How often is insider trading caught?
The notion that only a minority of actual insider trading violations (less than 20%) are detected and prosecuted is consistent with theories of rational crime such as the literature following the Becker (1968) framework.
"It is incredibly difficult to prove an insider trading case," said Daniel Taylor, a forensic accounting professor at the University of Pennsylvania. "Congress has never actually defined what insider trading was and explicitly outlawed it."
There are several ways that an inside trader may get caught. These include: Whistleblowers. Individuals inside or outside the alleged perpetrator's organisation may report the trader for insider dealing.
Insider trading happens when a person or company uses information that is not available to the public to make a profit or avoid losses in financial markets. The US Securities and Exchange Commission prosecutes approximately 50 insider trading cases per year, and there are harsh penalties of up to 20 years in prison.
Insider trading is a type of market abuse when an advantageous trade is made based on material nonpublic information. The issue is there's not a specific law defining what insider trading is, which makes it difficult to prosecute cases as they arise.
The estimates also imply that there is at least four times more actual insider trading than there are prosecution cases. We estimate that the probability of detection/prosecution of insider trading in both M&A and earnings announcements is approximately 15%.
On June 17, 2004, a judge sentenced Martha Stewart to five months in prison and two years of supervised release, along with fining her $30,000. Stewart went to prison proclaiming her innocence, which she still maintains to this day.
Research shows that insider trading is common and profitable, yet notoriously hard to prove and prevent. A 2020 study estimated that only about 15% of insider trading in the U.S. is detected and prosecuted.
Four insider trading cases that received a lot of media coverage in the U.S. were those of Albert H. Wiggin, Ivan Boesky, R. Foster Winans, and Martha Stewart. Financial Markets Standards Board (FMSB).
Detection methods have evolved over the years to include increasingly sophisticated technology. The SEC now utilizes advanced data analytics and machine learning algorithms that can sift through enormous volumes of trading data to identify patterns indicative of insider trading.
What is the burden of proof for insider trading?
Burden of Proof in Insider Trading Cases
The government must prove that a defendant bought or sold one or more securities “on the basis of material nonpublic information about that security or issuer,” according to the SEC's Rule 10b5-1, 17 C.F.R. § 240.10b5-1.
Insiders can (and do) buy and sell stock in their own company legally all of the time; their trading is restricted and deemed illegal only at certain times and under certain conditions. A common misconception is that only directors and upper management can be convicted of insider trading.
Some traders follow something called the "10 a.m. rule." The stock market opens for trading at 9:30 a.m., and the time between 9:30 a.m. and 10 a.m. often has significant trading volume. Traders that follow the 10 a.m. rule think a stock's price trajectory is relatively set for the day by the end of that half-hour.
Those who commit insider trading face harsh consequences, so it's important to know what it is and how to avoid it if you own company shares and have information that can affect other investors.
Complaints From Traders
Such trades before big events can signal to regulators that someone is trading on inside information; the big losses taken by investors without material nonpublic information on the other end of these trades also cause such investors to come forward and report the unusual returns.
The individual charged with insider trading must have been aware that the information was material and nonpublic. For example, if you overhear a conversation on a train but have no knowledge that it is insider information, you cannot be convicted if you act on this information.
To be considered an insider, a person must have either access to such information or stock ownership equaling more than 10% of the company's equity.
SEC Tracking
Market surveillance activities: This is one of the most important ways of identifying insider trading. The SEC uses sophisticated tools to detect illegal insider trading, especially around the time of important events such as earnings reports and key corporate developments.
Individuals who willfully violate the U.S. Securities Exchange Act of 1934 through insider trading could face criminal penalties of up to 20 years in prison and fines of $5 million per violation. Companies may be fined up to $25 million.
On the other hand, SEC prosecutions provide a lower bound estimate of the extent of insider trading – approximately 50 insider trading cases are prosecuted by the SEC per annum.
Was Martha Stewart insider trading?
Martha Stewart and Peter Bacanovic Agree to Settle SEC Insider Trading Charges. The Securities and Exchange Commission today announced that it has reached an agreement to settle insider trading charges against Martha Stewart and Peter Bacanovic relating to Stewart's sale of ImClone Systems stock in December 2001.
Allegations of insider trading can have severe criminal and civil repercussions. Federal courts impose strict penalties, including steep fines and prison terms. A criminal conviction may also lead to civil litigation.
Direct evidence of insider trading is rare. There are no smoking guns or physical evidence that can be scientifically linked to a perpetrator. Unless the insider trader confesses his knowledge in some admissible form, evidence is almost entirely circ*mstantial.
Insiders may be sued civilly either by the Securities and Exchange Commission ("SEC") or by private litigants if they trade in securities while in possession of material nonpublic information concerning the issuer of the securities. They may also be charged with a criminal violation.
As to the criminal penalties for insider trading, the maximum sentence for an insider trading violation is 20 years in federal prison. The maximum criminal fine for individuals is $5 million, and the maximum fine for a company is $25 million.
