Insider trading is the sharing of information around a securities transaction to a select or small group of people. Vital information is usually given to a select group of people within the company (insiders) and then those insiders share it with a select group of people outside the company. Insider trading creates an unfair advantage that allows people to profit from secure information.
The two most important reasons why insider trading is illegal is because 1) it puts the interests of the insider above those to whom they owe a fiduciary duty, and 2) allows an insider to artificially influence the value of a company’s stocks and misrepresent the company on a global scale.
You may have heard of the famous case against Martha Stewart for insider trading.
In 2004 Martha Stewart was sentenced to prison, receiving the minimum sentence of five months in prison for lying to federal investigators about a stock sale. She sold about $230,000 worth of ImClone shares just before bad news from the company was made public. The founder of ImClone was also sentenced to a seven-year prison term after pleading guilty to orchestrating stock trades. Although she had a significant amount of money invested, other shareholders sold $2.5 million to $8.1 million through insider trading as well.
During the hearings and investigation into ImClone, the SEC unveiled a culture of corruption dating back to 1986. This was the year that ImClone CEO Waksal first forged the signature of the company’s general counsel for financial gain. What seemed so minuscule at the time led to the ultimate disaster for ImClone. Insider trading completely changed the reputation, structure, and future of ImClone.
Insider trading can completely shift financial markets on a global scale and cause domino effects within all the employees and those affected by the company’s trading. To those who personally participate in insider trading, they risk their reputation and sense of ethics.
Diligent Insights has put together 5 practices to avoid insider trading that can be helpful for a company during its initial stages.
Strategy #1: Restrict risky trading
A popular strategy to reduce the risk of violating insider trading rules is to restrict employee trading on company-owned securities at specific times, such as the weeks around when earnings reports come out. This approach removes the ability to trade on any insider information at all – thus insulating the corporation by circumventing any intent to do so.
Strategy #2: Appoint an in-house watchdog
Instead of simply relying on your employees to submit clearance requests for trades of covered securities, one way to ensure compliance, for posterity’s sake, is to mandate employee submission of statements from the brokerages that they personally use – combined with attestations from each employee that their submissions of trades are accurate, this can be a powerful deterrent against insider trading on the securities owned by your firm.
Strategy #3: Ensure that your employees are educated on insider trading
Insider trading is easier to commit than most would like to admit. Having a robust training program that not only acknowledges this but drives home just how serious the penalties for insider trading are – for both insiders and the companies they work for – is integral. This should cover all possible instances of insider trading.
Strategy #4: Act quickly to investigate insider trading
Should one of your employees come under scrutiny for their personal trading, it is imperative to move as quickly as possible to assess the legitimacy of the allegations. Launching an investigation will involve judging whether this was an isolated incident and whether any other employees exhibited similar trading patterns. It should be clear after due diligence, however, whether insider trading has been committed or not.
Strategy #5: Leverage technology to prevent insider trading
Some of these options simply boil down to having additional personnel to monitor, log, and clear trades – but this isn’t always necessary. There is a class of software known as Insider Trade Management Systems (ITMS), which is available in legal entity management software. These can range from a speculative conversation on the future of a security with a family member or friend, to purposefully shirking blackout periods to trade on covered securities, which hammers home the point that not all insider trading is preventable by the firm in which it happens, but the firm will be in the best possible position with these measures in place.
Wilson Bradshaw LLP is a corporate securities law firm located in Irvine, California with offices in New York, NY. If you are ready to take your company public, please contact us for a free consultation today: https://bradshawlawgroup.com/location/contact/