Insider trading is when someone with privileged access, such as directors, executives and employees, buys or sells the company’s securities (e.g., stocks, bonds and investment contracts) based on material information not yet available to the public.
While the process can be legal if reported to and compliant with the Securities and Exchange Commission (SEC) regulations, trading confidential knowledge can also breach fiduciary duties.
An unfair advantage
A fiduciary duty exists when an individual or entity, known as the “principal,” entrusts another person to act on their behalf. It is a legal and ethical responsibility that upholds the values of honesty, loyalty and care.
Suppose a corporate officer trades details about quarterly earnings, leadership changes, product releases, or mergers and acquisitions. In that case, they may use what they know for personal gain instead of advancing the company. Employees may also invest in a competitor, which can cause conflicts of interest.
The misappropriation of classified data can go deeper. Families, friends or business partners may receive a “tip” that gives them an unjust edge over other investors. They can also be liable if they use such tips before the news goes public.
All cases tend to go against the principal’s best interests. If fiduciaries abuse their power, the fiduciary relationship can erode due to broken trust and confidence.
The SEC recognizes the significant impact illegal insider trading has on businesses and the entire market integrity. To mitigate negative consequences, they introduced amendments to existing insider trading rules. One of the adjustments is limiting plans to once every year to level the playing field. This restriction tries to eliminate selective plans in favor of an insider, who ensures profits and avoids losses not necessarily for the company’s benefit.
In pursuit of fairness
Insider trading can harm any business in numerous ways. It can ruin a company’s reputation and what they stand for. It may also set a precedent that fosters a culture of corruption. Further, it can have a ripple effect on the market’s efficiency. No doubt, it is a complex field to navigate. Thus, it will be wise for companies to seek their legal teams for valuable guidance. They can develop plans of action that promote fairness and prevent unwanted lawsuits.