U.S. insider trading is relatively easy to commit but extremely difficult to prove. Here is a primer for fraud examiners explaining the problem, how to tell if a trade is illegal, and what can be done to detect and prevent this popular crime.
A chemist is surprised at the swift progress of a new drug his pharmaceutical company is developing. Anticipating a successful market release of the drug, the chemist purchases several hundred shares of his company’s stock. One week later, the company issues a press release announcing the significant advancement of its drug. The value of the company’s stock increases by 30 percent in one day. The chemist sells his shares the following day for a gain of nearly $25,000. Does the profit sound too good to be true? It should, because it is illegal. The chemist purchased shares on the basis of material non-public information. Therefore, insider trading occurred.
Insider trading is relatively easy to commit but extremely difficult to prove, which makes it a popular form of white-collar crime. In a well-known ongoing case, Martha Stewart has pleaded not guilty to U.S. federal criminal charges of conspiracy, obstruction of justice, and securities fraud, all linked to the sale of her nearly 4,000 shares of ImClone Systems, Inc. stock. The sale took place on Dec. 27, 2001, the day before the company announced negative news about its cancer-fighting drug, which sent the value of its shares into a tailspin. Stewart has denied any wrongdoing. The former chief executive of ImClone, Sam Waksal, a friend of Stewart’s, pleaded guilty to criminal charges of insider trading for tipping off family members and trying to sell his own shares before the news was made public. He was sentenced to more than seven years in prison.
Many corporate insiders have access to non-public information that they easily can use for profitable but illegal trading. In fact, several insider trading studies show that insiders consistently earn higher returns than public investors. One survey even indicated that when executives and directors purchase shares of their own company’s stock, percentage returns during the first year tend to outperform the market by nearly 50 percent.1