Today we look at some activities that are considered illegal or an abuse to the integrity of financial markets. Such activities include insider dealing or trading, improper disclosure, misuse of information, dissemination, manipulating transactions and so on. In the United States of America, financial markets are strictly monitored by regulatory bodies such as the securities and exchange commissions (SEC), Financial Industry Regulatory Authority (FINRA), Federal Deposit Insurance Corporation (FDIC), Consumer Financial Protection Bureau (CFPB), Commodity Futures Trading Commission (CFTC), Federal Reserve System (“Fed”), Office of the Comptroller of the Currency (OCC), and National Credit Union Administration (NCUA). Activities such as those listed above are considered illegal and punishable by law based on the Jurisdiction of the various financial regulated bodies listed above.
The purpose of this post is to explain what these market abuse activities are, and to analyze how each one of them affects the financial market. We would start first with insider dealing or trading.
1) Insider dealing or Trading: Insider trading is not always illegal as opposed to the general view of the public. They are some allowances for the legality of insider trading. For example when corporate insiders, directors and employees trade in stocks in their own companies, and report their trades to the Securities and Exchange Commission (SEC). Insider trading becomes illegal when an individual, institution or company buys and sells securities, in breach of fiduciary duty or other relationship of trust or confidence, based on material non-public Information which affects the valuation of the security.
Examples of insider trading cases include:
- Dealing in securities by directors, officers and employees of a company on the back of significant, confidential corporate developments which would inevitably affect the valuation of the company and its stocks.
- Friends, family members and others who traded after they were tipped off about the significant developments, and material information concerning the company.
- Third party companies and employees who needed such vital information to carry out their duties to the company. For example employees of banks and law firms rendering services to the company.
- Government employees who learnt of such information because of their employment with the government
Penalties for Insider Trading
Violation of the population on insider trading can result in a prison sentence and civil or criminal fines for the individuals who commit the violations, and civic and criminal fines for the entities that commit the violation.
The criminal penalties for individuals or companies caught to engage in illegal insider trading is a maximum of 20 years prison sentence, and a maximum of $5,000,000 for individuals, and $25,000,000 for non-natural persons (such as entities whose securities are being traded). Aside the prison sentences and fines, an individual or entity that engages in illegal insider trading may be forced to disgorge any profits gained or losses avoided.
2) Improper disclosure: This occurs when an insider improperly discloses inside information to another person. Improper disclosure is the disclosure of inside information other than in his proper course of employment or duties. For example the disclosure of takeover or acquisition offers which would have an impact of share prices by a director or employee, to a third party who has no relation with the company, disclosure of inside information by an analyst to a prospective buyer who he seeks to make an acquisition or take over deal with on behalf of his client (the company)
3) Misuse of information: This occurs when an individual acts based on information that is not generally available but which would affect an investor’s decision about the terms in which to deal. An example of a misuse of information is an individual who fraudulently obtains vital information about a company whose shares he owns, in a bid to increase the share price and make a quick profit, he leaks the information by sharing it on social networks or bulletins, and when this drives the share price up in the short run, he immediately sells his holdings to make a profit.
4) Dissemination: This is the dissemination of false of misleading information about an investment or issuer of an investment while knowing such information to be false or misleading. The motive behind this may be to make a personal profit from such misleading information of to intentionally mislead another for nefarious reasons.
5) Manipulating transactions: The practice of manipulating transactions may be used by companies that seek to artificially increase the price of their stocks. Manipulating transactions is considered illegal and it involves placing orders to trade that gives a false or misleading impression of the supply of or demand for an investment or a security, which artificially increases the price of such an investment or security. Manipulating transactions in a market, ie market manipulation is prohibited in the United States under section 9(a) (2) of the securities exchange act of 1934.
Barry Rider., Kern Alexander., Stuart Bazley., Jeffrey Byrant., Market Abuse and Insider Dealing.