Monday, 31 October 2011

An Insight on Insider Stock Trades

When Raj Rajaratnam left his homeland in the Indian Ocean Island of Sri Lanka many years ago, he couldn't have dreamed of being the owner of his own hedge fund many years later. But that is just what he became-the founder of one of Wall Street's biggest funds, The Galleon Group.
Neither could have Mr.Rajaratnam dreamed of being accused thereafter of some of the biggest exchange market crimes-insider trading. While his trial for the same has been a sensation, the lack of clear comprehension on how insider stock trades work has not. Furthermore, there's a thin line between what is legal insider trading and what is not.
Individuals with company information that is not public may be in possession of a most valuable weapon in the finance markets, even unwittingly.
These individuals include chief executives, officers, key employees, directors, large stockholders and their immediate families are the most likely to bandy important company details while unknowingly committing punishable financial crimes.
Insider information is information that is not within public domain and could materially affect the market price of a particular stock.
Following from this definition, insider stock trades are buys and sells that are made based on this kind of information. The key individuals mentioned above would be in breach of their fiduciary duty to the company if they engaged in this kind of trade.
An example of an illegal insider trade would be one where the wife of a Chief Financial Officer, with prior knowledge of the company's impending filing for bankruptcy, sells the couple's joint portfolio of the same company.
On the other hand, if you are on the train home and overhear a company CEO discussing with a fellow passenger about the certain takeover of his company you would not be liable for the financial crime since the information did not come directly from the CEO.
Nejun Seyhan is an insider trading expert from the University of Michigan and has done a number of studies concerning the issue. During one of the studies, he found that when key personnel engaged in insider stock trades, their company's stock price outperformed the rest of the industry by 8.3% in the following 12 months. If they sold the shares, the stock underperformed the market by 5.4%. Insiders typically trade on their company's stock when events such as takeovers, mergers, acquisitions are imminent. They also engage in insider stock trades when they think that they stock is undervalued.
To avoid charges of illegal insider stock trading, an insider has to report their trades within 2 business days to the SEC ( Securities and Exchange Commission) .This also applies to all shareholders who have more than 10% of the stock of the company as they are also considered as insiders.
Back to Rajaratnam-his defence team is now alleging that he only made $7 million from his trades, down from the $70 m that the prosecutors claim. And for this they want him jailed for between 19.5 and 24.5 years. Tough luck.

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