Insider Information - Paper Example

Insider Information in the stock market is information that is not public knowledge, and that refers to a company that issues securities (stocks or bonds, among others), to its business or the securities themselves (Billings & Cedergren, 2015). This information, to properly qualify as inside information, must have relevance or importance such that it is capable of generating effects on the price, the price and the liquidity of security. Besides, it has to be under the control of a few people who are in an advantageous position in front of those who do not know such information (Brochet, 2010). Usually, these people are aware of the information due to their position, activity or relationship with the respective issuing company have access to relevant information.

The improper use of inside information in the stock market is one of the behaviors that can cause the greatest damage to the same due to the evident inequality that it represents in front of the investors and the loss of trust that it can generate among them, which is why said the practice is severely punished internationally. US law considers that the inside information to be such must be "not disclosed to the market and that "if it were made public, it would influence the investment decisions made by the investors" (Cheng & Lo, 2016) It should be noted that it does not qualify as inside information if it is obtained from estimates made on public data or by legal, financial intelligence from the legitimate exercise of a profession or technical analysis (Bhattacharya, 2014). Likewise, it is included within the inside information qualification the information that receives the reserved treatment and "the information obtained from the acquisition or disposal transactions to be carried out by an institutional investor in the securities market, as well as that referred to the takeover bids" (Agrawal & Cooper, 2015)

Why Insider Information Is Prohibited

The prohibitions of the improper use of inside information consist of:

Negotiate and trade securities on which inside information is held

Communicate inside information to third parties

Recommend carrying out operations based on said information.

These prohibitions on the use of inside information seek to ensure the equal information in negotiations and transactions in a securities market. This is so that they are produced without informative advantages over an issuer or certain transferable securities, which have not been the result of estimates prepared on public data or by lawful financial intelligence (Agrawal & Nasser, 2012). Consequently, these prohibitions are intended to ensure:

Integrity, which expresses loyalty and honesty in the concurrence of supply and demand in the securities market

Transparency in this market, which allows for its correct and efficient operation

Equal opportunities in negotiation as an expression of the protection of the rights and legitimate interests of the investor, which strengthens their confidence in the operation of the stock market.

The Relationship between Inside Information and the Obligation to Disclose Important Facts (Relevant Information)

The important facts are defined by the SEC regulation, in general terms, as "any act, decision, agreement, event, negotiation in progress or information referred to the Issuer, the securities of the latter or its businesses that have the ability to significantly influence in The decision of a wise investor to buy, sell or hold a security; or, (...) The liquidity, the price or the price of the securities issued (Aitken, Cumming, & Zhan, 2015) As can be seen, this definition is substantially the same as the one that corresponds to inside information.

Every company issuing securities must continuously disseminate the relevant information about itself as a matter of importance. Note that, before spreading, in some cases, such information is susceptible to qualify as inside information (Agrawal, Erel, Stulz, & Williamson, 2009). The obligation to disclose significant events, in charge of an issuing company, seeks to ensure the permanent transparency required by the proper operation of the securities market and the confidence of investors. The foregoing implies that the existence or generation of relevant information (important fact) imposes two obligations on the issuing company, its managers or their representatives, as appropriate, namely (Billings & Cedergren, 2015):

Publicly disclose this information, immediately, for the knowledge and disposition of the investors in the market, to ensure its transparency

Refrain from using such information and prevent others from using it, as long as it has not been disclosed.

Both duties are two complementary pillars in the securities market: transparency and integrity, since the immediate disclosure of the relevant information prevents its advantageous use and the obtaining of undue benefits by those who know it (as inside information). They are prohibited from using it for their benefit or that of others, for example, through the improper negotiation of securities of the respective issuing company (Cheng & Lo, 2016). In the US, it has been recognized that i) disclosure of relevant information, available to the public in a sufficient, timely manner and under equal conditions, ensures transparency of information; and, ii) the correct formation of prices, which occurs when the parties to a negotiation or transaction do not improperly use inside information, ensures the transparency of operations.

Recommendations to Companies

It is clear that disclosure, through important events, seeks to avoid the misuse of inside information. Consequently, it is advisable that all companies issuing in the stock market disseminate, in condition of fact of importance, any information that could qualify as "inside", according to the criteria indicated above, with the highest level of immediacy possible (considering that the SEC regulations require disclosure as soon as such event occurs or the company becomes aware of it, and never beyond the day it has occurred or has been known) (Aitken, Cumming, & Zhan, 2015). In this regard, the provisions of the Regulation of Relevant Facts and Reserved Information, issued by the Superintendence of the Securities Market, must always be taken into account; as well as the Internal Rules of Conduct that each issuing company has approved. Likewise, it is advisable that, in the period between the generation of inside information and the time of dissemination of an important event, all issuing companies adopt the necessary measures to restrict and safeguard their inside information (Brochet, 2010). Thus, for example, through the rigorous registration of people with access to it; the establishment of secure channels and mechanisms for the transfer of said information within the company; and, the permanent assurance of the strictest reserve concerning it.

References

Agrawal, A., & Cooper, T. (2015) Insider trading before accounting scandals. Journal of

Corporate Finance, 34, 169190.

Agrawal, A., & Nasser, T. (2012). Insider trading in takeover targets. Journal of Corporate

Finance, 18, 598625.

Aggarwal, R., Erel, I., Stulz, R. & Williamson, R. (2009). Differences in governance practices

between U.S. and foreign firms: Measurement, causes, and consequences. Review of

Financial Studies, 22(8), 31313169.

Aitken, M., Cumming, D., & Zhan, F. (2015). Exchange trading rules, surveillance and

suspected insider trading. Journal of Corporate Finance, 34, 311330.

Bhattacharya, U. (2014). Insider trading controversies: A literature review. Annual Review of

Financial Economics, 6, 385403.

Billings, M. B., & Cedergren, M. C. (2015). Strategic silence, insider selling and litigation risk.

Journal of Accounting and Economics, 59(23), 119142.

Brochet, F. (2010). Information content of insider trades before and after the Sarbanes-Oxley

Act. The Accounting Review, 85(2), 419446.

Cheng, Q., & Lo, K. (2016). Insider trading and voluntary disclosures. Journal of Accounting

Research, 44(5), 815848.