The Concept and the Problem of Insider Trading - Essay Example

This second portion of the definition ensures that the primary subjects of the law, corporate officers, and fiduciaries, cannot escape punishment by secretly providing information to outsiders and non-fiduciaries (Insider Trading, 2006). The causes of insider trading are quite easy to understand. To illustrate, a corporate officer knows when the value of the corporation is going to increase or decrease. Perhaps there are secret negotiations for a takeover in which share prices are going to increase.

He can sell his securities in order to maximize his profits or minimize his losses. Because this information is not known to the outside world, it is considered unethical in many circumstances to act on this inside information. This is because there is an implicit conflict of interest. People in positions of trust are expected to act in the best interests of shareholders. The potential, therefore, to maximize profits or minimize losses, on a personal level, is intolerable to the shareholders.

In short, the effect is that fiduciary responsibility is compromised. There is an incentive to lie. It is important to note, however, that insider trading is sometimes legal and sometimes illegal. Insider trading is legal under certain circumstances. This legal version of insider trading requires that persons in positions of trust must report their transactions to the Securities and Exchange Commission. In contrast, illegal insider trading involves, in effect, an abuse of power. The information known is material.

That means that, in some way, this information will affect the share value of the corporation. There are many examples. The IRS may be disallowing tax deductions retroactively and share prices might be affected negatively. The research and development department may have failed, and a substantial portion of the company's recent investments might yield no returns. Insiders can use this information to dump securities while publicly reassuring investors that the financial status of the corporation is healthy.

In the final analysis, illegal insider trading is an abuse of power and an abuse of trust. It is abuse because people in positions of trust take advantage of confidential and material information for their own personal benefit. This is the classic conflict of interest. The conflict exists. Individuals in positions of trust can opt to benefit themselves at the expense of investors; in the end, investors and countries lose confidence in corporations, industries, and countries. Transparency is the ultimate goal.