What is the Penalty for Insider Trading?

Compliance Knowledge Base | Ethics

Posted by: India Wentworth Published: Wed, 17 Jul 2019 Last Reviewed: Wed, 17 Jul 2019
What is the Penalty for Insider Trading?

Illegal insider trading is when non-public information is used by a company 'insider' such as an employee to make a profit through the trading of company stocks and shares. Insider trading was the focus of the 2019 ITV drama, Cleaning Up, starring Sheridan Smith. The programme featured two cleaners that used their place within a business to exploit the confidential stocks and shares information to make a healthy sum of money.

The legal process of insider trading is insiders buying and selling their own company's stock all above board. The illegal version is all about when they choose to do this, why they do it, and the information they're using to make that decision. To sum up, if you have an advantage over the public, what you're doing is illegal and holds serious legal consequences.

Legislation

Although the rules and laws around insider trading vary across the world, in the majority of countries it is illegal due to the fact that it gives some people an unfair advantage. A person who becomes aware of insider information that then trades using that information may be guilty of illegal insider trading.

The term 'insider trading' has been labelled as a 'criminal offence' ever since 1980 – it is a criminal offence in the UK. All over the world insider trading is seen as the biggest offence against the ethics of business and is also seen as a way to destroy the confidence that the public has around the stock exchange.

Insider trading is legal once the confidential information has been released to the public because the insider loses any advantage once the information once it is known to the public.

The laws come from the Criminal Justice Act 1993 and the Financial Services and Markets Act 2000 – although there are small differences between them, both need to be taken into account when considering if insider trading has occurred. Insider trading is sanctioned by civil law under the control of the Financial Services Authority, the FSA.

The FSA is a non-governmental organisation that fights against market abuse. They have a model code that companies have a duty to adopt.

If found guilty of insider training, an individual can be sentenced up to seven years in prison, as well as facing hefty fines. Additionally, the FSA can issue a public announcement that the individual engaged in insider trading – an action that can destroy their reputation.

Illegal insider trading can lead to serious prison sentences, as well as hefty fines to pay – a serious offence has serious results.

What is the Penalty for Insider Trading?

The case of Martha Stewart

One of the most famous examples of insider trading is the case against the American TV star and home goods vendor, Martha Stewart.

In December 2001, the Food and Drug Administration (FDA) announced that it was rejecting ImClone's new cancer drug, Erbitux. As the drug represented a major portion of ImClone's pipeline, the company's stocks took a sharp dive. As a result, many pharmaceutical investors were hurt by the drop, but not Martha Stewart. She sold 4,000 shares when the stock was still trading in the high $50s and made nearly $250,000 through the sale. The stock would plummet to $10 in the following months.

Stewart claimed to have a pre-existing sales order with her broker, but her lies continued to unravel, and public shame eventually forced her to resign as the CEO of her own company. Her friendship with the CEO Samuel Waksal suggested that she was warned about what was going to happen to the shares, and therefore triggered her to sell them when she did.

Waksal was arrested and sentenced to more than seven years in prison and fined $4.3 million in 2003. In 2004, Stewart and her broker were also found guilty of insider trading. Stewart was sentenced to the minimum of five months in prison and fined $30,000.

If she has held only her ImClone stock, she would still have benefitted from the Eli Lilly takeover, and made more money than she did through insider trading! She would have earned $60,000 if she had just waited – instead, she was fined $30,000 and went to jail. Her case shows how the risks outweighed the returns.

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