Question

In this week's lecture we have discussed the concept of insider trading as it exists and is viewed around the world. Discuss your view on how insider trading should be viewed

Answer 1

Insider trading is the buying or selling of a security by someone who has access to material nonpublic information about the security.

Insider trading can be illegal or legal depending on when the insidermakes the trade. It is illegal when the material information is still nonpublic.Illegal insider trading includes tipping others when you have any sort of nonpublic information. Legal insider trading happens when directors of the company purchase or sell shares, but they disclose their transactions legally. The Securities and Exchange Commission has rules to protect investments from the effects of insider trading.

In my view, insider trading should be viewed as illegal because it robs the investors who do not have nonpublic information of receiving the full value for their securities. If nonpublic information became widely known before an insider trading situation took place, the markets would integrate that information and the securities in question would become more accurately priced as a result. If, for instance, a pharmaceutical company is having success in Phase 3 trials (Phase 3 trials are used to obtain additional information about the new drug’s effectiveness and safety so as to assess the benefit versus risk of the therapy and use this information in the drug’s labeling if approved by the FDA.) for one of its new drugs and will make that information public in a week, there exists an opportunity for an investor with that nonpublic information to exploit it. Such an investor could purchase the pharmaceutical company's stock prior to the public release of the information and benefit from a rise in the price after the news is made public. The investor who sold the stock without knowledge of the success from the Phase 3 trials might have kept his or her stock and could have benefited from the price appreciation if the success in the clinical trials was widely known.