Description of the legal term Insider Trading:
Insider trading refers to the practice whereby an individual with access to non-public, material information about a company uses this information to make a profit or avoid a loss by trading in the company’s securities. This practice is illegal in the United Kingdom and is regulated by the Financial Conduct Authority (FCA). The legal prohibition is based on the principle that all participants in the market should be on an equal footing, and no one should benefit from undisclosed information that could affect the value of securities.
The offense can involve employees of a company, investment bankers, lawyers, and others who might have access to confidential information. These insiders are prohibited from buying or selling shares or other securities based on this information until it has been made public. Equally, passing on insider information to others (known as “tipping”) is also illegal if the tippee subsequently trades on the basis of the information.
The legislation covering this is the Criminal Justice Act 1993 and the Market Abuse Regulation (MAR), which apply across the European Union. Under these laws, insider trading can lead to criminal prosecution, with potential penalties including prison sentences, unlimited fines, and reputational damage.
The justification for these laws is to ensure the integrity of financial markets and to maintain investor confidence. If investors believe that others have an unfair advantage, they may feel discouraged from investing, which can have a detrimental effect on the liquidity and capital formation required for economic growth.
It’s important to note that not all trading by insiders is illegal. Insiders are entitled to buy and sell shares of their own companies within the confines of the law. However, they must not use material information that is not available to the public to make these trades. They must also report their trades to the appropriate authorities, often within a strict timeframe.
Legal context in which the term Insider Trading may be used:
One pertinent example of illegal activity occurred when a senior executive of a pharmaceutical company became aware of the results of a clinical trial for a new drug before the information was released to the public. The trial had failed, meaning the drug was unlikely to receive regulatory approval, which would significantly affect the company’s share price. Instead of keeping this information confidential, the executive sold a large portion of their shares to avoid the loss that would inevitably follow once the trial results were made public. This action constituted an illegal use because the executive used their privileged access to sensitive information to their advantage and the detriment of other investors.
Another instance involves an employee overhearing a confidential conversation about an impending takeover bid for their company. Armed with this information, the individual might be tempted to buy shares in their employer’s company, anticipating a surge in the share price once the takeover bid is announced. This would also be a clear violation of the laws against this kind of behavior. Not only is the individual using information not yet available to the wider market, but they’re also potentially influencing the price of shares for personal gain, undermining the fairness and transparency that the markets rely on.
It is imperative for the proper functioning of efficient markets that the principle of fair dealing be upheld. By enforcing laws against this malpractice, the United Kingdom upholds a market system where trust and investor protection are central, ensuring that all market participants have equal access to information and can make investment decisions on a level playing field. This legal framework is thus crucial in maintaining the confidence and integrity of the British financial markets.