Who remembers the film WALL STREET from 1988? A budding young trader (Charlie Sheen) bags himself a once in a lifetime opportunity to impress the shark of all sharks ( Michael Douglas ) and in doing so enters the murky waters of insider trading. But what is Insider Trading? In essence it is using information to make money in the stock market that hasn’t yet been disclosed to the public. In the film Charlie tells Michael that there will be an announcement in the morning about a company that his father works for. This information made the share price rocket and Michael made a killing. Insider trading is considered an illegal act and punishable by imprisonment in extreme cases but the circumstances surrounding insider trading are not so clear cut so in this blog Insider trading: what you need to know, I’m going to describe 4 scenarios of potential wrong doing and identify which ones qualify for investigation and which ones don’t.
Scenario 1
You’ve been invited to your next door neighbours summer BBQ and you’re in the queue for your burnt sausage. It’s a long queue so you strike up a conversation with the guy in front of you. It goes like this;
You: Hi, not seen you before are you new around here?
Him: Hi, yeah, I’m Steve. Just moved here a few months back. Started working for dibdabs inc.
You: Oh yeah, a big employer around here. How’s it going?
Steve: Yeah, fantastic, We’ve just landed a major client and the company is going from strength to strength.
You: That’s great news. Enjoy your burnt sausage.
You happen to know that Dibdab Inc is listed on the stock market and that particular piece of news has not yet been disclosed to the public via the RNS (Regulatory News Service). The first thing you do on Monday morning is buy 50K of Dibdab shares. A few days later the news comes out that sure enough Dibdab Inc has won a major contract with a new client and the share price soars. You sell making a nice little profit.
Scenario 2
You are the chief accountant of a publicly listed company and during the board meeting it is announced that the CEO is to be replaced with immediate effect and will be announced to the stock market in the morning. The time is 4.15 PM. You get back to your office and call your brother in law who you know has shares in the company and get him to sell before the bell.
scenario 3
You friend calls you on the phone. The conversation goes like this;
You: Hello Son, what’s up?
Him: My neighbour has come round and is in a flap and he needs your help.
You: Oh yeah, what’s the story?
Him: He’s just left a company and was paid in stock options. Now they have dropped and he doesn’t know what to do. I said, I’d ask you if you’d take a look.
You go snooping around google and find that the company has been charged with price fixing and handed a multi million pound fine which they have since paid and are now challenging the court decision.
You call back.
You: I’ve had a look on Stockopedia and can’t find anything wrong per se.It looks solid enough.
Him: Yes, the neighbour said it’s a good solid company but he’s just heard from a friend that still works there that they’ve changed distribution channels in a particular country and the products aren’t hitting the shelves. It’ll have an adverse consequence on sales.
You: Yeah, that’s not good, but give it a couple of years and they’ll sort that out. It’s still a good company so I would still hang on to the shares. You forget all about the conversation and a month later sure enough, the RNS disclosed the distribution problems and the share price drops. You buy and sell 12 months later when the share price rises on good news about the distribution problems.
scenario 4
You’re in an airport lounge and there are 4 ‘SUITS’ sitting next to you. They’re talking about the acquisition they are going to negotiate when they arrive at their destination and you overhear them talking about the staffing restructure that is going to take place. In particular they made reference to a person called Toby Nailsworthy and where he would fit into the new company system. Being an unusual name you decide to google him to see if he pops up anywhere. Sure enough he is the CEO of a company and there was a news report a few years back (also on google) making reference to a possible buyout but the rumour fizzled out. Knowing that any takeover usually comes with a 20% or more share price increase of the shares in the company being bought out, you take a punt. A few months later the takeover is announced to the stock market making you a tidy profit.
which scenarios are classed as insider trading?
The definition of insider trading is as follows: It is the distribution of Material non-public information (MNPI) and refers to any data or knowledge about a company that has not been disclosed to the general public, and if it were disclosed, would be substantially likely to affect the company’s stock price or influence a reasonable investor’s decision to buy, sell, or hold the security. In my blog, the stock market, I made reference to the fact that the stock market is there not only to raise public funds for companies but also to protect potential investors from unscrupulous individuals that just want to deceive and ‘GET RICH QUICK’. Receiving and using information BEFORE it reaches the public domain is one such activity so let’s evaluate which scenarios constitute insider trading.
Scenario 1
Even though it’s just a BBQ you have inadvertently received and acted upon information so this would be considered Insider trading
Scenario 2
The classic case of abuse of power by someone on the inside. You don’t collect £200 when you go past GO, you go straight to prison.
Scenario 3
You have waited until the distribution problems were reported to the public ( knowing that this would probably drop the share price) and then bought. However innocuous the delivery of the information it would be seen as you having acted on information prior to it’s delivery to the public and again this would be insider trading.
Scenario 4
Surely over hearing a conversation in an airport can’t be insider trading. How can it? Well, only if you act upon it and make a profit so yes it is insider trading in the eyes of the stock exchange.
Conclusion
Insider trading comes in many forms but in each case the key determinant as to whether insider trading has taken place is if you acted upon information received ( irrespective of it’s delivery) prior to its release to the general public. In reality, however, the regulatory bodies (FSA ( UK)) and (SEC (USA)) are only interested in large sums of money and systematic abuse at the highest levels so these types of scenarios won’t feature on any radar and I’m sure happen inadvertently all the time.
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