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Understanding Insider Trading And Its Consequences InBusiness1
1. INTRODUCTION
The Investments and Securities Act 2007 ("ISA 2007")defines insider trading or dealing thus: "Insider dealingincludes insider trading and occurs when a person or group ofpersons who being in possession of some confidential and pricesensitive information not generally available to the public,utilizes such information to buy or sell securities for the benefitof himself, itself or any person."2
The United States Securities and Exchange Commission alsodefines that term as follows: "illegal insider trading refersgenerally to buying or selling a security, in breach of a fiduciaryduty or other relationship of trust and confidence, on the basis ofmaterial, non-public information about the security. Insidertrading violations may also include "tipping" suchinformation, securities trading by the person "tipped",and securities trading by those who misappropriate suchinformation."3
Individuals who exploit confidential, non-public information togain an unfair advantage in the financial markets pose significantethical, legal, and financial challenges in the realm of business.Understanding the intricacies of insider trading and itsconsequences is crucial to maintaining fairness, integrity, andtrust within the business landscape.
In this article, we will delve into who an insider is, theissues related to insider trading, explore its implications forcompanies and investors and discuss measures that can be undertakento address this unethical behaviour. By shedding light on thiscomplex issue, we aim to foster awareness and facilitate informeddiscussions on insider trading and its impact on the businessworld.
2. WHO IS AN INSIDER?
Simply put, an insider is a person who has knowledge of theinside dealings of the company and uses that information to deal inbuying and selling of securities to their advantage.
3. LAWS GUIDING INSIDER TRADING IN NIGERIA
The primary law regulating insider trading in Nigeria is theInvestment and Securities Act 2007, which empowers the Securitiesand Exchange Commission ("SEC") to enforce rules andregulations to prevent insider trading. Section 111 (1) of the ISA2007 provides on the prohibition of insider trading in Nigeria asfollows:
"Subject to section 104 of this Act, a person who is aninsider of a company shall not buy or sell, or otherwise deal inthe securities of the company which are offered to the
public for sale or subscription if he has information which heknows is unpublished price sensitive information in relation tothose securities".
Section 115 of the ISA 2007 also provides the penalty forinsider trading and other criminal offences as follows:
"Any person who contravenes any of the provisions ofthis part of this Act commits an offence and is liable onconviction —
(a) in the case of a person not being a body corporate,to-
(i) a fine of not less than x500,000 or an amount equivalentto double the amount of profit derived by him or loss averted bythe use of the information obtained in contravention of any of theprovisions of this part ; or
(ii) to imprisonment for a term not exceeding seven years;or
(b) in the case of a person being a body corporate, to afine not less than x1,000,000 or an amount equivalent to twice theamount of profit derived by it or loss averted by the use of theinformation obtained in contravention of any of the provisions ofthis part."
The SEC issued several guidelines and rules to prevent insidertrading in Nigeria. It established Codes of Conduct for CapitalMarket Operators (Institutions) and Employees of Capital MarketInstitutions (Operators) in the Securities and Exchange CommissionRules and Regulations 2013.4 The Codes of Conduct set out therules and procedures for handling confidential information, tradingin the company's securities, and reporting any violations ofthe code.
4. ISSUES RELATED TO INSIDER TRADING INBUSINESS
4.1 Market Manipulation5
When insiders use privileged information to buy or sellsecurities, they can distort market prices and create an unevenplaying field for other investors who do not have access to thesame information. This can erode investor confidence and lead to aloss of trust in the fairness and integrity of financialmarkets.
4.2 Legal and Ethical Implications6
Another issue is the legal and ethical implications of insidertrading. It is illegal in many jurisdictions and can result insevere penalties, including fines, imprisonment, and the loss ofprofessional licenses. Additionally, it can damage the reputationof the company and the individuals involved, leading to a loss oftrust from stakeholders and customers. An example of such a damagedreputation is that of Martha Stewart in the insider trading scandalof 2003.7
4.3Company Performance
When insiders trade on confidential information, it can lead tosuboptimal decisions and ultimately hurt the company'sfinancial performance. Furthermore, it can create a toxic culturewithin the organization that prioritizes personal gain over thebest interests of the company and its stakeholders.
Overall, the issues related to insider trading in business arenumerous and far-reaching, affecting not only the individualsinvolved profit, but also the broader financial system and societyas a whole. It is important for companies to establish clearpolicies and procedures to prevent and detect insider trading andfor regulators to enforce strict penalties for those who engage inthis illegal and unethical behaviour.
5. IMPLICATIONS OF INSIDER TRADING FOR BUSINESSES ANDINVESTORS
Insider trading carries far-reaching implications that cansignificantly affect businesses and investors. These consequencesarise from the unfair advantages gained by insiders and the erosionof trust and integrity in the market.
5.1 Lack of Fairness and Transparency
When insiders engage in trading based on non-public information,it can undermine the principles of fairness and transparency thatare vital for a well-functioning market. This unethical practicecan damage a company's reputation, leading to decreasedinvestor confidence and potential legal repercussions. Moreover,insider trading can create a toxic corporate culture, wherepersonal gain takes precedence over the best interests of thecompany and its stakeholders.
5.2 Uneven Playing Field
Insider trading directly affects investors who do not haveaccess to privileged information. It creates an uneven playingfield, where insiders can profit at the expense of other marketparticipants.8 This disparity erodes investorconfidence and undermines the integrity of the financial markets.Investors may become hesitant to participate in the market, fearingthat their investments are compromised by insider tradingactivities. As a result, overall market liquidity may be impacted,hindering efficient capital allocation and impeding economicgrowth.
6. MEASURES THAT CAN BE UNDERTAKEN TO ADDRESS THIS UNETHICALBEHAVIOUR
Addressing the implications of insider trading requires amulti-faceted approach. Regulatory bodies play a crucial role inenforcing stringent laws and regulations, imposing penalties, andpromoting transparency and disclosure. Companies should establishrobust internal controls, codes of conduct, and compliance programsto deter insider trading and foster a culture of integrity. Hereare some recommendations of measures that can be undertaken totackle insider trading in Nigeria:
6.1 Strengthening Legal Framework
Enhance existing laws to explicitly define insider trading,broaden the scope of prohibited activities, and increase penaltiesfor offenders. This would act as a strong deterrent and increasethe effectiveness of enforcement.
6.2 Enforcement and Surveillance
Strengthen the capacity and resources of regulatory bodies likethe SEC and the Nigerian Stock Exchange ("NSE") toeffectively monitor and investigate instances of insider trading.Implement sophisticated surveillance systems to detect suspicioustrading patterns and identify potential insider trading activitiespromptly.
6.3 Insider Trading Policies and Education
Encourage listed companies to establish clear insider tradingpolicies and codes of conduct. These policies should outline theresponsibilities and obligations of insiders, restrict tradingduring sensitive periods, and establish mechanisms for reportingand addressing potential violations.
6.4 Whistle-blower Protection
Establish robust whistle-blower protection mechanisms toencourage individuals to come forward with information regardinginsider trading. Provide incentives and safeguards forwhistle-blowers, such as confidentiality, non-retaliationprovisions, and potential rewards.
6.5 Collaboration and Information Sharing
Foster cooperation between regulatory bodies, law enforcementagencies, and exchanges to facilitate information sharing andcoordination in investigating and prosecuting cases of insidertrading. Promote international collaboration to combat cross-borderinsider trading activities effectively.
6.6 Strict Penalties and Prosecution
Ensure that penalties for insider trading are severe andcommensurate with the gravity of the offence. Actively prosecuteoffenders, including company insiders and accomplices, to send astrong message that insider trading will not be tolerated.
6.7 Investor Education and Protection
Educate investors about the risks of insider trading, the redflags, and the importance of conducting thorough due diligencebefore making investment decisions. Enhance investor protectionmechanisms and avenues for legal recourse in cases of insidertrading-related losses.
6.8 Continuous Monitoring and Adaptation
Regularly review and update regulations and enforcementpractices to keep pace with evolving market dynamics andsophisticated trading practices. Stay vigilant to emerging trendsand technologies that may be exploited for insider trading, such asalgorithmic trading and blockchain/distributed ledgers that powercryptocurrencies.
7. CONCLUSION
Insider trading presents significant implications forbusinesses, investors, and the overall financial system.Recognising and addressing these implications is essential topromote fairness, transparency, and trust within the businessenvironment and maintain the integrity of financial markets.
There are laws and regulations in place to prevent and deterinsider trading. It is important for individuals and companies tobe aware of these laws and regulations and to comply with them toavoid severe penalties.
Measures should collectively be implemented to curb insidertrading, foster market integrity, and enhance investor confidencein Nigeria's financial markets. It will require closecollaboration between regulators, companies, investors, and otherstakeholders to create a robust and ethical businessenvironment.
Footnotes
1.Ufuoma Eferha, Associate,Corporate Finance & Capital Markets,S.P.A. Ajibade & Co., Lagos,Nigeria.
2. See,Section 315 of the Investments and Securities Act 2007.
3. See,U.S. Securities and Exchange Commission https://www.investor.gov/introduction-investing/investing-basics/glossary/insider-tradingaccessed on 11th May 2023.
4. See,Schedule IX 1&2 of the Securities and Exchange Commission Rulesand Regulations 2013.
5. See,Andrew Sebastian "Argument For and Against InsiderTrading" Investopedia (30 January 2022) https://www.investopedia.com/articles/markets-economy/092216/why-insider-trading-bad-financial-
markets.asp#:~:text=The%20main%20argument%20against%20insider,material%20nonpublic%20information%20is%20illegal.accessed on 26th May 2023.
6. See,"Insider Trading and Business Ethics", Law Teacher (31August 2021) https://www.lawteacher.net/free-law-essays/business-law/insider-trading-and-business-ethics-business-law-essay.phpaccessed on 26th May 2023.
7 See, "SEC Charges MarthaStewart, Broker Peter Bacanovic with Illegal Insider Trading"(4 June 2003) https://www.sec.gov/news/press/2003-69.htmaccessed on 26th May 2023.
8 See, Babajide Shoroye,"Insider Dealing and Corporate Governance: Understanding theLegal Position of Directors" African Journals OnLine,pages 92-93 https://www.ajol.info/index.php/naujilj/article/view/225875/213146accessed on 31st May 2023.
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