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The Inside View

January 2016

Insider trading tends to dilute investor confidence in the integrity and fairness of the stock market. Here’s how

Instances of insider trading have prevailed ever since stock markets came into being. It involves use of material non-public information that impacts a stock price for personal gains. The prevalence has made regulators around the world deal with increasing strictness with cases of insider trading even though lack of concrete evidence drives many cases to settlement.

Investigations related to insider trading is on the rise and cases are being taken to their logical conclusion.In the US, Raj Rajaratnam of Galleon Group was sentenced to 11 years of imprisonment and a fine of $10 million after it was established that he made $72 million through illegal trade in securities using nonpublic information.

The insider trading episode in China involving an official from Chinese securities regulator and executives from leading brokerage houses in the country saw strict actions. China was making efforts to arrest the decline in its stock market that was spooked by concerns of slowdown in the economy and the devaluation of the yuan. Insider trading tends to dilute investor confidence in the integrity and fairness of the stock market. It raises question over ethics. Insider trading amounts to violation of justice in the framework of the present finance theory. It is regarded unfair because it does not offer an equal opportunity to all the market participants to use specific information to his or her advantage.

It gives the holder of the non-public information to real personal gains or avoids losses in case the information is negative. Such a gain or safety is considered conflicting. This is the basic argument against insider trading where money is made at the expense of other participants. With the increasing globalisation and cross border investments, insider trading today affects a much wider set of market participants than in the past.

Participants who suffer a loss tend to withdraw as they feel a sense of unfairness. This ultimately impacts the institutions like investment agencies and banks that are in the business of facilitating equity trading. Traders or executives associated with insider trading will harm their own business volume in the long run that will also impact their colleagues.

There is a school of thought that argues in favour of legalising the insider trading. At present, a stock price tends to jump or decline sharply while insider trading activity happens. The argument put forth in favour says if the insider trading is permitted, the stock will see a gradual price movement and reach the appropriate value. Else, insiders will continue to have access to privileged information and exploit it to their benefit and drive up or down stock prices.

The debate over insider trading however is never-ending. One thing is for sure, say market experts: it is wrong to resort to illegal means to acquire confidential price-sensitive information or data that can provide an unfair advantage when buying and selling shares of a publicly traded company. The biggest obstacle however is how to define, prove and prevent insider trading. One of the biggest difficulties, experts say, is to detect insider trading in the first place and to prove it occurred.

In the UAE, the Securities and Commodities Authority has regulations imposing insider trading restrictions and requiring regular disclosure requirements so that the market knows of any financially significant development that can impact a company. Last year, Saudi Arabia’s Capital Market Authority said it had launched investigations into charges of insider trading in shares of telecom operator Mobily.

Across the region however, analysts feel, more efforts need to be focused towards making comprehensive regulations concerning transparency, disclosure rules and insider trading practices, in order to make capital markets more efficient, to attract more investors and to spur volumes.

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