ETHICAL ISSUES: ETHICS AND INSIDER TRADING 1

Ethical Issues: Ethics and Insider Trading

Capella University
ETHICAL ISSUES: EARNINGS MANAGEMENT 2

INTRODUCTION

Since the establishment of the stock market, insider trading has been an ubiquitous

activity. Viewpoints vary on whether insider trading is legal or illegal and whether it is ethical or

unethical. There are many competing viewpoints on the ethical implications of this behavior

(insider trading) and how severely it violates justice and the social contract of modern finance to

which market participants tacitly agree when they invest (Wenzel, n.d.). The Securities and

Exchange Commissioner (SEC) has been quelling insider trading in which numerous arrests,

convictions, and prison sentences have been handed down through the court system.

INSIDER TRADING IN BUSINESS

Insider trading can be defined as trading of a companys stocks or other securities by

individuals with access to confidential or non-public information about the company. Taking

advantage of this privileged access is considered a breach of the individuals fiduciary duty

(LII, 2016). Insider trading can be legal or illegal dependent upon when the insider reveals the

trade.

Insider trading is legal when executives, administration, and/or other personnel purchase

or sell their own company stock. Once insiders trade their own securities, it must be reported to

the U.S. Securities and Exchange Commissioner (SEC). Also, insider trading is legal if the

information has already been made public. On the other hand, insider trading is illegal when the

insider communicates non-public information to another person in which that information

could influence the companys publicly-traded stock price. Illegal insider trading happens

behind closed doors, in whispers, and phone calls which makes it one of the hardest crimes to

detect (Whitaker, 2016).

ETHICAL ISSUES: EARNINGS MANAGEMENT 3

Example of Illegal Insider Trading

After a 12-year-long investigation, Raj Rajaratnam, founder of Galleon Group and one of

Wall Streets savviest investors, was arrested in 2009 of insider trading. In 2011, Raj was found

guilty of fourteen counts of securities fraud and conspiracy to commit securities fraud. He was

sentenced to 11 years in prison and fined $10 million (Wenzel, n.d.). The Galleon Group hedge

fund managed more than $7 billion in assets. Raj was using insider trading to illegal trade stocks

such as eBay Inc., Goldman Sachs Group Inc., and Google Inc., which amounted to $63.8

million in illicit profit from 2003 to 2009. There were forty-seven conspirators, in overlapping

networks of insider trading, who were also charged with insider trading (Packer, 2011). Raj was

charged with partaking in one of the biggest insider trading cases in U.S. history (Karnik, 2015).

Since the arrest of Raj, Preet Bhara, U.S. Attorney for the Southern District of New York,

surveyed the extensive rot of illegal activity on Wall Street and concluded, The bigger and

better question may not be whether insider trading is rampant but whether corporate corruption

in general is rampant; whether ethical bankruptcy is on the rise; whether corrupt business models

are becoming more common. The Galleon case helps to answer these broader questions about

the culture of the financial world: it illustrates how, over the past decade, cheating and self-

dealing became the principal ways to succeed on Wall Street (Packer, 2011).

ETHICAL IMPLICATIONS FROM INSIDER TRADING

There is much debate on whether illegal insider trading is ethical or unethical. The illegal

form of insider trading is believed to be unethical because it is a form of securities fraud, and

fraud is viewed as a type of larceny or theft (Henning, 2011). Insider trading, however, is not

merely a complication in the free market mechanism. Insider trading, whether it is legal or

illegal, affects negatively the ideal of laissez-faire of any market: competition, just as insider
ETHICAL ISSUES: EARNINGS MANAGEMENT 4

rules affect the fairness of the trader even if that activity is not illegal and even if one could, in

theory, obtain inside information oneself. This is because the same information, or equal

information, is not available to everyone (Werhane, 1989).

Illegal insider trading is unethical because the company whose information was taken are

victims of fraud because it is their own information that is stolen and used for personal gain by

someone else (Henning, 2011). Insider trading is discriminating against investors who are not

privy to information on a company; therefore, it is unfair that an insider advises another

person who then takes advantage of that information to achieve personal gains.

Illegal insider trading has negative effects. Some of the negative effects are (1) dislocates

the market, (2) shareholders suffer, (3) erodes market confidence, (4) raising of capital is made

more difficult, and the (5) company is harmed by the misuse of information which belongs to it

(Canberra, 1991).

Insider trading is unfair in the same way as a fixed horse race is unfair (Canberra, 1991)

CONCLUSION

There will be continued debates concerning the legality and ethical repercussions from

insider trading for years to come. Insider trading is unethical as it violates the use of company

information in order to obtain a personal gain for an individual(s). A prime example of insider

trading and the consequences is Raj Rajaratnam. According to the theory of John Rawls, traders

should avoid engaging in insider trading in order to protect their own interests as well as the

interests of others (Wenzel, n.d.). Insider trading not only affects a companys capital and

shareholders, it also has an impact on the confidence of the stock market.

ETHICAL ISSUES: EARNINGS MANAGEMENT 5

The ethical principle is easy to understand because the principle tenet of our

securities market is that no trader should have an unfair advantage when

trading (Seyedin-Noor & OBrien, 2010).

ETHICAL ISSUES: EARNINGS MANAGEMENT 6

References

Canberra, R. Tomasic. (1991). Chapter 6: The Effects of Insider Trading. Casino capitalism?

Insider trading in Australia. Australian Institute of Criminology. (Australian studies in

law, crime and justice series); pp 55-67. Retrieved July 3, 2016, from

http://www.aic.gov.au/publications/previous%20series/lcj/1-20/casino/chapter%206.html

Henning, Peter. J. (2011). Why Insider Trading Is Wrong. DealBook. Retrieved July 3, 2016,

from http://dealbook.nytimes.com/2011/04/11/why-is-insider-trading-wrong/?_r=0

Karnik, Madhura. (2015). The Indian Woman Who Helped Crack Wall Streets Biggest Insider

Trading Case is Applying to Business School. Galleon Gang. Quartz India. Retrieved

July 4, 2016, from http://qz.com/354179/the-indian-woman-who-helped-crack-wall-

streets-biggest-insider-trading-case-is-applying-to-business-school/

LLI. (2016). Insider Trading. Cornell University Law School. Retrieved July 3, 2016, from

https://www.law.cornell.edu/wex/insider_trading

Moore, J. (1990). What is really unethical about insider trading? Journal of Business Ethics,

9(3), 171. Retrieved July 3, 2016, from

http://search.proquest.com.library.capella.edu/docview/198083685?accountid=27965

Packer, George. (2011). A Dirty Business. The New Yorker. Retrieved July 4, 2016, from

http://www.newyorker.com/magazine/2011/06/27/a-dirty-business

Scheppele,Kim Lane. (1993). Its Just Not Right: The Ethics of Insider Trading, 56 Law and

Contemporary Problems 123-174. Retrieved July 3, 2016, from

http://scholarship.law.duke.edu/lcp/vol56/iss3/6

SEC.gov. (2016). Insider Trading. U.S. Securities and Exchange Commission. Retrieved July 3,

2016, from https://www.sec.gov/answers/insider.htm

ETHICAL ISSUES: EARNINGS MANAGEMENT 7

Seyedin-Noor, Bahram & OBrien, Hollis. (2010). Insider Trading: Law, Trust, and Prevention.

Markkula Center for Applied Ethics: Santa Clara University. Retrieved July 4, 2016,

from https://www.scu.edu/ethics/focus-areas/business-ethics/resources/insider-trading-

law-trust-and-prevention/

Wenzel, Sara. (n.d.). Insider Trading: What Would Rawls Do? Seven Pillars Institute for Global

Finance and Ethics. Retrieved July 4, 2016, from http://sevenpillarsinstitute.org/case-

studies/insider-trading-what-would-rawls-do

Werhane, Patricia. (1989). The Ethics of Insider Trading. Journal of Business Ethics, 8(11), 841.

Retrieved from

http://search.proquest.com.library.capella.edu/docview/198066348?accountid=27965

Whitaker, Bill. (2016). A Rare Look at How Insider Trading Works. 60 Minutes. Aired May 22,

2016 on CBS. Retrieved July 4, 2016, from http://www.cbsnews.com/news/60-minutes-

rare-look-at-how-insider-trading-actually-works/