BUS401 Project by AZAZ

8/9/2019 BUS401 Project by AZAZ

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When information is profitAn ethical issue regarding Capital Market

Submitted to:

M. Saidur Rahman

Faculty

School of Business

North South University

Submitted by:

Arif Mahmood ID: 061 313 030 Sec: 02

Richard Aungon Gomes ID: 061 389 030 Sce: 02Towhidul Hasan ID: 061 159 030 Sec: 02

Azazuzzaman ID: 062 397 030 Sec: 05

BUS-401

North South University

Bashundhara, Dhaka


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10th April, 2010

Mr. M Saidur RahmanHonorable FacultySchool of BusinessNorth South University

Dear Sir,

We would like to submit our Group Project on Insider Trading named When information isprofitas assigned to us by you. It was an enormous opportunity for us to prepare this project.We would like to recall with gratitude, the tremendous support and encouragement, which wereceived from you. In this project, we have tried our level best to follow the relevant theories

and topics that you taught us in the course BUS401 (Business Ethics).

As an instructor and advisor to the project, you provided valuable insights and academictraining to improve the quality of the work. We are grateful for your stimulating guidance andencouragement during the period of preparation of the project. Without your guidance, thiswould simply not have been possible.

There may have many omissions and errors on our part, but we have tried our level best toprepare this project to the required standard.

Thanking you in anticipation,

.............................................Arif Mahmood

( on behalf of the members of The Groip)

Other Group members:

Richard Aungon Gomes ID: 061 389 030

Towhidul Hasan ID: 061 159 030

Azazuzzaman ID: 062 397 030


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Preamble

Pjk

Relevence of the Study


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Major Objectives of the research:Specific objective:

To evaluate whether insider trading is unethical or justifyable. To justify that we have taken our

hypothesis as follows:

Insider trading is ethical and it is justifyable when Bangladeshi capital market is

concerned

Broad objectives:

There are several broad objectives of our project those are follows:

Using different ethical theories to justify whether insider trading is ethical or not. Relating both traditional as well as contemporary ethical theory to evaluate. Look into the process of insider trading.

Methodology of the research

As our project is mainly based on qualitative research, thats why we have collectedrelevant secondary data of this topic and used secondary data sources. While doing thisresearch we have taken some secondary data which helped us to make our conceptunderstandable. As secondary data we have collected our relevant information about the stock


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market and also about the trading process from different articles and books relevant to ourtopic. This project helped us to experience practical implication of those theories learned fromtext book as well as from these references. Moreover to make our project more attractive wehave taken some real interview of some beneficial inside trader.

Literature review

Insider trading is the trading of a corporation's stockor other securities (e.g. bonds or

stock options) by individuals with potential access to non-public information about thecompany. In most countries, trading by corporate insiders such as officers, key employees,directors, and large shareholders may be legal, if this trading is done in a way that does nottake advantage of non-public information. However, the term is frequently used to refer toa practice in which an insider or a related party trades based on material non-publicinformation obtained during the performance of the insider's duties at the corporation, orotherwise in breach of a fiduciary or other relationship of trust and confidence or wherethe non-public information was misappropriated from the company.

In the United States and several other jurisdictions, trading conducted by corporateofficers, key employees, directors, or significant shareholders (in the U.S., defined as

beneficial owners of ten percent or more of the firm's equity securities) must be reportedto the regulator or publicly disclosed, usually within a few business days of the trade. Manyinvestors follow the summaries of these insider trades in the hope that mimicking thesetrades will be profitable. While "legal" insider trading cannot be based on material non-public information, some investors believe corporate insiders nonetheless may have betterinsights into the health of a corporation (broadly speaking) and that their trades otherwiseconvey important information (e.g., about the pending retirement of an important officerselling shares, greater commitment to the corporation by officers purchasing shares, etc.)

Illegal insider trading is believed to raise the cost of capital for securities issuers, thusdecreasing overall economic growth.


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Legal insider trading

Legal trades by insiders are common, as employees of publicly-traded corporations oftenhave stock or stock options. These trades are made public in the US through SEC filings,mainly Form 4. Prior to 2001, US law restricted trading such that insiders mainly traded

during windows when their inside information was public, such as soon after earningsreleases.[3] SEC Rule 10b5-1 clarified that the U.S. prohibition against insider trading doesnot require proof that an insider actually used material nonpublic information whenconducting a trade; possession of such information alone is sufficient to violate theprovision, and the SEC would impute an insider in possession of material nonpublicinformation uses this information when conducting a trade. However, Rule 10b5-1 alsocreated for insiders an affirmative defense if the insider can demonstrate that the tradesconducted on behalf of the insider were conducted as part of a preexisting contractorwritten, binding plan for trading in the future.[3] For example, if a corporate insider planson retiring after a period of time and, as part of his or her retirement planning, adopts awritten, binding plan to sell a specific amount of the company's stock every month for the

next two years, and during this period the insider comes into possession of materialnonpublic information about the company, any subsequent trades based on the originalplan might not constitute prohibited insider trading.

Illegal insider trading

Insider

trading

Legalinsider

trading

Illegalinsider

trading


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Rules against insider trading on material non-public information exist in most jurisdictionsaround the world, though the details and the efforts to enforce them vary considerably. TheUnited States is generally viewed as having the strictest laws against illegal insider trading,and makes the most serious efforts to enforce them.

Definition of "insider"

In the United States and Germany, for mandatory reporting purposes, corporate insidersare defined as a company's officers, directors and any beneficial owners of more than tenpercent of a class of the company's equity securities. Trades made by these types ofinsiders in the company's own stock, based on material non-public information, areconsidered to be fraudulent since the insiders are violating the fiduciary duty that they oweto the shareholders. The corporate insider, simply by accepting employment, hasundertaken a legal obligation to the shareholders to put the shareholders' interests beforetheir own, in matters related to the corporation. When the insider buys or sells based uponcompany owned information, he is violating his obligation to the shareholders.

For example, illegal insider trading would occur if the chief executive officer of Company Alearned (prior to a public announcement) that Company A will be taken over, and boughtshares in Company A knowing that the share price would likely rise.

In the United States and many other jurisdictions, however, "insiders" are not just limitedto corporate officials and major shareholders where illegal insider trading is concerned,but can include any individual who trades shares based on material non-public informationin violation of some duty of trust. This duty may be imputed; for example, in manyjurisdictions, in cases of where a corporate insider "tips" a friend about non-publicinformation likely to have an effect on the company's share price, the duty the corporate

insider owes the company is now imputed to the friend and the friend violates a duty to thecompany if he or she trades on the basis of this information.

Liability for insider trading

Liability for insider trading violations cannot be avoided by passing on the information inan "I scratch your back, you scratch mine" or quid pro quo arrangement, as long as theperson receiving the information knew or should have known that the information wascompany property.

For example, if Company A's CEO did not trade on the undisclosed takeover news, butinstead passed the information on to his brother-in-law who traded on it, illegal insidertrading would still have occurred.

Misappropriation theory

A newer view of insider trading, the "misappropriation theory" is now part of US law. Itstates that anyone who misappropriates (steals) information from their employer and


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trades on that information in any stock (not just the employer's stock) is guilty of insidertrading.

For example, if a journalist who worked for Company B learned about the takeover ofCompany A while performing his work duties, and bought stock in Company A, illegal

insider trading might still have occurred. Even though the journalist did not violate afiduciary duty to Company A's shareholders, he might have violated a fiduciary duty toCompany B's shareholders (assuming the newspaper had a policy of not allowing reportersto trade on stories they were covering).

Proof of responsibility

Proving that someone has been responsible for a trade can be difficult, because traders maytry to hide behind nominees, offshore companies, and other proxies. Nevertheless, the U.S.Securities and Exchange Commission prosecutes over 50 cases each year, with many beingsettled administratively out of court. The SEC and several stock exchanges actively monitor

trading, looking for suspicious activity.

Trading on information in general

Not all trading on information is illegal inside trading, however. For example, while diningat a restaurant, you hear the CEO of Company A at the next table telling the CFO that thecompany's profits will be higher than expected, and then you buy the stock, you are notguilty of insider trading unless there was some closer connection between you, thecompany, or the company officers. However, information about a tender offer (usuallyregarding a merger or acquisition) is held to a higher standard. If this type of information isobtained (directly orindirectly) and there is reason to believe it is non-public, there is a

duty to disclose it or abstain from trading.

Tracking insider trades

Since insiders are required to report their trades, others often track these traders, andthere is a school of investing which follows the lead of insiders. This is of course subject tothe risk that an insider is making a buy specifically to increase investor confidence, ormaking a sell for reasons unrelated to the health of the company (e.g. a desire to diversifyor pay a personal expense).

As of December 2005 companies are required to announce times to their employees as towhen they can safely trade without being accused of trading on inside information.

American insider trading law

The United States has been the leading country in prohibiting insider trading made on thebasis of material non-public information. Thomas Newkirk and Melissa Robertson of theU.S. Securities and Exchange Commission (SEC) summarize the development of U.S. insider


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trading laws.[8] Insider trading has a base offense level of 8, which puts it in Zone A underthe U.S. Sentencing Guidelines. This means that first-time offenders are eligible to receiveprobation rather than incarceration.[9]

Common law

U.S. insider trading prohibitions are based on English and American common lawprohibitions against fraud. In 1909, well before the Securities Exchange Act was passed, theUnited States Supreme Court ruled that a corporate director who bought that companysstock when he knew it was about to jump up in price committed fraud by buying while notdisclosing his inside information.

Section 17 of the Securities Act of 1933 contained prohibitions of fraud in the sale ofsecurities which were greatly strengthened by the Securities Exchange Act of 1934.

Section 16(b) of the Securities Exchange Act of 1934 prohibits short-swing profits (from

any purchases and sales within any six month period) made by corporate directors,officers, or stockholders owning more than 10% of a firms shares. Under Section 10(b) ofthe 1934 Act, SEC Rule 10b-5, prohibits fraud related to securities trading.

The Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities FraudEnforcement Act of 1988 provide for penalties for illegal insider trading to be as high asthree times the profit gained or the loss avoided from the illegal trading.

SEC regulations

SEC regulation FD ("Fair Disclosure") requires that if a company intentionally discloses

material non-public information to one person, it must simultaneously disclose thatinformation to the public at large. In the case of an unintentional disclosure of materialnon-public information to one person, the company must make a public disclosure"promptly."[13]

Insider trading, or similar practices, are also regulated by the SEC under its rules ontakeovers and tender offers under the Williams Act.

Court decisions

Much of the development of insider trading law has resulted from court decisions.

In SEC v. Texas Gulf SulphurCo. (1966), a federal circuit court stated that anyone inpossession of inside information must either disclose the information or refrain fromtrading.[14]

In 1909, the Supreme Court of the United States ruled in Strong v. Repide that a directorupon whose action the value of the shares depends cannot avail of his knowledge of what


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his own action will be to acquire shares from those whom he intentionally keeps inignorance of his expected action and the resulting value of the shares. Even though ingeneral, ordinary relations between directors and shareholders in a business corporationare not of such a fiduciary nature as to make it the duty of a director to disclose to ashareholder the general knowledge which he may possess regarding the value of the shares

of the company before he purchases any from a shareholder, yet there are cases where, byreason of the special facts, such duty exists.

In 1984, the Supreme Court of the United States ruled in the case ofDirks v. SECthat tippees(receivers of second-hand information) are liable if they had reason to believe that thetipper had breached a fiduciary duty in disclosing confidential information and the tipperreceived any personal benefit from the disclosure. (Since Dirks disclosed the information inorder to expose a fraud, rather than for personal gain, nobody was liable for insider tradingviolations in his case.)

The Dirks case also defined the concept of "constructive insiders," who are lawyers,

investment bankers and others who receive confidential information from a corporationwhile providing services to the corporation. Constructive insiders are also liable for insidertrading violations if the corporation expects the information to remain confidential, sincethey acquire the fiduciary duties of the true insider.

In United States v. Carpenter(1986) the U.S. Supreme Court cited an earlier ruling whileunanimously upholding mail and wire fraud convictions for a defendant who received hisinformation from a journalist rather than from the company itself. The journalistR. FosterWinans was also convicted, on the grounds that he had misappropriated informationbelonging to his employer, the Wall Street Journal. In that widely publicized case, Winanstraded in advance of "Heard on the Street" columns appearing in the Journal.

The court ruled in Carpenter: "It is well established, as a general proposition, that a personwho acquires special knowledge or information by virtue of a confidential or fiduciaryrelationship with another is not free to exploit that knowledge or information for his ownpersonal benefit but must account to his principle for any profits derived therefrom."

However, in upholding the securities fraud (insider trading) convictions, the justices wereevenly split.

In 1997 the U.S. Supreme Courtadopted the misappropriation theory of insider trading inUnited States v. O'Hagan, 521 U.S. 642, 655 (1997). O'Hagan was a partner in a law firm

representing Grand Metropolitan, while it was considering a tender offer for Pillsbury Co.O'Hagan used this inside information by buying call options on Pillsbury stock, resulting inprofits of over $4 million. O'Hagan claimed that neither he nor his firm owed a fiduciaryduty to Pillsbury, so that he did not commit fraud by purchasing Pillsbury options.

The Court rejected O'Hagan's arguments and upheld his conviction.


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The "misappropriation theory" holds that a person commits fraud "in connection with" asecurities transaction, and thereby violates 10(b) and Rule 10b-5, when hemisappropriates confidential information for securities trading purposes, in breach of aduty owed to the source of the information. Under this theory, a fiduciary's undisclosed,self-serving use of a principal's information to purchase or sell securities, in breach of a

duty of loyalty and confidentiality, defrauds the principal of the exclusive use of theinformation. In lieu of premising liability on a fiduciary relationship between companyinsider and purchaser or seller of the company's stock, the misappropriation theorypremises liability on a fiduciary-turned-trader's deception of those who entrusted him withaccess to confidential information.

The Court specifically recognized that a corporations information is its property: "Acompany's confidential information...qualifies as property to which the company has a rightof exclusive use. The undisclosed misappropriation of such information in violation of afiduciary duty...constitutes fraud akin to embezzlement the fraudulent appropriation toone's own use of the money or goods entrusted to one's care by another."

In 2000, the SEC enacted Rule 10b5-1, which defined trading "on the basis of" insideinformation as any time a person trades while aware of material nonpublic information so that it is no defense for one to say that she would have made the trade anyway. This rulealso created an affirmative defense for pre-planned trades.

Security analysis and insider trading

Security analysts gather and compile information, talk to corporate officers and otherinsiders, and issue recommendations to traders. Thus their activities may easily cross legallines if they are not especially careful. The CFA Institute in its code of ethics states thatanalysts should make every effort to make all reports available to all the broker's clients ona timely basis. Analysts should never report material nonpublic information, except in aneffort to make that information available to the general public. Nevertheless, analysts'reports may contain a variety of information that is "pieced together" without violatinginsider trading laws, under the mosaic theory. This information may include non-materialnonpublic information as well as material public information, which may increase in valuewhen properly compiled and documented.

In May 2007, a bill entitled the "Stop Trading on Congressional Knowledge Act, or STOCKAct" was introduced that would hold congressional and federal employees liable for stock

trades they made using information they gained through their jobs and also regulateanalysts or "Political Intelligence" firms that research government activities.[18] The bill hasnot passed.

Arguments for legalizing insider trading

Some economists and legal scholars (e.g. Henry Manne, Milton Friedman, Thomas Sowell,Daniel Fischel, Frank H. Easterbrook) argue that laws making insider trading illegal should


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be revoked. They claim that insider trading based on material nonpublic informationbenefits investors, in general, by more quickly introducing new information into themarket.

Milton Friedman, laureate of the Nobel Memorial Prize in Economics, said: "You want more

insider trading, not less. You want to give the people most likely to have knowledge aboutdeficiencies of the company an incentive to make the public aware of that." Friedman didnot believe that the trader should be required to make his trade known to the public,because the buying or selling pressure itself is information for the market.

Other critics argue that insider trading is a victimless act: A willing buyer and a willingseller agree to trade property which the seller rightfully owns, with no prior contract(according to this view) having been made between the parties to refrain from trading ifthere is asymmetric information.

Legalization advocates also question why "trading" where one party has more information

than the other is legal in other markets, such as real estate, but not in the stock market. Forexample, if a geologistknows there is a high likelihood of the discovery ofpetroleum underFarmer Smith's land, he may be entitled to make Smith an offer for the land, and buy it,without first telling Farmer Smith of the geological data.[14] Nevertheless, circumstancescan occur when the geologist would be committing fraud if, because he owes a duty to thefarmer, he did not disclose the information; e.g., if he had been hired by Farmer Smith toassess the geology of the farm.

Advocates of legalization make free speech arguments. Punishment for communicatingabout a development pertinent to the next day's stock price might seem to be an act ofcensorship.[21] If the information being conveyed is proprietary information and the

corporate insider has contracted to not expose it, he has no more right to communicate itthan he would to tell others about the company's confidential new product designs,formulas, or bank account passwords.

There are very limited laws against "insider trading" in the commodities markets, if, for noother reason, than that the concept of an "insider" is not immediately analogous tocommodities themselves (e.g., corn, wheat, steel, etc.). However, analogous activities suchas front running are illegal under U.S. commodity and futures trading laws. For example, acommodity broker can be charged with fraud if he or she receives a large purchase orderfrom a client (one likely to affect the price of that commodity) and then purchases thatcommodity before executing the client's order in order to benefit from the anticipated price

increase.

Legal differences among jurisdictions

The US and the UK vary in the way the law is interpreted and applied with regard to insidertrading.


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In the UK, the relevant laws are the Criminal Justice Act 1993 Part V Schedule 1 and theFinancial Services and Markets Act 2000, which defines an offence of Market Abuse. It isalso illegal to fail to trade based on inside information (whereas without the insideinformation the trade would have taken place). The principle is that it is illegal to trade onthe basis of market-sensitive information that is not generally known. No relationship to

the issuer of the security is required; all that is required is that the party guilty traded (orcaused trading) whilst having inside information.

Japan enacted its first law against insider trading in 1988. Roderick Seeman says: "Eventoday many Japanese do not understand why this is illegal. Indeed, previously it wasregarded as common sense to make a profit from your knowledge."

In accordance with EU Directives, Malta enacted the Financial Markets Abuse Actin 2002,which effectively replaced the Insider Dealing and Market Abuse Actof 1994.

The "Objectives and Principles of Securities Regulation"[ published by the International

Organization of Securities Commissions (IOSCO) in 1998 and updated in 2003 states thatthe three objectives of good securities market regulation are (1) investor protection, (2)ensuring that markets are fair, efficient and transparent, and (3) reducing systemic risk.The discussion of these "Core Principles" state that "investor protection" in this contextmeans "Investors should be protected from misleading, manipulative or fraudulentpractices, including insider trading, front running or trading ahead of customers and themisuse of client assets." More than 85 percent of the world's securities and commoditiesmarket regulators are members of IOSCO and have signed on to these Core Principles.

The World Bankand International Monetary Fund now use the IOSCO Core Principles inreviewing the financial health of different country's regulatory systems as part of these

organization's financial sector assessment program, so laws against insider trading basedon non-public information are now expected by the international community. Enforcementof insider trading laws varies widely from country to country, but the vast majority ofjurisdictions now outlaw the practice, at least in principle.

Larry Harris claims that differences in the effectiveness with which countries restrictinsider trading help to explain the differences in executive compensation among thosecountries. The U.S., for example, has much higher CEO salaries than do Japan or Germany,where insider trading is less effectively restrained.

Example of Insider Trading

Insider Trading in UTTAM GALVA STEEL ?

05 September 2009


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ArcelorMittal gets in through Uttam Galva

Uttam Galva, in a late evening notice to the Bombay Stock Exchange (BSE), announced thatit will allow ArcelorMittal to acquire shares in the company through an open offer.

At the first stage, Lakhmi Mittal-owned ArcelorMittal will purchase a 5% stake for Rs69.6crore atRs120 a share.

Subsequently, the Mittals will make an open offer to purchase a 30% stake at the sameprice paid to the promoters for the 5% stake, valuing the company at Rs1,384.3 crore.


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This is Daily chart of UTTAM STEEL.

Just see the movement of the stock from Rs.53 on 11th August and on Friday it closed at113.95 level.

My question to Readers ,Traders ,STOCK EXCHANGE and SEBI is .The annoucement ofstake sale or picking of stake by Arcelor Mittal was decided on Friday (4th September) ortalks were going on since last 1-2 months ??


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References

y Stephen M. Bainbridge, Securities Law: Insider Trading (1999) ISBN 1-56662-737-0.y Larry Harris, Trading & Exchanges, Oxford Press, Oxford, 2003. Chapter 29 "Insider

Trading" ISBN 0-19-514470-8.y Grechenig, The Marginal Incentive of Insider Trading: an Economics

Reinterpretation of the Case Law, 37 The University of Memphis Law Review 75-148 (2006).

y Grechenig, Positive and Negative Information - Insider Trading Rethought(http://ssrn.com/abstract=1019425).

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BUS401 Project by AZAZ