What does insider trading mean?
Trading, which is carried out in financial markets, is constantly associated with high risk. That is why all traders seek to predict the price movement in the short or long term. To make a similar forecast, it is necessary to analyze a large amount of information. But not all data is available to market players. For example, they do not know what decision the general director of the company whose shares they are going to sell will take. In this case, the help of insiders – people close to the company management is required. For a fee, they are ready to tell interested parties about the plans of their superiors.
What is insider information?
From an economic point of view, this is important information that is intended solely for official use. If it becomes public, the company may suffer serious losses.
Insider Trading – What is it? As it is already clear by definition and entry, this is trading in financial markets using closed, non-public information, which makes it possible to obtain guaranteed benefits in transactions.
Why is insider trading prohibited?
The answer to this question is obvious. After all, insider trading can cause imbalances in investment markets. It is noteworthy that in the 30s of the 20th century. Pecora’s legislative act was approved, which regulates such concepts as “insider”, as well as “secret information”, etc. In a word, it became a kind of prohibition on insider trading. At the same time, its appearance did not put an end to insider trading.
One of the first high-profile cases that related to insider trading, appeared only in the 2nd half of the 20th century. The TGS organization known at that time, specializing in the extraction of natural resources, came across a promising field. Of course, if journalists got wind of this, then the shares of this organization would immediately rise in price. Charles Fogarty, who at the time was the vice-president of TGS, quickly realized what was happening. He immediately bought a large package of securities of an organization that was still relatively inexpensive. But literally in a few days, their cost increased significantly. As a result, Charles became rich by 150 thousand dollars. USA. Small investors instantly made a fuss about the media and the entire TGS leadership found itself in the dock. As a result, they all paid huge fines totaling $ 1.2 million.
At the dawn of the 20th century. such notion as “false insider information data” has been widely adopted on the stock market. It was especially true for unscrupulous holders of large packages of securities. At the same time, with their submission in the newspapers, on the radio and TV, there appeared false information that in the near future we should expect a collapse of the shares of certain companies. The market reacted to such news instantly, and the value of assets immediately dropped.
Something similar happened with a company called MISC. She specialized in developing processors that had a unique architecture. At that time, they were several times superior to similar products, which were produced by other brands. So, the competitors of this company spread false rumors in the media that during the testing process of MISC processors it was revealed that they allegedly have extremely low productivity. This false information led to the rapid collapse of MISC securities. As a result, this company, together with its talented developers, was sold for a pittance.
But it is necessary to take into account the fact that insider information is a peculiar driving force of the investment market. That is, without the former, the latter could not fully function. After all, its yield would be negligible – on the strength of 15%, or even 10% per annum.
In today’s reality, it is much easier to watch insiders. Now all their transactions can be monitored in real time. Thus, insiders began to try on the role of such signaling devices that market participants are targeting. However, the former tend not to cross a particular line. What is the point in this case? If we recall the same Pecora’s law, then according to him, insider transactions are recognized as such if they were made during 1 trading day. At the same time, a subsequent rapid fall or increase in the value of shares under the influence of events that provoked the actions of the company’s management, the main group of asset holders, should be recorded.
How do rumors affect stock value?
Over time, all insiders have come to understand that information plays a decisive role for traders when they make certain decisions. That is, based on the data, market participants make a choice. They either buy or sell stocks. In other words, by providing informational data, one can exercise control over supply and demand.
In order to gain personal gain, large traders have been more sophisticated. They “poured” false insider information into the media. Thus, they inspired people that a company would soon go bankrupt. Then all the shareholders immediately rushed to get rid of the securities. As a result, there was a collapse in the value of securities. Then the large traders, who started the whole mess, quickly bought up the shares for almost nothing.
It is noteworthy that the holder of a large stake may provoke a “mirror” situation. To do this, he needs to spread rumors in the media that will increase the price of shares and, thereby, increase demand for them. As a result, most of the shares are sold out. When assets fall in value and reach the previous level, the shareholder redeems them again.
Not caught, not a thief
Those who are familiar with insider trading have probably already heard about the theory of misappropriation. It allows you to observe all operations in this segment from a completely new angle and study them. By the way, this theory is already enshrined in US legislation that regulates the activities of insiders .
In accordance with the theory of misappropriation, a person who uses company business data to make a trade transaction is a malicious violator of insider trading. For clarity, we will try to imagine that a journalist is on the staff of the organization. In the performance of his official duties, he learns that the management of the organization plans to sign a merger agreement. Then the shares of his company, which will soon be “absorbed” by another organization, will rise sharply in price. Certainly, the journalist will be in big profit if he buys these assets at current value. At first glance, he will not become a violator if he decides to turn such a little thing. After all, the fiduciary duties of the second organization will not be violated. In short, it is almost impossible to catch an insider in conducting illegal insider trading.
However, in the US, experts from the Commission, which monitors securities and stock exchanges, reveal about fifty illegally executed transactions annually.