and-agrees-to-give-up-notional-profits/">emphasised by Justice Wigney of the Federal Court</a>:</p>
<blockquote>
<p>It resulted in significant trading in a major Australian public company which, because it involved insider trading, had the capacity to significantly undermine the integrity and efficiency of the relevant securities markets. It was by no means a victimless crime: the victim was the market.</p>
</blockquote>
<p>The fine of A$400,000 was less than the maximum civil penalty of A$1,000,000, in recognition that while the case involved significant trading, it was inadvertent and not the most serious breach imaginable. However, in cases of more egregious breaches, A$1,000,000 is not a large fine for a publicly listed company with significant resources. </p>
<p>Due to its nature, insider trading is extremely difficult to detect and prosecute. Accordingly, it is appropriate to consider increasing the civil penalties available for insider trading, to an amount more likely to deter such conduct and to encourage corporations to limit opportunities for insider trading. </p>
<p>It is encouraging that the current Senate Inquiry is focusing on penalties for insider trading and other white collar crimes. We all benefit from a fair, efficient securities market with its integrity protected and maintained.</p><img src="https://counter.theconversation.com/content/70191/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Juliette Overland does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>For the first ever case a corporation was fined for insider trading. But we should consider stiffer penalties to protect markets.Juliette Overland, Senior lecturer, Corporate Law, University of Sydney Business School, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/607922016-06-12T19:40:27Z2016-06-12T19:40:27ZInsider trading is greedy, not glamorous, and it hurts us all<p>Much of the focus on the <a href="http://asic.gov.au/about-asic/media-centre/find-a-media-release/2016-releases/16-180mr-oliver-curtis-found-guilty-of-insider-trading-conspiracy/">insider trading case of Oliver Curtis</a> has been on the titillating details of the <a href="http://www.abc.net.au/news/2016-05-18/oliver-curtis-trial-hears-he-was-swept-up-in-fake-world/7425708">man’s social life</a>, <a href="http://www.dailymail.co.uk/tvshowbiz/article-3628587/Roxy-Jacenko-shakes-darker-days-planning-designer-wardrobe-ahead-social-media-seminar.html">his wife</a> and past relationship with his partner in crime John Hartman. However all this misses the point, it’s not about what the pair gained and stand to lose from the insider trading, it’s what we all lost.</p>
<p>Last week Curtis was found guilty of insider trading. His unethical behaviour hurts your retirement wealth and damages the integrity of our investment systems.
It’s true that he wasn’t an “insider” to the companies he was trading. He had no knowledge of CEO and Board decisions or other company-specific material price-sensitive non-public information. </p>
<p>Rather, Curtis was receiving non-public information about buying and selling taking place at a friend, John Hartman’s, funds management firm. The firm Hartman worked for, Orion Asset Management, managed around $6 billion of funds at the time and the trades Hartman was privy to were often sufficiently large to affect prices.</p>
<p>The illegal trading took place through 45 buys and sells of “contracts for difference’ (CFDs) between May 2007 and June 2008. In simple terms, CFDs are securities which allow the holder to bet on stock gains and losses. </p>
<p>Most trades don’t affect prices, in a way that most fish don’t create waves. Large value ‘block’ trades though can impact prices like a humpback whale breaching. </p>
<p>Curtis was "front-running” these large trades using CFDs. <a href="http://www.nasdaq.com/investing/glossary/f/front-running">Front running</a> is a practice of placing orders ahead of upcoming block trades in order to benefit from the anticipated up or down movement it will have on the stock price. ASIC estimated the net profits Curtis made through this strategy <a href="http://asic.gov.au/about-asic/media-centre/find-a-media-release/2016-releases/16-180mr-oliver-curtis-found-guilty-of-insider-trading-conspiracy/">amounted to over $1 million</a>.</p>
<h2>What’s the problem?</h2>
<p>While there are legal forms of front running and insider trading, the kind of trading undertaken by Curtis is illegal for good reason. It is widely considered unethical, adds to the costs of investing, and destabilises core financial systems.</p>
<p>It is hard to believe Curtis and Hartman did not know they were breaking the law, particularly given <a href="http://www.dailytelegraph.com.au/news/nsw/oliver-curtis-insider-trading-trial-best-friend-john-hartman-testifies-against-roxy-jacenkos-husband/news-story/65b9d61f39b6e0ba75c490382ecea777">Hartman’s testimony</a> and the unambiguous wording. The ethics of insider trading, however, can be more complex.</p>
<p>In 1990, <a href="http://link.springer.com/article/10.1007%2FBF00382642">Jennifer Moore argued</a> that the key ethical considerations are: fairness, ownership of property rights, and harm. Curtis was unethical in each of these ways.</p>
<p>Curtis and Hartman took advantage of an unfair access to information that the rest of the market didn’t have about large pending trades. Hartman’s employer owned the rights to that information and did not grant permission for that information to be shared. </p>
<p>While there appeared to be no victims, front running reduces the potential profits for those outside the illegal trade. In other words, other market participants were disadvantaged.</p>
<p>That disadvantage translates to added costs of investing and lower returns for everyone else. That includes the <a href="https://www.superannuation.asn.au/resources/superannuation-statistics">$350 billion of ordinary Australians’ superannuation wealth</a> tied up in ASX traded securities. </p>
<p>This is the first major point that has been lost with the <a href="https://www.buzzfeed.com/ginarushton/this-woman-instagrammed-her-outfit-each-day-of-her-husbands?utm_term=.piqGJPx5B#.pd43MAKBj">misdirected focus on the socialite’s Instagram pages</a>.</p>
<h2>Destabilising the system</h2>
<p>The second and even more critical risk, however, is the potential erosion of the integrity of our financial systems. Lawful investors may shift their portfolios to other markets if they consider that there may be other illegal insider traders like Curtis still out there. Why play in system rigged against you?</p>
<p>One argument thrown up as a defence for insider trading is that if the <a href="http://www.cnbc.com/id/40318804">insiders bring information to the market sooner</a>, then prices will be more efficiently priced. There is little empirical evidence to indicate this works in reality. </p>
<p>Stock price efficiency is based on what is known about a company. Prices are most efficient when they reflect all known information, and “discovering” this efficient price is when new information (such as earnings announcement, CEO retirement, etc) becomes known.</p>
<p>Recent research on this topic in the U.S. found that <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1784528">insiders benefit for themselves</a> with little of their inside information spilling over to benefit the public through more efficient prices. Strict regulation deters illegal insider trading with minimal adverse impact on this price discovery process.</p>
<p>The unscrupulous will continue to pursue ways to counter regulations. Recent studies detecting <a href="http://www.sciencedirect.com/science/article/pii/S1386418113000438">shifts in informed trading</a> away from more heavily monitored equities markets to derivative and bond markets (which currently have less public data monitoring) point to this. </p>
<p>The public should expect more from those managing their wealth. Glamourising the lifestyles of those who have broken the law and acted unethically damages the good work being done by many others in our financial institutions. Illegal insider trading is not a victimless crime and we should not let tabloid distraction make us forget that.</p><img src="https://counter.theconversation.com/content/60792/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Danika Wright does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>It doesn’t matter how much Oliver Curtis and John Hartman stood to gain from insider trading, what matters is what we all lose from market tampering.Danika Wright, Lecturer in Finance, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/389162015-03-17T23:22:28Z2015-03-17T23:22:28ZSeven-year sentence for insider trading unlikely to deter others<p>The seven-year sentence for insider trading handed down by Justice Hollingworth of the Victorian Supreme Court yesterday is one of the harshest imposed on a white-collar criminal in living memory. </p>
<p>One of the offenders, former NAB foreign exchange trader Lukas Kamay, <a href="http://www.theage.com.au/victoria/lukas-kamay-christopher-hill-hatched-insider-trading-scheme-in-fitzroy-north-pub-20141211-124ulc.html">received confidential information</a> on labour force and retail sales figures from his friend, Christopher Hill, who worked at the Australian Bureau of Statistics. The original investment by Kamay was only A$1,000 on August 13, 2013 and by May 9, 2014 was worth A$6.98 million. Tipster Christopher Hill received A$20,000 from Kamay for the confidential information and the court imposed a lesser sentence of three years and three months.</p>
<p>In her <a href="http://scv2.webcentral.com.au/sentences/sentence_kamay_hill/index.html">sentencing</a>, Justice Hollingworth said she wanted to deter other young people in the corporate world from engaging in criminal conduct.</p>
<p>White-collar crimes tend to receive much lower criminal sentences than other crimes, such as armed robbery or assault. The major enforcer is the Australian Securities and Investments Commission (ASIC) working with the prosecutor, the Commonwealth Director of Public Prosecutions (DPP). Although ASIC has been successful in over 90% of litigation, in the last five years an average of just 14 people were sent to jail each year for all corporate crimes.</p>
<p>Over the last 20 years, the majority of people caught for insider trading have not made much money out of the transactions and have been accidentally <a href="https://theconversation.com/insider-trading-gets-more-scrutiny-but-convictions-may-not-flow-19683">investigated by a tip-off</a> or as part of a broader investigation. So the fact that Kamay received a $7 million profit is significant. But other NAB rogue traders, <a href="http://www.smh.com.au/news/business/former-nab-traders-jailed/2006/07/04/1151778911857.html">David Bullen and Vincent Ficarra</a> in 2006 reportedly caused the bank to lose A$160 million. Bullen received an effective sentence of 44 months, while Ficarra was given a term of 28 months.</p>
<h2>A patchy record</h2>
<p>Between 1973 and 2000 only 17% of insider trading cases in Australia were successful, according to <a href="https://theconversation.com/infographic-insider-trading-in-australia-33408">research</a> conducted by Professor Ian Ramsay and colleagues. This rate rose to 65% between 2001 to 2013. Only 3% of convictions led to a sentence exceeding three years and 27% of convictions resulted no jail time at all. Other high profile cases have included Steven Xiao with 104 charges netting A$1.4 million; John Gay in 2013, netting $800,000 and John Hartman in 2010, who made A$1.9 million. In 1999, the author and finance professor, Mark Freeman published findings that 5% of all trades on the stock market are tainted with insider trading.</p>
<p>The two questions worth analysing are whether the penalties are severe enough (the maximum a judge can impose) and whether the penalties actually act as a deterrent. </p>
<p>The Corporations Act does impose a severe penalty for insider trading, when compared to all other crimes included within the corporations’ legislation. The maximum penalty for an individual (compared to a company) is imprisonment for up to 10 years or fines - up to the greater of A$765,000 or three times the benefits obtained. This depends on whether the the court can determine the total value of the benefits that have been obtained by one or more persons and are reasonably attributable to the commission of the offence.</p>
<p>For companies the fine can be the greater of A$7.65 million, three times the total value of the benefits obtained, or 10% of the body corporate’s annual turnover during the 12-month period in which the offence was committed. Professors Ayres and Braithwaite research on regulatory enforcement (1992) provides the ‘pyramid of enforcement’, which has criminal sentencing at the very top of the regulators toolkit.</p>
<p>In practice, it is very hard to obtain a conviction, unless the defendant pleads guilty, as Kamay did. Under the law, three main contraventions of the Act relating to insider trading are found in section 1043A:</p>
<ul>
<li><p>actually trading in (acquiring, buying or selling) the financial products</p></li>
<li><p>procuring (actively encouraging another) to buy or sell the financial products and</p></li>
<li><p>communicating the confidential inside information to someone who is likely to use the secrets to trade in the financial products.</p></li>
</ul>
<p>The bigger question is whether this maximum penalty and the sentence imposed on the particular facts of Kamay and Hill would have any impact on other potential insider traders. </p>
<p>The judge said: </p>
<blockquote>
<p>“The crimes were motivated by pure greed and the DPP was right to describe the conduct as the ‘worst instance of insider trading to have come before the courts in this country’.” </p>
</blockquote>
<p>However, it is unlikely to really deter future insider traders. They will either not evaluate the risks of being caught or think they are smarter than the regulators or internal controls of the large corporations that employ such traders. Reducing the opportunities for crime to occur are a critical part of a <a href="http://www98.griffith.edu.au/dspace/bitstream/handle/10072/29205/8427_1.pdf?sequence=1">two-stage crime prevention process</a> developed by Professor Richard Wortley in 1998. </p>
<p>Insider trading and market manipulation are not just about the issue of trust and making an unfair and secret profit. The larger problem is one of market confidence and as such all listed companies, financial institutions and the regulators have a strong onus and commitment to detect and prevent insider trading. </p>
<p>The use of technology is making it easier and quicker to identify suspicious transactions and this has to be a positive for the whole of the Australian securities markets.</p><img src="https://counter.theconversation.com/content/38916/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Michael Adams does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The sentences handed to insider traders Lukas Kamay and Christopher Hill send a strong message, but preventing the opportunity for such crimes to occur is just as important.Michael Adams, Dean, School of Law, Western Sydney UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/378912015-02-26T19:31:20Z2015-02-26T19:31:20ZWhite collar crime and metadata: beware of building a new honeypot<figure><img src="https://images.theconversation.com/files/72882/original/image-20150224-32226-luacdh.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Regulators like ASIC are turning to metadata to help make their cases against white collar criminals.</span> <span class="attribution"><span class="source">Image sourced from Shutterstock.com</span></span></figcaption></figure><p>With the struggle by law enforcement agencies to keep pace with new technologies has come calls by the agencies for additional investigatory powers.</p>
<p>The <a href="http://www.smh.com.au/digital-life/digital-life-news/metadata-retention-those-with-nothing-to-hide-have-nothing-to-fear-says-australian-federal-police-assistant-commissioner-tim-morris-20150222-13ljzi.html">call</a> for communications service providers to retain two years of their customers’ metadata is simply the latest round in this debate. While much of the current discussion has centred on consumer data and policing agencies, the proposal also covers the communications of businesses, and the Australian Securities and Investments Commission (ASIC) is one of the agencies seeking access.</p>
<p>Analysing two years’ retained metadata about your communications would give any law enforcement agency enormous insight into your life and, potentially, leverage over you. Using the data they could easily identify completely legal but otherwise embarrassing confidential events in your life, such as whether you have, for example, had an affair, an abortion, called a suicide help-line, a brothel or alcoholics anonymous. </p>
<p>Having the power to analyse two years’ retained metadata about a business’ communications creates different risks: for example, knowing whether the senior executives of a listed company are talking often with a bankruptcy advisory firm or an investment bank’s mergers/acquisitions team could create enormously valuable trading opportunities prior to the release of that information to investors and the general public.</p>
<p>The benefits of granting additional powers designed to increase the efficiency of law enforcement agencies need to be balanced against a range of risks, including the need to protect civil liberties and the possibility of unintended consequences. </p>
<h2>What ASIC wants</h2>
<p>The government’s current plan for data retention law includes provisions which would limit which law enforcement agencies could gain warrantless access to the retained metadata. In its submission to the <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/Joint/Intelligence_and_Security/Data_Retention">Parliamentary Joint Committee for Intelligence and Security Inquiry into Data Retention</a>, ASIC argued the proposed Bill would reduce its existing powers to access telecommunications data and stored communications for the purposes of investigating white collar criminal activities, such as insider trading, market manipulation and financial services fraud.</p>
<p>Over the last five years, ASIC has secured convictions against 129 people for serious offences under the Corporations Act (including sentences of more than 13 years’ incarceration in some instances) and 2404 people for less serious offences, though it did not specify how many of these convictions depended upon evidence gained from metadata.</p>
<p>ASIC currently has access to telecommunications data under sections 178-179 of the Telecommunications Interception Act. It claims it has used that information in over 80% of its insider trading investigations, including in the <a href="http://www.afr.com/p/business/companies/how_used_linkedin_to_bust_the_nab_G8l59FUftwlEtCGtlBiceL">Lucas Kamay (NAB) and Christopher Hill (ABS) case</a>.</p>
<p>ASIC uses a <a href="https://theconversation.com/insider-trading-gets-more-scrutiny-but-convictions-may-not-flow-19683">variety of techniques</a> to investigate white collar crimes, including data analytics of trading patterns. It also receives reports of suspicious trading activities from industry participants and the general public.</p>
<p>Metadata is particularly useful for ASIC when seeking to identify potential suspects (and their accomplices) and their methods/patterns of communication, so that further surveillance of ongoing behaviour can be undertaken. While metadata itself does not definitively prove the identity of who was talking on a particular phone, typing a text message or sitting behind a keyboard, it can suggest who was most likely to have been doing those things (i.e. in many cases, the registered owner of the account). The actual identities of the participants can then be confirmed through follow-up surveillance.</p>
<p>Metadata can provide information on the methods that two or more people are using to communicate (whether by landline, mobile phone, SMS, Skype, etc). It can also provide a rich history of both patterns of communication (which devices are in contact with which other devices, when and how often) and interruptions to such patterns of communication, such as ceasing to communicate by mobile phone or changing phone SIMs, which could indicate the suspects believe they are under surveillance.</p>
<p>In some trials, evidence of the timing of communications can be critically important. For example, when NAB trader Lukas Kamay received confidential information from Christopher Hill about yet-to-be-released Australian Bureau of Statistics’ data, Kamay was able to profit by placing leveraged foreign exchange trades on the value of the Australian dollar. ASIC only became aware of this activity after it was tipped off by Kamay’s forex brokerage firm, Pepperstone Financial, and while access to metadata played a small part in the investigation, it was traditional surveillance which resulted in the convictions of Kamay and Hill.</p>
<p>Access to retained metadata would grant ASIC the ability to search the history of patterns of conduct between suspects, such as whether they were repeatedly communicating and trading just prior to the announcement of market-sensitive information, even in situations where ASIC only became aware of the possibility of illegal activities well after they had actually occurred. It may also assist them to identify additional co-conspirators.</p>
<h2>A new honeypot?</h2>
<p>To be able to undertake such analysis, ASIC would need metadata to be retained from businesses as well as from individuals. Under the Bill, such metadata would be stored by communications providers, such as mobile phone companies and ISPs. This poses a risk for some businesses as their communications metadata contains highly valuable confidential information.</p>
<p>In its drive to increase the effectiveness of its fight against white collar crimes, it is possible ASIC and the government may unintentionally increase the risk of such crimes occurring while also making them harder to detect.</p>
<p>Communications service providers forced by the proposed legislation to store metadata are likely to provide security sufficient to protect against unauthorised access based upon the risk profile of their average customer, rather than for their most-at-risk customers. This raises the possibility of third parties seeking to gain unauthorised access to businesses’ financially sensitive information through their retained metadata, whether third party hackers using zero-day exploits, or trusted public servants (like Hill) looking to supplement their government pay cheques.</p>
<p>Insider trading and market manipulation may become harder to detect because third party hackers will no longer need to directly <a href="http://www2.fireeye.com/rs/fireye/images/rpt-fin4.pdf">attack</a> listed companies and their advisers, but instead could indirectly gain information by attacking metadata repositories. If a communications service provider pooled all of its customers’ metadata into a single database, then this may represent the equivalent of an inadequately secured goldmine for white collar criminals. </p>
<p>We should not rush to implement a system of metadata retention before all of the costs and benefits of such a proposal are fully considered.</p><img src="https://counter.theconversation.com/content/37891/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Selby is also affiliated with the UNSW Cyberspace Law and Policy Community, other members of which made separate submissions to the PJCIS Inquiry into Data Retention. In 2001, he was seconded as an in-house counsel for Telstra's Retail eCommerce legal team. He previously worked as an Internet lawyer for Mallesons Stephen Jaques (now King & Wood Mallesons). </span></em></p>Businesses as well as individuals could soon see their metadata retained, making the data storage points even more attractive to criminals.John Selby, Lecturer - Faculty of Business and Economics, Macquarie UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/334082014-10-26T19:07:34Z2014-10-26T19:07:34ZInfographic: insider trading in Australia<figure><img src="https://images.theconversation.com/files/62807/original/gkgyj32h-1414373889.png?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Screen shot at PM</span> </figcaption></figure><p>The typical insider trader is male, aged between 30 and 49, and holds a company director position, according to a new study from researchers at the University of Melbourne.</p>
<p>The <a href="http://newsroom.melbourne.edu/news/insider-trading-study-shows-stronger-enforcement">study</a> analysed all insider trading enforcement cases since legislation to prohibit insider trading was introduced in 1971.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/62770/original/qhmg9p5v-1414325249.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/62770/original/qhmg9p5v-1414325249.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=3059&fit=crop&dpr=1 600w, https://images.theconversation.com/files/62770/original/qhmg9p5v-1414325249.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=3059&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/62770/original/qhmg9p5v-1414325249.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=3059&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/62770/original/qhmg9p5v-1414325249.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=3844&fit=crop&dpr=1 754w, https://images.theconversation.com/files/62770/original/qhmg9p5v-1414325249.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=3844&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/62770/original/qhmg9p5v-1414325249.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=3844&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
</figcaption>
</figure>
<p><em>The authors of the study are Victor Lei and Ian Ramsay and the title of the study is “Insider Trading Enforcement in Australia” (2014) 8 Law and Financial Markets Review 214-226.</em></p><img src="https://counter.theconversation.com/content/33408/count.gif" alt="The Conversation" width="1" height="1" />
The typical insider trader is male, aged between 30 and 49, and holds a company director position, according to a new study from researchers at the University of Melbourne. The study analysed all insider…Charis Palmer, Deputy Editor/Chief of StaffEmil Jeyaratnam, Data + Interactives Editor, The ConversationLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/316932014-09-15T15:54:56Z2014-09-15T15:54:56ZWall Street tries to weed out the wolves while London stays sheepish<p>When Mathew Martoma, the former portfolio manager of SAC Capital, was <a href="http://online.wsj.com/articles/martoma-sentenced-to-nine-years-1410208845">sentenced to nine years in prison for insider trading</a> last week, much of the comment was about how harsh the punishment looked. It must have seemed particularly so to traders in the dealing rooms of light-touch London.</p>
<p>In truth, Martoma should take some of the blame. <a href="http://www.nysd.uscourts.gov/judge/Gardephe">Federal court judge Paul Gardephe</a> justified the length of the sentence by the exceptionally high gains that he had made from this deal, his lack of repentance and his refusal to co-operate with the authorities.</p>
<p>Martoma had been dealing on non-public information he had received from a doctor about clinical trials of a new Alzheimer’s drug. He received the private information on a Sunday in July 2008. The next day, SAC Capital sold its $700m stake in US-based <a href="http://www.fiercepharma.com/story/doctor-2-elan-wyeth-insider-trading-case-said-be-well-connected-alzheimers/2013-09-06">Wyeth Pharmaceuticals and Irish Élan Corporation</a>, the two joint developers of the drug, before the stock prices of the latter two crashed. Martoma’s trade generated roughly $275m for SAC Capital and just above $9m in bonuses for himself. Meanwhile, <a href="https://theconversation.com/sac-capital-and-the-curious-economics-of-insider-trading-25403">billionaire Steve Cohen</a>, the only owner of now-defunct SAC Capital, managed to avoid jail and <a href="http://dealbook.nytimes.com/2013/11/04/sac-capital-agrees-to-plead-guilty-to-insider-trading/">walked off with a fine of $1.2 billion</a>.</p>
<h2>Rebirth</h2>
<p>This was not the first time SAC Capital had been in the spotlight for insider trading. While several traders associated with the fund – <a href="http://nypost.com/tag/michael-steinberg/">such as Michael Steinberg</a> who was sentenced for insider trading of Dell and Nvidia stock – had been convicted of insider trading offences, the prosecutors had never been able to go after Steve Cohen, Mr Big himself. </p>
<p>The Martoma case was different, though, and there was enough evidence for the courts to shut down SAC Capital. Although Cohen had to pay $600m in a settlement with the Securities and Exchange Commission (SEC), in addition to the $1.2 billion fine and the shutting down of SAC Capital, he nevertheless managed to avoid a prison sentence. He is now in charge of <a href="http://qz.com/187063/point72-inside-joke-in-sac-capital-new-name-that-everyone-is-missing/">Point 72 Asset Management</a>, which invests the massive fortune he made as a hedge fund manager.</p>
<p>Martoma’s prison sentence is one of the longest for insider trading in US history, <a href="http://online.wsj.com/news/articles/SB10001424052970203914304576627191081876286">alongside Raj Rajaratnam’s 11 years</a> in 2011 and <a href="http://fortune.com/2014/07/07/matthew-kluger-talks/">Matthew Kluger’s 12 years</a> also in 2012. He made a fundamental error of judgement by refusing to co-operate with the investigators or testify against Cohen. By contrast, Cohen’s SAC itself pleaded guilty. </p>
<p>In fact, when we take into account the gains he generated from his trade, Martoma’s sentence still compares favourably to those of Rajaratnam and Kluger. While Kluger had made illegal profits of a mere $32m from three trades over 17 years, he was sentenced to 12 years. Rajaratnam’s illegal trades also spanned over several years and raked in a relatively modest $70m. </p>
<h2>London calling</h2>
<p>All these sentences have brought the number of successful convictions for insider trading in the US to about 80 cases since the 2007/8 financial crisis. The UK Financial Conduct Authority (FCA) and its predecessor, the Financial Services Authority (FSA), have <a href="http://www.risk.net/operational-risk-and-regulation/feature/2253142/fsa-toughens-insider-dealing-enforcement">so far secured just 24 convictions</a>.</p>
<p>There is another way of looking at it. In 2013, UK-based trader <a href="http://www.telegraph.co.uk/finance/financial-crime/9923248/Financier-jailed-for-insider-trading.html">Richard Joseph</a> was sentenced to 4 years in prison for insider dealings around takeover bids which made him a net profit of just £591,117. Aside from his prison sentence, in <a href="http://www.fca.org.uk/news/insider-dealers-ordered-to-pay-32m-in-confiscation">September 2014</a> he was also subjected to a confiscation order amounting to £2,170,191. You might argue that FCA and UK courts do seek to create deterrents, via harsh sentences, to dissuade those tempted by illegal insider dealing. By contrast, Martoma could probably have got away with an out-of-court settlement had he decided to be more co-operative. </p>
<p>That said, the conviction rate remains underwhelming, but it does at least represent an improvement on the pre-crisis period. The FSA managed to secure only one successful conviction between 2001 and 2006. Historically, there have been few successful convictions in the UK. For example, between 1981 and 1998 there were only 17 prosecutions of which only 12 were successful. </p>
<p>And even if the authorities do come knocking, London’s City traders can comfort themselves with the knowledge that the maximum prison sentence for illegal insider dealing in the UK is only seven years. The highest jail sentence so far in the UK has been four years, as it was <a href="http://www.theguardian.com/business/2012/jun/20/husband-and-wife-jailed-insider-dealing">for James Sanders in 2012</a>. </p>
<p>At the heart of the matter seems to be a conscious decision by the US prosecutor to doff its cap to public opinion and seek to to weed out the wolves of Wall Street. In the UK, meanwhile, there seems little evidence as yet that City traders who engage in illegal insider dealings are being treated any harsher than was the case before the financial crisis.</p><img src="https://counter.theconversation.com/content/31693/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Marc Goergen does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>When Mathew Martoma, the former portfolio manager of SAC Capital, was sentenced to nine years in prison for insider trading last week, much of the comment was about how harsh the punishment looked. It…Marc Goergen, Professor of Finance, Cardiff UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/260262014-04-30T05:16:03Z2014-04-30T05:16:03ZHeartbleed bug: insider trading may have taken place as shares slid ahead of breaking story<figure><img src="https://images.theconversation.com/files/47294/original/skpc62hp-1398783384.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Saw it coming?</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/jooon/2432064925/in/photolist-mZdKrD-4GUYaT-mYec7R-n4Te9S-n4tixv-nhZwtE-n174PX-mXZ8xL-n1WHrX-naJCem-n2iyiH-n2ixxB-n2ixrV-n8Wrf5-nf92fS-naQx9D-mVbXze-nbqU4Y-n6Y57w-mZhmxe-mZt99K-mWrtUh-n6KDwn-n57ydM-nbou86-mZiFUX-mWkjCT-n5PbZ3-mY2r8H-n8xmPP-4HnUAc-n9z6j9-ndb1FH-mZTmjP-n12jH6-n292ph-mVZ9ra-n31ZjJ-mYbPKB-ni9yrn-npmjXA-mZohiR-mWkYyx-mY2ksp-mYajNF-mZhmwH-mZhmvR-mZhmtX-mZj9Pu-n89CYC">Jon Åslund</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span></figcaption></figure><p>Here is a puzzle for you. Why did shares in Yahoo! slide by nearly 10% in the days before Heartbleed was announced and then recover after the main news items broke?</p>
<p>It has long been the case that security vulnerabilities can have a negative effect on the public’s perception of tech companies and the value of their stock. All chief executives need to understand this and take action to reduce the exposure and associated risks. </p>
<p>It happened with Sony three years ago, for example, with an <a href="http://www.bbc.co.uk/news/technology-13169518">outage on their PlayStation network</a>. This lasted more than a week, resulting in a share price drop of 8%. It affected both consumers and developers, causing major embarrassment for the company. </p>
<p>I have analysed how the recent <a href="http://www.businessinsider.com/heartbleed-bug-explainer-2014-4">Heartbleed bug</a> affected certain major tech companies. Yahoo! was widely reported to have been hit hard by Heartbleed and to have leaked user information. Amazon had more to lose than most major companies from a dip in consumer confidence related to electronic commerce. Also included in the analysis were HP, Dell, Google, AOL and Microsoft. </p>
<p>The chart below shows the stock price of these companies over the time of the Heartbleed vulnerability. You can see there are two dips, which can be explained by three main phases.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/47176/original/r42zg52x-1398701187.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/47176/original/r42zg52x-1398701187.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=420&fit=crop&dpr=1 600w, https://images.theconversation.com/files/47176/original/r42zg52x-1398701187.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=420&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/47176/original/r42zg52x-1398701187.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=420&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/47176/original/r42zg52x-1398701187.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=528&fit=crop&dpr=1 754w, https://images.theconversation.com/files/47176/original/r42zg52x-1398701187.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=528&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/47176/original/r42zg52x-1398701187.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=528&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The ups and downs of big tech stock during Heartbleed crisis.</span>
<span class="attribution"><span class="source">Google Finance</span></span>
</figcaption>
</figure>
<h2>Day zero minus two</h2>
<p>The first phase related to the <a href="http://blog.easydns.org/2014/04/07/urgent-security-advisory-heartbleed-openssl-vulnerability/">technical release of information</a> about the vulnerabilty. The first major news release was on April 7 with the stark message: <a href="http://seclists.org/fulldisclosure/2014/Apr/106">“We are doomed.”</a></p>
<p>We can see that the full dip happened that day, taking these companies’ stock prices down between 3% and 10%. But the slide had been happening for a few days, having started on the previous Thursday. This may have been due to information being disseminated to the major companies, most likely from the security authorities before the rest of the world knew about it.</p>
<p>This would have been intended to give the major companies a day or two to get their systems ready for the so-called day zero threat, where it would be an open season in terms of intruders probing systems. </p>
<p>It could be that this information was also leaked to insiders who then sold their stocks in the major IT companies, waiting for a time to repurchase them at a tidy profit. One thing that would certainly be well known to traders is that a news item can push down a company’s stock price, only for it to recover after it blows over. </p>
<h2>Day zero plus one</h2>
<p>In the next phase, from April 7 to 9, the companies’ stock prices went back up, almost to normal levels. This was the period where the key technical teams within the major IT companies were patching their systems and reporting back. The information coming back perhaps didn’t look too bad on their systems, which would have made them think they weren’t badly exposed. </p>
<p>The vulnerability was only seen as a technical flaw and nothing to alarm the business community. Few at the time were predicting the storm would hit and the impact that it would have. Traders may well have gone back into the market to repurchase stocks that they had sold in the days before. </p>
<h2>Day zero plus two</h2>
<p>The news of Heartbleed <a href="http://money.cnn.com/2014/04/09/technology/security/heartbleed-bug/">broke in a major way</a> around the world on April 9. Yahoo! and Amazon were heavily quoted in the news and were seen as being at the most risk. </p>
<p>Yahoo! stock lost 9.4%, while Amazon’s lost 8.3%. More curiously Microsoft went down nearly 5%, even though it was not exposed to the vulnerability.</p>
<p>Two things appear to have been going on – the first could have been profit taking. Traders could bail out of a stock, wait for the news item to play through, then go back in when the stock was at its lowest and make a nice profit. The second may have been a general knee-jerk feeling that the internet was cracking, and that the roof was about to collapse. It seemed possible that user trust in online commerce could be broken. </p>
<p>When the news broke, no one really knew what was going on, even at the highest level. Some governments were advising users to change all their passwords immediately, for example, while others were saying don’t change until things had been patched. For a company such as Amazon this lack of user trust, even for a short period, can have major effects on their infrastructure.</p>
<h2>The after effects</h2>
<p>After the main news events, stock prices mostly went back to where they started. None of the major companies caused the problem, so their reputations have not been tarnished. Yahoo! is now showing a 0.0% change overall, for example. </p>
<p>Some traders may have done well from the rises and falls during the crisis. The evidence suggests that there could have been some insider trading taking place in the days before the story became big news. In theory the companies should have announced the problem to the stock market as soon as they became aware, but this series of events probably illustrates the limits of the duty on companies to disclose: when matters of national security are at stake, the rules may not be so rigorously applied. </p><img src="https://counter.theconversation.com/content/26026/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Bill Buchanan does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Here is a puzzle for you. Why did shares in Yahoo! slide by nearly 10% in the days before Heartbleed was announced and then recover after the main news items broke? It has long been the case that security…Bill Buchanan, Head, Centre for Distributed Computing, Networks and Security, Edinburgh Napier UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/254032014-04-11T13:10:27Z2014-04-11T13:10:27ZSAC Capital and the curious economics of insider trading<p>A US judge has approved a US$1.2 billion settlement and <a href="http://www.reuters.com/article/2014/04/10/us-saccapital-crime-idUSBREA391B520140410">accepted a guilty plea</a> by hedge fund SAC Capital in what has been described as the largest insider trading settlement in the country’s history.</p>
<p>Eight people related to the fund have now been found guilty in a wide-ranging investigation of insider trading in US stock markets. Given the economics of insider trading aren’t widely understood, let’s remind ourselves why SAC did ought to be punished.</p>
<p>Insider trading simply means trading based on important undisclosed information. Insiders make profits by buying shares when they have confidential information about positive developments or can avoid losses when they sell shares based on undisclosed negative information. As financial instruments and transactions become increasingly complex so other ways to profit from insider information evolve to match them.</p>
<p>Insiders buy or sell shares from or to less informed investors who are willing to sell or buy anyway, unlike thieves who steal against someone’s will. This leads some to call insider trading “<a href="http://www.marketwatch.com/story/why-insider-trading-should-be-legal-2011-05-17">victimless crime</a>”.</p>
<p>Building on this argument, <a href="http://online.wsj.com/news/articles/SB10001424052748704224004574489324091790350?mg=reno64-wsj&url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB10001424052748704224004574489324091790350.html">some economists</a> say insider trading should be legalised entirely as it levels the playing field. According to this theory, allowing insider transactions would mean stock prices that reflect all information, whether public or private. This in turn makes markets more efficient (an “efficient market” after all is simply a market where prices reflect all information). Investors could therefore make more accurate decisions, and corporations could raise capital at fair prices.</p>
<p>But this argument clearly hasn’t won over regulators throughout the world. Insider trading remains prohibited, primarily to increase confidence and trust in markets. </p>
<p>If insider trading was allowed, those investors without access to the best information might hold on to their cash. After all, who wants to make bets with someone who knows more than you do? As such, insider trading decreases market liquidity, increases the cost of trading and consequently makes it more difficult for corporations to raise capital. None of these effects do much good for the economy.</p>
<h2>Fine lines</h2>
<p>Insider trading is difficult to detect and prosecute as the line between legal and illegal is extremely fine. Investors collect and analyse huge amounts of information and frequently trade across a large pool of stocks. It’s very tough to prove that they made a specific investment decision based on specific piece of information which was undisclosed to the public.</p>
<p>Given these obstacles, insider trading investigations tend to be long and expensive. The digital forensic techniques used – analysing emails, phone records and so on – aren’t simple.</p>
<p>For example, the UK’s Financial Services Authority successfully prosecuted six individuals in 2012 for insider trading which made them a combined profit of £732,000. To build their case, the FSA obtained and reviewed over 200,000 lines of trading in 130 brokerage accounts and 375,000 lines of telephone call records. More than 300 witness statements were included and the trial itself was four and a half months long. That’s a lot of effort just to uncover a scam worth less than £1m.</p>
<h2>Economic benefits</h2>
<p><a href="http://deepblue.lib.umich.edu/bitstream/handle/2027.42/40127/wp741.pdf?sequence=3">Empirical evidence</a> is in favour of prohibiting insider trading. Interestingly though, what brings benefits is not the fact that insider trading law are enacted. Apparently insider trading laws on books do not matter <a href="https://faculty.fuqua.duke.edu/%7Echarvey/Teaching/BA453_2005/BD_The_world.pdf">until they are first enforced</a>. </p>
<p>This supports the efforts of regulators around the world to detect and prosecute insiders. The benefits of effective insider trading laws include lower costs of raising capital, greater stock market liquidity, more accurate (and not less accurate, as proponents of deregulation of insider trading argue) pricing driven by a larger group of market participants, including analysts, willing to collect information and participate in the stock market when they have confidence that insider trading is not rampant.</p>
<p>Finally, it is worth bringing up an argument made by those who look at the economics of crime. Prohibition of insider trading and relevant enforcement will discourage or eliminate smaller insiders but will not eliminate insider trading entirely. Instead, it will create <a href="http://onlinelibrary.wiley.com/doi/10.1111/j.1354-7798.2005.00285.x/abstract">large monopoly profits</a> available to the few who still decide to break the law. SAC Capital’s gains from insider trading may be one such example.</p><img src="https://counter.theconversation.com/content/25403/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Piotr Korczak does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A US judge has approved a US$1.2 billion settlement and accepted a guilty plea by hedge fund SAC Capital in what has been described as the largest insider trading settlement in the country’s history. Eight…Piotr Korczak, Senior Lecturer in Finance, University of BristolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/233652014-02-20T03:47:52Z2014-02-20T03:47:52ZLow penalties, high costs: ASIC needs legislative reform<p>In 2005, the Federal Court faced the difficult task of arriving at a penalty for Steve Vizard after he was found in breach of his duties as a director of Telstra. </p>
<p>In his judgment, Raymond Finkelstein <a href="http://www.smh.com.au/federal-politics/political-news/law-too-soft-on-whitecollar-criminals-says-former-judge-finkelstein-20120322-1vmxb.html">criticised the level of penalty</a> allowed under the Corporations Act and recommended that the upper limit of A$200,000 be reconsidered. </p>
<p>This week the Senate Economic References Committee is <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/ASIC">considering the performance of ASIC with public hearings in Sydney and Canberra</a>. Regrettably, nearly a decade after the Vizard case, nothing has changed.</p>
<p>ASIC is often subject to <a href="http://www.smh.com.au/business/scrutinising-asic-is-it-a-watchdog-or-a-dog-with-no-teeth-20131122-2y1s0.html">pointed criticism</a> for its perceived failures in policing the “big end of town” and its lack of timely, or sometimes any, intervention in matters that have attracted considerable media and public attention. </p>
<p>Some of these criticisms are well founded. But it should also be remembered that ASIC’s powers and functions are determined by its legislative framework. And that framework is overdue for reform.</p>
<h2>Insignificant penalties</h2>
<p>The upper limit of the penalty for directors and officers who breach their duties under the civil penalty scheme is still $200,000. This is without doubt a considerable sum. </p>
<p>But it does not lead to significant fines for individual directors who breach their duties. </p>
<p>In recent key cases the courts levied fines at the lower end of the spectrum. <a href="https://theconversation.com/the-hardie-judgement-muscling-up-asic-6840">In the James Hardie litigation</a>, for example, the Court of Appeal reduced the penalties imposed by the trial judge from $30,000 to $25,000 for the Australian directors and to $20,000 for the US directors. </p>
<p>These directors had breached their duties of care by approving a false and misleading announcement. </p>
<p>The non-executive directors in the <a href="https://theconversation.com/will-centros-mistakes-prompt-action-across-the-board-2048">Centro case</a> also breached their duties of care by approving the financial statements of the company despite a significant misclassification of the company’s debt. There was no fine imposed, in part due to the significant reputational damage they suffered. </p>
<p>It is perfectly clear from these and other cases that without legislative intervention to raise the upper limit of the penalty, we will continue to see relatively insignificant penalties handed out to directors. </p>
<p>While ASIC doesn’t suggest specific figures, it does make a submission based on the range currently available and within the parameters established by the legislation and the courts in previous cases. </p>
<p>It is proper that the courts weigh up a number of factors when arriving at an appropriate penalty. It is also fair that attention be paid to the reputational damage and embarrassment suffered by those who come before the courts. </p>
<p>However, it is notable that in the James Hardie case the fines for the Australian directors represented less than 40% of their directors’ fees in the year that they breached their duties. </p>
<p>In the Centro matter, the non-executive directors’ fees for the year in question ranged from $104,000 to $389,000. </p>
<p>The influence of the parity principle – that similar breaches should attract similar penalties – means that it is unlikely the courts will feel free to depart from the approaches in these cases without a circuit breaker. </p>
<p>Amending the legislation is the only way to change this pattern.</p>
<h2>Sky-high court costs</h2>
<p>The level of penalty is not the only area of the legislative framework ripe for reform. Other obstacles faced by ASIC include a cumbersome and costly civil penalty scheme where cases can cost many millions. </p>
<p>To ensure defendants aren’t exposed to penalty during proceedings, they aren’t obliged to specify their defences until ASIC’s case has closed. </p>
<p>As a consequence, ASIC is forced to plead all possible alternatives, increasing the complexity of its case and the time required to present it in court. Unsurprisingly, court time is wasted and costs escalate alarmingly. </p>
<p>For example, the costs incurred in the recent <a href="http://www.austlii.edu.au/au/cases/cth/HCA/2012/39.html">Fortescue case</a> have been estimated at A$30 million. Even before heading to the High Court, the total cost of the James Hardie litigation was said to be over $35 million.</p>
<p>In the Senate Committee hearings ASIC Chairman Greg Medcraft gave evidence that the <a href="http://www.abc.net.au/news/2013-08-12/asic-wins-storm-appeal/4881380">Storm Financial debacle</a> had so far cost ASIC $50 million. </p>
<p>Unless ASIC has accessible, efficient and powerful options that can be pursued through the courts, its position as the key regulator of companies and markets is undermined. This has inevitable consequences for all of us, as we are all now compulsorily investing through our superannuation schemes.</p>
<p>As the Senate Economic References continues to examine the performance of ASIC, it has an opportunity to recommend some real practical changes that can improve that performance. It’s an opportunity to act in the public interest that should not be missed.</p><img src="https://counter.theconversation.com/content/23365/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Suzanne Le Mire does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>In 2005, the Federal Court faced the difficult task of arriving at a penalty for Steve Vizard after he was found in breach of his duties as a director of Telstra. In his judgment, Raymond Finkelstein criticised…Suzanne Le Mire, Senior Lecturer, Law, University of AdelaideLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/196832013-11-10T19:44:02Z2013-11-10T19:44:02ZInsider trading gets more scrutiny, but convictions may not flow<figure><img src="https://images.theconversation.com/files/34503/original/ftrfr4b3-1383709742.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Former Gunns chairman John Gay is the most senior executive to have been convicted of insider trading in Australia. He received a fine of $50,000.</span> <span class="attribution"><span class="source">David Beniuk/AAP</span></span></figcaption></figure><p>The Australian Securities and Investments Commission is moving to “real-time” monitoring of share trading as another weapon in the ongoing fight against insider trading. </p>
<p>But will the use of this form of surveillance technology actually lead to an increase in the number of insider trading cases which are successfully mounted?</p>
<p>This month ASIC will <a href="http://www.afr.com/p/business/chanticleer/insider_traders_under_brighter_spotlight_ccLDeKRm9hPeKJqGCwPYDP">reportedly</a> adopt the long awaited FAST (Flexible Advanced Surveillance Technologies) market surveillance system, enabling it to engage in real-time monitoring of physical and future securities markets. </p>
<p>It’s hoped this technology will make it easier for ASIC to identify unusual or suspicious trading patterns in order to better identify insider trading. </p>
<p>But detecting likely insider trading is only the first step in the long journey to a successful prosecution, and ASIC’s track record in this area is also in the spotlight as a result of the current Senate <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/ASIC">inquiry</a> into its performance.</p>
<h2>No smoking gun</h2>
<p>Insider trading has a reputation as a notoriously difficult offence to successfully prosecute and is viewed by many as being both under-detected and under-prosecuted. Some even believe it is unavoidable and endemic to securities markets. </p>
<p>In Australia, insider trading is prohibited because it is a threat to the integrity of our securities markets. In addition to the unfairness which exists in giving “insiders” the opportunity to trade using information which others cannot access, if potential investors believe that “insiders” have a distinct advantage over all other investors, they are likely to lose confidence in the securities market and will be much less likely to participate.</p>
<p>A person commits the offence of insider trading when they trade in company shares (or other financial products) while they possess information which they know, or should know, is price-sensitive and not generally available. </p>
<p>To successfully prosecute a suspected insider trader, a number of elements must be proven:</p>
<ol>
<li> That the person had inside information.</li>
<li> That the person knew (or ought to have known) that the inside information was not generally available.</li>
<li> That the person knew (or ought to have known) that the inside information was price-sensitive.</li>
<li> That the person traded in share or other financial products to which the inside information related.</li>
</ol>
<p>The use of improved market surveillance technologies, enabling the regulator to detect more easily when suspicious trading has occurred, is likely to assist in relation to the fourth element above – proving that there has been trading in relevant shares or other financial products, but it will not necessarily make it any easier to prove the other elements of the offence.</p>
<p>Proving the state of mind of a suspected insider trader – that is, proving that the person knew or ought to have known that inside information was not generally available and was price-sensitive – is generally recognised as one of the major difficulties faced in insider trading prosecutions. Indeed, Alan Cameron, former Chair of ASIC, has even noted that “proving that a person had knowledge is often harder than it sounds unless there is smoking-gun type of evidence”. </p>
<p>There may be many reasons for a person to engage in securities trading – the mere existence of the trading itself is not indicative or conclusive of insider trading without additional strong evidence to support such a claim and prove the other elements of the criminal offence beyond a reasonable doubt.</p>
<h2>Helping ASIC</h2>
<p>In the past, ASIC has been criticised over its conduct of insider trading cases, but more recently it has had an improved track record in the pursuit of insider traders. </p>
<p>Twenty-nine individuals have reportedly been <a href="http://www.asic.gov.au/asic/asic.nsf/byheadline/13-226MR+Former+Gunns+chairman+convicted+of+insider+trading?openDocument">prosecuted</a> for insider trading since January 2009 – of whom 20 have been convicted, six have been found to be either “not guilty” or with a conviction quashed after a “guilty” verdict, with three sets of contested proceedings awaiting trial, and one matter discontinued. ASIC has also recently confirmed that insider trading will remain a significant focus of future investigations.</p>
<p>ASIC has a number of powers which can also be used to assist in the detection and investigation of insider trading – gaining access to telephone records and stored communications, the use of search warrants and compulsory information gathering powers. </p>
<p>Anecdotal evidence also suggests ASIC may rely to a certain degree on “tip-offs” from whistle-blowers and other informal sources. </p>
<p>Interestingly, in ASIC’s own submission to the Senate inquiry into its performance, lodged late last week, ASIC suggested it would be much better placed to carry out its many functions if granted <a href="https://theconversation.com/asic-underwhelms-with-call-for-greater-powers-19728">greater investigative powers</a>. If it succeeds the new real-time surveillance tool will be one new weapon in its armoury. </p><img src="https://counter.theconversation.com/content/19683/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Juliette Overland does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Australian Securities and Investments Commission is moving to “real-time” monitoring of share trading as another weapon in the ongoing fight against insider trading. But will the use of this form of…Juliette Overland, Senior lecturer, Corporate Law, University of Sydney Business School, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/162762013-07-25T20:09:34Z2013-07-25T20:09:34ZA hedge on the edge: SAC Capital’s insider trading scandal<figure><img src="https://images.theconversation.com/files/28051/original/3jpkp9rz-1374727022.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The SEC is going after one of the world's largest hedge funds in a civil suit. But will the action act as a deterrent against insider trading?</span> <span class="attribution"><span class="source">Image from www.shutterstock.com</span></span></figcaption></figure><p>After causing the <a href="http://www.economist.com/topics/galleon-group">collapse of the Galleon Group</a> hedge fund in 2009, insider trading enforcements have once again shaken the hedge fund industry. Late last week, the US <a href="http://www.sec.gov/">Securities and Exchange Commission</a> (SEC) <a href="http://business.time.com/2013/07/24/u-s-poised-to-charge-billionaire-steve-cohens-sac-capital-hedge-fund-reports/">charged</a> Steven A. Cohen, CEO of SAC Capital Advisors LP, one of the world’s largest hedge funds, with failing to supervise two of his managers, Mathew Martoma and Michael Steinberg, who traded on material non-public information concerning three US listed companies in 2008. </p>
<p>As a result of these illegal insider trades, SAC Capital Advisors earned profits and avoided losses of almost $300 million. If the high-profile administrative suit of the SEC proves to be successful on August 26, Cohen could face a permanent bar from the financial services industry, leaving the survival of SAC Capital on the edge and sending shivers through the entire hedge fund industry.</p>
<p>In general, insider trading refers to some investors (e.g. managers and directors of corporations) trading on proprietary information that is not yet available to the rest of the market. In the US, insiders are allowed to trade, as long as they meet two fundamental requirements: they do not trade ahead of information events – for instance, mergers and acquisitions and corporate announcements - where they have access to sensitive information prior to the rest of the market; and they report their trades by filing a <a href="http://www.sec.gov/answers/form345.htm">Form 4</a> with the SEC.</p>
<p>In the 2012 fiscal year, the SEC brought 58 insider trading actions against 131 managers and entities accused of gaining profits – or avoiding losses – totalling approximately A$600 million. Between 2010 and 2012, the SEC has filed more insider trading actions — a total of 168 cases against nearly 400 individuals and entities — than in any three-year period in the SEC’s history. “[T]hese illegal practices impose a cost on law-abiding investors and the integrity of the financial markets,” said Robert Khuzami, director of the SEC’s division of enforcement, in a <a href="http://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171482492#.UfCnPmT89Hg">press statement</a>.</p>
<h2>Insider trading: costs and benefits</h2>
<p>There is much debate among economists and jurists on whether the benefits of insider trading outweigh its costs. On the cost side, insider trading is <a href="http://qje.oxfordjournals.org/content/104/4/823.abstract">said</a> to decrease market liquidity due to greater adverse-selection costs of asymmetric information imposed on outside investors, and reduce investors’ confidence in capital markets, hence increasing the cost of capital and <a href="http://homepages.rpi.edu/%7Etealj2/Bainbridge2002.pdf">lowering firms’ value</a>. </p>
<p>Other academic studies suggest there could be benefits. One view is that insider trading could <a href="http://books.google.com.au/books/about/Insider_trading_and_the_stock_market.html?id=X7pEAAAAIAAJ&redir_esc=y">improve market efficiency</a> by impounding quickly certain <a href="http://www.insead.edu/facultyresearch/research/doc.cfm?did=50361">strategic non-public information</a> (such as earnings management) into prices, information that would <a href="http://books.google.com.au/books/about/The_Regulation_of_Insider_Trading.html?id=95zEGwAACAAJ&redir_esc=y">otherwise be withheld by corporations</a>.</p>
<h2>Strengthening internal governance</h2>
<p>Notwithstanding the uncertainty regarding the balance between informational costs and benefits of insider trading, little is known about how internal governance affects managerial incentives and profitability of insider trading.</p>
<p>Given that better governance could influence strong managerial incentives from performance fees and investors’ flows to engage in insider trading activities, understanding the role of hedge funds’ governance in preventing insider trading is crucial.</p>
<p>It is unsurprising that the <a href="http://www.banking.senate.gov/public/_files/070110_Dodd_Frank_Wall_Street_Reform_comprehensive_summary_Final.pdf">Dodd-Frank Act</a> took an important step in this direction by eliminating the previous exemption of advisory registration for hedge funds. </p>
<p>Starting from March 2012, all hedge funds were now required to file <a href="http://www.sec.gov/answers/formadv.htm">form ADV</a> with the SEC. This form requires information on the hedge funds’ organisational structure, compensation, assets under management, clientele, disciplinary history, and governance. As such, not only does it improve the transparency of hedge fund operations, but it could also help <a href="http://ideas.repec.org/a/bla/jfinan/v63y2008i6p2785-2815.html">better manage potential operational risks</a>.</p>
<p>More importantly, form ADV requires the board of a hedge fund to designate an independent chief compliance officer (CCO) with the aim of strengthening internal governance. The CCO should be responsible for supervising all portfolio transactions and overseeing the implementation of insider trading compliance policy which must include an affirmative statement of prohibition against insider trading. It is also important to remember that US mutual fund advisors have been filing form ADV since the introduction of the <a href="http://www.sec.gov/about/laws/iaa40.pdf">Investment Advisers Act of 1940</a>. It might not be a coincidence that many of the targets of the SEC’s insider trading investigations are managers of hedge funds, rather than mutual funds.</p>
<h2>What next?</h2>
<p>There is no doubt that despite this significant regulatory change, we will continue to see hedge fund managers populating the SEC’s “name and shame” enforcement action policy. Even so, the new provision of the Dodd-Frank Act represents an interesting experiment to study whether the new requirement of designating a CCO within the hedge fund organisation will provide hedge funds with various ex-ante and ex-post mechanisms to prevent their managers from exploiting inside information. </p>
<p>The stakes are high not just for the SEC, which has been pummelled for not always holding Wall Street accountable for misconduct, but also for the hedge fund industry as a whole, given its $1.5 trillion of assets under management.</p><img src="https://counter.theconversation.com/content/16276/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lorenzo Casavecchia does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>After causing the collapse of the Galleon Group hedge fund in 2009, insider trading enforcements have once again shaken the hedge fund industry. Late last week, the US Securities and Exchange Commission…Lorenzo Casavecchia, Lecturer in Finance, University of Technology SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/44292011-11-23T19:08:53Z2011-11-23T19:08:53ZCharges against former Gunns boss John Gay may test insider trading laws<figure><img src="https://images.theconversation.com/files/5808/original/tradingjohngay.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Australia's listed companies face tough insider-trading regulation, but aspects of the law are untested.</span> </figcaption></figure><p>Former Gunns chairman John Gay is facing <a href="http://www.smh.com.au/national/gunns-boss-accused-of-inside-trade-20111122-1nsy4.html">insider trading charges</a> after he allegedly sold more than $3 million worth of the beleaguered timber company’s shares just months before its share price plunged due to poor financial performance.</p>
<p>Sydney University senior lecturer in corporate and business law Juliette Overland explains the significance of the case and the challenges is presents to Australia’s insider-trading laws.</p>
<hr>
<h2>How does this case compare with other insider trading cases in terms of the scale of the alleged offence and the profile of the person involved?</h2>
<p>At this stage, it has only been reported that this individual has been charged with insider trading, so not a lot of information is yet known. But this case seems to rate quite highly on both counts. It has been reported that the net profit on the trading was over $3 million, which is significant. Cases have been brought in the past over much lower amounts, such as <a href="http://www.asic.gov.au/asic/asic.nsf/byheadline/03-170+Rene+Rivkin+sentenced+to+jail?openDocument">Rene Rivkin</a>’s case in which the insider trading resulted in profit of only a few thousand dollars. </p>
<p>This is also a very high-profile individual, more likely to be known to a large number of Australians than in many previous cases, which have not always involved senior people within organisations.</p>
<p>The particular issue for directors of listed companies is that there are a number of additional rules they must abide by, in addition to insider-trading prohibitions that apply to everybody.</p>
<p>These include share trading policies, which every listed company must have, that restrict the times at which directors and other senior employees can trade. </p>
<p><figure class="align-left ">
<img alt="" src="https://images.theconversation.com/files/5807/original/johngay.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/5807/original/johngay.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=682&fit=crop&dpr=1 600w, https://images.theconversation.com/files/5807/original/johngay.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=682&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/5807/original/johngay.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=682&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/5807/original/johngay.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=857&fit=crop&dpr=1 754w, https://images.theconversation.com/files/5807/original/johngay.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=857&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/5807/original/johngay.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=857&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Former Gunns chairman John Gay.</span>
<span class="attribution"><span class="source">AAP</span></span>
</figcaption>
</figure> </p>
<p>These policies usually have block-out periods, or “closed” periods as the ASX now calls them, in which directors and senior employees are not permitted to trade because they are likely to be in possession of sensitive information at particular times of the year.</p>
<p>The ASX also has to be notified within five business days of any share trades by directors of listed companies. </p>
<p>It has been <a href="http://www.smh.com.au/business/exgunns-chairman-charged-with-insider-trading-20111122-1nsva.html">reported</a> that a spokeperson for Gunns has stated that the relevant trading took place at a time when directors were permitted to trade, meaning it was not during one of Gunns’ closed periods.</p>
<p>But even during times when directors are permitted to buy or sell shares under a trading policy, they are still prohibited if they possess inside information.</p>
<h2>On the basis of what has been reported, how likely is it that ASIC will be able to begin criminal proceedings and potentially see a criminal conviction in this case?</h2>
<p>The fact that there are reports of him being “charged” with insider trading makes it sound as if ASIC has already decided to go ahead with criminal rather than civil proceedings. </p>
<p>ASIC may have already successfully made arrangements with the Department of Public Prosecutions to bring criminal proceedings.</p>
<p>We don’t tend to use the word “charged” for civil actions.</p>
<p>One of the issues that arises with criminal proceedings is that there is a higher burden of proof. The prosecution has to prove beyond reasonable doubt that the elements of the offence are made out.</p>
<p>In civil proceedings, there is a lower burden of proof. It only needs to be proved on the balance of probabilities – which essentially means that it is more likely than not that insider trading has occurred.</p>
<p>One of the key elements of insider trading is knowledge, but it also must be proved that the person knew the information wasn’t publicly available and that it was likely to affect the price of shares, and these are matters hard to prove beyond reasonable doubt.</p>
<p>Even though Australian law no longer makes any practical distinction between different types of insiders, a director of a listed company would be regarded by many as a “true insider”.</p>
<p>In other words, these are people who work within a company, have access to a range of information that is not publicly available, and generally have it in advance of the general public and the market. The insider trading laws, together with the ASX Listing Rules, are designed to ensure these people aren’t able to misuse information they can access, for their own benefit.</p>
<h2>What kind of potential penalty could we expect if there is a criminal conviction in this case?</h2>
<p>Within the last year the <a href="http://www.abc.net.au/pm/content/2010/s2804066.htm">sentences for insider trading</a> have been significantly increased – this is one of the initiatives that Chris Bowen achieved when he was Minister for Financial Services.</p>
<p>He wanted to significantly increase the maximum penalties for insider trading so that there would be a greater deterrent effect. </p>
<p>Individuals can now face a jail term of up to ten years, up from a previous maximum of five years. The maximum fine for every count of insider trading has been increased from $220,000 to $495,000.</p>
<p>However, the real question is, will anything like this ever be imposed?</p>
<p>There are principles of consistency and precedent in sentencing, which aim to ensure that sentences are relative and comparable to those that have been given to other offenders in the past. The deterrent factor is only one of a number of factors that need to be considered.</p>
<p>The highest sentence given in the past is a jail term of four and a half years to <a href="http://www.asic.gov.au/asic/asic.nsf/byheadline/10-258AD+Former+equities+dealer+imprisoned+on+front-running+and+tipping+charges?openDocument">John Hartman</a>, who was sentenced prior to the implementation of the new maximum (although that sentence is currently being appealed). </p>
<p>If a director of a large listed company was found guilty of insider trading in shares in that company, their status as a “true insider” could be expected to indicate that they would face a heavier sentence than some other traders, particularly somebody outside of the company who simply came across the information in a manner unconnected with their employment. </p>
<p>Of course, there are many issues to be addressed here before any potential sentence might become relevant, so it will be interesting to see how this case plays out.</p><img src="https://counter.theconversation.com/content/4429/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Juliette Overland does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Former Gunns chairman John Gay is facing insider trading charges after he allegedly sold more than $3 million worth of the beleaguered timber company’s shares just months before its share price plunged…Juliette Overland, Senior lecturer, Corporate Law, University of Sydney Business School, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/40252011-11-01T19:40:44Z2011-11-01T19:40:44ZTrading on reputation: the trials of Rajat Gupta and the SEC<figure><img src="https://images.theconversation.com/files/5059/original/gupta.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Former Goldman Sachs and Procter & Gamble director Rajat Gupta faces securities fraud charges. </span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>The Department of Justice in the United States has significantly broadened the reach of its investigation into insider trading. </p>
<p>The <a href="http://www.guardian.co.uk/business/2011/oct/26/goldman-sachs-director-rajat-gupta-charged">charging</a> of a former director of Goldman Sachs and Procter & Gamble, Rajat Gupta, with securities fraud is designed to send a clear message to Wall Street and the judiciary that the regulatory system is capable of ensuring warranted trust. </p>
<p>It suggests that reputation does not provide impunity from investigation. It also addresses ongoing public and judicial concern about public enforcement, which has focused on either securing settlements that do not involve admissions of liability or on the prosecution of low-level actors. </p>
<p>The accusation that Rajat Gupta breached directors duties and committed securities fraud in passing on confidential information to Raj Rajaratnam, the head of Galleon Investments, had been flagged in the latter’s insider trading trial earlier this year. Rajaratnam was convicted and sentenced to 11 years imprisonment. </p>
<p>No evidence has yet been proffered that Gupta profited from the circumstantial evidence that he provided confidential information in relation to investments in Goldman Sachs and quarterly earnings at Proctor & Gamble. </p>
<p>The reputational damage, however, is complete. </p>
<p>The charges, which he denies, provide a humiliating capstone to what had been a storied career. Rajat Gupta served as chief executive of the consultancy firm McKinsey & Co before retiring to the boardrooms of two of the most influential corporations in the United States.</p>
<p><figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/5060/original/rajrajaratnam.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/5060/original/rajrajaratnam.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=782&fit=crop&dpr=1 600w, https://images.theconversation.com/files/5060/original/rajrajaratnam.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=782&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/5060/original/rajrajaratnam.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=782&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/5060/original/rajrajaratnam.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=983&fit=crop&dpr=1 754w, https://images.theconversation.com/files/5060/original/rajrajaratnam.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=983&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/5060/original/rajrajaratnam.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=983&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Raj Rajaratnam was sentenced to 11 years in prison.</span>
<span class="attribution"><span class="source">AAP</span></span>
</figcaption>
</figure> </p>
<p>According to the US Attorney for the Southern District, “Rajat Gupta was entrusted by some of the premier institutions of American business to sit inside their boardrooms, among their executives and directors, and receive their confidential information so that he could give advice and counsel for the benefit of their shareholders…He broke that trust and instead became the illegal eyes and ears in the boardroom for his friend and business associate, Raj Rajaratnam, who reaped enormous profits from Mr Gupta’s breach of duty.”</p>
<p>The Securities and Exchange Commission (SEC) simultaneously lodged a civil case. It cited what it claimed was evidence of an extensive and sophisticated insider trading network. As with the Southern District Attorney, the emphasis for the SEC in bringing the case was linked to the betrayal of trust. </p>
<p>When taking enforcement action, regulatory agencies need to balance the effect of conviction with the political costs associated with bringing complex and uncertain cases to trial. </p>
<p>Beyond the merits of an individual action, achieving wider demonstration effect requires changing both the content and context of the underpinning system of oversight. This requires two components. </p>
<p>First, the preparation of the case and its subsequent staging — including the critical initial presentation of the evidential base —needs to reconfigure media representations of what constitutes acceptable conduct. This applies despite the legal strength of the material claim. Trial strategies tend to focus on competing narratives. It is, therefore, essential to “own” the media agenda. </p>
<p>Second, the litigation needs to be capable of recalibrating — without credible dissension — the broader policy agenda. To be successful, therefore, prosecutorial strategies need to facilitate the positive framing of policy issues. This involves not only the regulator’s own conception of its interpretation of appropriate purpose and accountability, but also judicial and broader societal understandings. This coupling explains the emphasis on trust in both narratives. </p>
<p>The problem faced by the regulatory authorities, particularly the SEC, is that there is increasing scepticism that the enforcement agendas are fair, reasonable adequate or in the public interest. </p>
<p>The Federal Court judge, Jed Rakoff, who is responsible for hearing the Gupta case, is exceptionally sceptical of the SEC’s general approach. In a previous settlement reached by the SEC against Bank of America, he argued that it risked privileging “the façade of enforcement” in agreeing settlements that no not contain acceptance of wrongdoing. </p>
<p>Judge Rakoff refused to endorse the proposed settlement with Citigroup last week over litigation that it had engaged in deceptive and misleading conduct in a complex derivative transaction.</p>
<p>The charging of Gupta draws attention to the fact that the SEC recognises the limitations of previous strategies. If convicted, Wall Street has much to fear.</p><img src="https://counter.theconversation.com/content/4025/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Justin O'Brien receives funding from the Australian Research Council on two grants linked to the future of financial regulation.</span></em></p>The Department of Justice in the United States has significantly broadened the reach of its investigation into insider trading. The charging of a former director of Goldman Sachs and Procter & Gamble…Justin O'Brien, Professor of Law, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/33742011-09-14T04:05:22Z2011-09-14T04:05:22ZHanlong insider trading case will test ASIC’s resolve<figure><img src="https://images.theconversation.com/files/3584/original/trading.jpg?ixlib=rb-1.1.0&rect=239%2C97%2C3510%2C1949&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Insider trading detection in Australia has evolved, but ASIC still needs a win.</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>Five senior executives of the Chinese-owned investor Hanlong Mining have had assets frozen after the Australian Securities and Investments Commission (ASIC) launched an investigation into alleged insider trading.</p>
<p>Hanlong is currently involved in takeover bids Australia-based mining groups Sundance Resources and Bannerman Resources.</p>
<p>The executives are alleged to have been involved with highly lucrative trades in the takeover targets’ shares and derivatives before the bids were announced.</p>
<p>The case comes after the highly publicised jailing of Rio Tinto executive <a href="http://www.theaustralian.com.au/business/mining-energy/rio-tintos-stern-hu-jailed-10-years/story-e6frg9df-1225847088979">Stern Hu</a> on bribery charges ignited diplomatic tensions. </p>
<p>It is a high-stakes case for the regulator, which has a patchy record when it comes to successful insider trading prosecutions. </p>
<p>It will also test ASIC’s new market supervision role, which it took over from the Australian Securities Exchange (ASX) earlier this year. </p>
<p>So just what constitutes insider trading and how well does our regulatory system police it? Juliette Overland, senior lecturer in business law at the University of Sydney Business School explains why ASIC needs a win.</p>
<hr>
<h2>How has ASIC’s new market supervision role helped it detect these alleged cases of insider trading?</h2>
<p>The fact that ASIC now has the market supervision role, which used to belong to the ASX, should enable it to act more quickly.</p>
<p>In the past ASIC was dependent on the ASX, or other bodies, notifying it of suspicious trading and then acting on it.</p>
<p>ASIC has taken a number of employees who previously worked for the ASX in market surveillance and built its own team, so this now happens internally at ASIC. ASIC has control of the surveillance technology now, and while those technologies are very detailed and sophisticated, the regulator responsible for mounting the case can see what is occurring, or has occurred, without having to rely on notification from an external body.</p>
<p>In a case such as this, where there appear to be a concern that people might flee the jurisdiction, ASIC’s new powers may have helped its chances of success in being able to secure a prosecution in this case.</p>
<h2>The details are not yet entire clear in this case, but generally speaking, how does ASIC go about detecting insider trading?</h2>
<p>Because so many insider trading cases occur within the context of corporate takeovers and takeover announcements, both ASIC and previously the ASX have had a policy of reviewing prior trading in relevant shares and securities.</p>
<p>They do this for shares in the companies that are involved in the bid, and related derivatives, which appears to be where the alleged insider trading has occurred in the Hanlong case.</p>
<p>They generally go back over a period of between three and 10 days prior to the announcement of the takeover and look for any unusual trades – for instance, where there has been an unusual number or volume of trades, it could mean somebody knows something that isn’t publicly available.</p>
<p>They have very sophisticated formulas and algorithms for calculating what – for a particular company or security – is an unusual volume of trading, or number of trades. </p>
<p>This appears to be what they have done in this case.</p>
<h2>How successful has ASIC been in proving liability or guilt in these sorts of investigations?</h2>
<p>In terms of successful cases, it has not always had a good run. It has had some big - and very public - losses which has led to a lot of criticism and scrutiny.</p>
<p>The <a href="http://www.asic.gov.au/asic/asic.nsf/byId/PMIDDBDDC0E120AE85C2CA257142000374B9?opendocument">Citigroup civil case</a> for insider trading, which ASIC started in 2006 and lost in 2007, was particularly bad for ASIC because it came at a time when ASIC hoped to demonstrate an improved rate of success in insider trading cases.</p>
<p>If the proceedings against Citigroup had been successful, it would have been the first time a company had ever been found liable for insider trading in Australia.</p>
<p>There were multiple counts of insider trading alleged against Citigroup, and ASIC lost on every one in the Federal Court. </p>
<p>The previous big loss was the <a href="http://www.asic.gov.au/asic/asic.nsf/byheadline/05-215+Steve+Vizard+banned+for+10+years+and+fined+$390,000?openDocument">prosecution of businessman Steve Vizard</a> in 2005, which ASIC had wanted to run as a criminal proceeding, but the
Director of Public Prosecutions (DPP) declined to take it on as a criminal proceeding.</p>
<p>ASIC took on the case itself as a civil action, but civil proceedings were then limited to a breach of directors’ duties. Vizard admitted liability for the civil action but there was a view at the time that he should have faced a criminal prosecution and that the DPP might have been willing to take it on if a better case could have been mounted.</p>
<p>Then Federal Treasurer, Peter Costello was also <a href="http://www.crikey.com.au/2005/07/11/costello-not-satisfied-with-asic-over-vizard/">publicly critical</a> of ASIC in the absence of a criminal prosecution in what appeared to be a clear breach of the insider trading laws.</p>
<p>ASIC has had some smaller successes since, but it will be hoping for some large public successes and this Hanlong case, if successful, may enable ASIC to demonstrate additional credibility in its role in enforcing market integrity.</p>
<h2>Is this failure to bring successful actions due to deficiencies within ASIC itself, or are there limitations within the relevant legislation?</h2>
<p>There are a number of inherent difficulties in successfully prosecuting insider trading.</p>
<p>The first is that it is hard to detect the trading itself. For physical offences, for example murder, there a body or some other kind of physical evidence to indicate a crime has taken place.</p>
<p>Share trading happens everyday, with millions of transactions occurring without wrongdoing. Demonstrating that someone is trading with inside information is a very difficult thing to prove. While there is technology to pick up on unusual trades, if the trading falls within a range that appears to be normal it may not be detected in the absence of a whistle-blower or other evidence.</p>
<p>The second difficulty is that when the proceedings actually begin, it is also very hard to prove what somebody actually knew. </p>
<p>The legislation in very strict in that respect. It requires proof of knowledge, not only that the person had the information, but that they knew or should have known that it was not publically available.</p>
<p>As a matter of proof, it is difficult to prove what somebody knew – or what they must have know – particularly when it is somebody who trades on a regular basis who can offer other plausible reasons for the trading.</p>
<h2>Isn’t there also the broader problem of actually defining what constitutes inside information?</h2>
<p>This is an important issue. </p>
<p>Some people would take the view that the share market actually runs on the basis of trying to get access to information that others don’t have so you can use it to your own advantage. </p>
<p>Australian laws also define inside information much more broadly than in other jurisdictions. Rumours are still caught by the definition of inside information.</p>
<p>Other jurisdictions, for example many in Europe, are careful to exclude rumours from the definition of inside information, specifically to avoid this problem.</p>
<p>So even though prosecutors in Australia could mount an insider trading case based on rumours as inside information, there are none that have successfully been brought.</p><img src="https://counter.theconversation.com/content/3374/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Juliette Overland does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Five senior executives of the Chinese-owned investor Hanlong Mining have had assets frozen after the Australian Securities and Investments Commission (ASIC) launched an investigation into alleged insider…Juliette Overland, Senior lecturer, Corporate Law, University of Sydney Business School, University of SydneyLicensed as Creative Commons – attribution, no derivatives.