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Insider trading is a common malpractice perpetrated in securities markets. Insider trading takes place when an individual having access to the data concerning an organization that is not in the public domain takes advantage of such information to trade in securities and garners profit or evades loss. Perpetual insider trading erodes investor confidence in the equity and integrity of securities markets. Consequently, a number of legislations have been enacted to curb insider trading and protect investors. The Securities Act of 1933 is the major insider trading law. One of the recent cases of insider trading in the United States involved a former Capital One analyst.
According to Reuters, on Jan 16th, 2016 Nan Huang, a former employee of Capital One Corporation was found guilty of insider trading in a civil case. It was alleged that Nan Huang used some data obtained from at work, a credit card issuer, to purchase and sell stocks. A federal jury in Philadelphia reached a consensus with the U.S. Securities and Exchange Commission (SEC) which had filed the suit claiming that the information used by the defendant to trade in shares of consumer retail firms prior to the official earning reports was material and accused him of insider trading. The SEC Lawyer argued that the aforementioned data provided the ex-Capital One employee with a substantial advantage over other investors resulting in his revenues reaching $4.4 million from the trading.
The defendant did not deny using non-public information from Capital One to trade. Rather, the point of argument from the defense was that the information was neither material in line with the facts of the case presented nor it was the matter of law. Nevertheless, in his closing argument, SEC’s lawyer contended that the disclosure qualified as material information because the defendant used it partly to perform calculations that enabled him to predict myriad retail firms’ revenue patterns (Reuters).
The Securities and Exchange Commission filed an action against Nan Huang and Bonan Huang alleging that they made hundreds of key search words on their employer’s confidential database looking for sales data on more than 170 listed firms between November 2013 and January 2015. According to SEC, while working for Capital One, the two analysts leveraged the information to trade in accounts at several brokerages before the announcement of quarterly earnings by the firms. Bonn Huang settled with the SEC agreeing to pay penalties and other charges amounting to more than $4.7 million. Nan Huang chose to go to court (Reuters).
Definition of an Insider
The typical definition of the term “insider” encompasses the officers, directors and other employees of the firm that issued securities trading in an exchange market. However, the legal definition of “insider” also includes persons who can be argued to have a fiduciary relationship with the issuing firm to the extent that latter provides the individuals with the access to relevant non-public information. These parties include auditors, bankers, and counsels. The legal definition of “insider” also covers security analysts, stockbrokers, and shareholders in the event that they obtain material information that is not available to the public from the other insiders (Stuart 23).
The latter definition of an insider formed the basis for Nan Huang being deemed as an insider under SEC laws. As reported by Reuters, Nan Huang worked as an analyst who was in charge of investigating credit frauds for Capital One Financial Corporation, the bank’s parent company for Capital One Bank (the United States), Capital One and other companies that offers financial products and services in the U.S.,U.K., and Canada. He accessed non-public information from his company’s private database and used it to purchase and sell stocks from various listed retail companies (Reuters).
Materiality of Non-Public Information
Non-public information is considered material if there is a significant likelihood that an investor would judge the information as relevant to decision-making process. Essentially, any information that can have an impact on a company’s stock price or the value of other securities, is considered material. Examples of material information include earning results, increase or decrease of dividends, dispositions or acquisition of major assets including joint ventures and mergers, imminent major legal actions among others (Stuart 24). Information becomes public upon its release by an issuer or another authority to investors in the exchange market, for instance, by being published by the Wall Street Journal, Reuters, and Bloomberg. Furthermore, company filings with the SEC and postings on websites are considered public information (Stuart 24). In the case under consideration, the defendant used information on earnings of several retail companies which was yet to be made public by any means mentioned above to trade on stocks.
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Federal Statutes on Insider Trading
Several legislations deal with insider trading practices. Section 16 of the Securities Exchange Act is about sanctions on insiders who utilize classified information to make short-swing profits. Considering this definition, an insider is any individual who either directly or indirectly owns over 10% of any class of registered securities or a director or an officer of the issuing company (Seitzinger 1). An insider, as per this definition, is mandated to issue a report to the SEC at the time the firms’ securities are registered on stock exchange or by the effective date of an issued statement of registration or within ten days subsequent to the individual becoming a beneficial owner, director, or officer. Every time there is a sale or purchase of securities, the insider is supposed to issue a report before the end of the following business day after the day of the transaction (Seitzinger, 1).
To prevent unfair usage of insider information, section 16 (b) of the Act allows the firm or any other holder of a security bringing a legal action on behalf of the firm to recover any gains which the individual realizes from any sale or purchase of the securities of the company within six months (Seitzinger 1-2).