It seems obvious on first glance: Insider trading is cheating and ought to be a crime. Ivan Boesky and hedge fund billionaire Raj Rajaratnam famously went to jail for doing it and George Soros paid a big fine. Actually, though, it’s not obvious at all. In the U.S., where prosecutors have vigorously pursued insider trading cases, there’s no law defining it. Courts are split about where to draw the line between legal and illegal use of private information in pursuit of profit. Some scholars think it shouldn’t be illegal at all, reasoning that outlawing it restricts information flow in markets. There’s also a huge variance in penalties, with a maximum two years’ jail time in France versus 20 in the U.S. and South Korea.
The U.S. Supreme Court upheld a case in December that resolved what sort of benefit a defendant must receive to make insider trading a crime. The decision restores some, though not all, of the leverage lost by prosecutors in 2014 when an appeals court in New York narrowed the definition and made it harder to bring cases. It was a confusing coda to the biggest crackdown in U.S. history, which saw hedge fund SAC Capital Advisors pay a record $1.8 billion after pleading guilty to reaping hundreds of millions of dollars in illegal profits for more than a decade. But federal prosecutors in New York dismissed or lost on appeal 14 of 91 convictions from August 2009 to December 2015. Famous convictions included Rajaratnam, who was sent to jail after wiretaps showed that his firm used insiders to trade ahead of public announcements about earnings, forecasts and mergers. The U.K. convicted a high-profile ex-Moore Capital trader, while billionaire Paul Singer’s Elliott Management was assessed $22 million in civil penalties in France. In 2015, a French court blocked a trial of Airbus executives who sold shares when they knew about costly production delays. Meanwhile, hedge funds are snooping on their own employees, using keystroke-reading software to spot rogue traders.
There’s no U.S. law specifically barring insider trading. It became a crime through judicial interpretation of a 1934 law aimed at cleaning up markets after the 1929 stock market crash. Not until the 1980s did prosecutions really take off. One of the most famous cases made household names of financiers Michael Milken, Dennis Levine, Martin Siegel, and Boesky. He’s thought to be at least part of the inspiration for the character Gordon Gekko in the 1987 film “Wall Street.” In the U.K., insider trading became illegal in 1980, but only 14 convictions were secured in the next 26 years. The U.K. markets regulator only recently began prosecuting the behavior, and had 31 convictions from 2009 to December 2016. Legislation against insider trading wasn’t enacted in Germany, India and China until the 1990s. Japan tightened insider trading laws in 2013 after scandals embroiled prominent firms including Nomura Holdings. The country made it a crime to give out inside information even if nobody trades on it.
There are two schools of thought about the uses of insider trading. One holds that it allows information to be incorporated into stock prices quickly, making them more accurate. By that reasoning, insider trading helps investors and criminalizing it hurts them. The contrary view is that access to non-public information allows a select few to make big bucks while other investors are kept in the dark, damaging the integrity of markets. To complicate the issue, corporate employees — the real insiders — are allowed to trade their own stock so long as the information they’re trading on is generally available. That’s hard to define and regulate. Insider trading can be difficult to prove and prosecute but it generates headlines that regulators have come to depend on as a deterrent to market abuse. Does it work? At least sometimes.
The Reference Shelf
- A QuickTake Q&A on the U.S. Supreme Court decision, and an explainer on the charges against Leon Cooperman, chairman of Omega Advisors.
- Bloomberg data visualization on how prosecutors pulled off the biggest insider trading case in U.S. history.
- A 2014 study claims there is suspicious trading that could be insider dealing in nearly a quarter of all M&A deals.
- A 2013 law firm review gives a detailed breakdown of U.S. legislation and high-profile cases
- A 1999 study looks at the possible profits made from insider trading.
- Matt Levine summarized the U.S. definition of illegal insider trading in an April 2015 Bloomberg View column.
- A New York Times review of “The Billionaire’s Apprentice,” a book about the Rajaratnam case by Anita Raghavan.
First published May 19, 2015
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Leah Harrison at firstname.lastname@example.org