Insider trading in options markets

Author: Gravicapa On: 28.06.2017

Contrary to common belief, insider trading is not always illegal. Insider trading is legal when corporate insiders — such as a company's directors, officers and employees — buy or sell shares in their company in accordance with securities laws and regulations.

Such legal insider trading must be filed with the US Securities and Exchange Commission SEC on certain forms within stipulated time periods. The version of insider trading that makes the headlines, however, is the illegal trading made by someone who possesses material and nonpublic information. The SEC vigorously pursues such insider trading cases in order to ensure that the capital market is a level playing field where no one has an unfair advantage.

Otherwise, rampant insider trading can erode public confidence in the market and impede its functioning. The SEC's successful cases against high-profile individuals like Martha Stewart and former McKinsey global head Rajat Gupta prove that no one is above the law if they undertake such illegal activity. The SEC defines illegal insider trading as "buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security.

What is material information anyway? This could include a vast array of items, including financial results that differ from current expectations; business developments ; security-related items such as an increase or decrease in dividend, share split, or buyback ; acquisition or divestiture ; winning or losing a major contract or customer. In a September speech titled "Insider Trading — A US Perspective" by Thomas Newkirk and Melissa Robertson of the SEC's Division of Enforcement , Newkirk and Robertson pointed out that insider trading is a very difficult crime to prove.

They noted that since direct evidence of insider trading is rare, evidence is almost completely circumstantial. Such surveillance activity is helped by the fact that most insider trades are conducted with the intention of "hitting it out of the ballpark. Such huge, anomalous trades are usually flagged as suspicious and may trigger an SEC investigation.

The easiest way for someone to capitalize on inside information is through the use of OTM options, since these deliver the most bang for the buck. Would it be any surprise if they complained about the suspicious nature of this trade, which has saddled them with a gigantic loss, to the SEC? However, because insider trading is typically done on a one-off basis by a single insider who may either trade directly or tip someone else, whistleblowers seem to be more successful in unearthing widespread fraud rather than isolated insider trading abuses.

Once the SEC has the basic facts on a possible securities violation, its Division of Enforcement launches a full investigation that is conducted privately.

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The SEC develops a case by interviewing witnesses, examining trading records and data, subpoenaing phone records, etc. In recent years, the SEC has employed a bigger arsenal of tools and techniques to combat insider trading. In the landmark Galleon Group case, for instance, it used wiretaps for the first time to implicate a number of people in a wide-ranging insider-trading ring.

As the evidence in an insider trading case is largely circumstantial, SEC staff has to establish a chain of events and fit together pieces of evidence much like a jigsaw puzzle.

New Academic Study Suggests Insider Trading in Options Market - Barron's

A case brought by the SEC against a consulting executive and his friend in September illustrates this point. The executive passed on confidential information he had learnt about the impending takeovers of two biotechnology companies to his friend, who bought a large number of call options on these companies. The SEC alleged that the two communicated about the potential takeovers during in-person meetings and on the phone.

Some of these meetings were tracked through the two perpetrators' use of MetroCards at New York subway stations and large cash withdrawals from ATMs and banks made by the executive's friend before their meetings. Following an insider trading investigation, staff presents their findings to the SEC for review, which can authorize staff to bring an administrative action or file a case in federal court.

How The SEC Tracks Insider Trading | Investopedia

In a civil action, the SEC files a complaint with a US District Court and seeks a sanction or injunction against the individual that prohibits any further acts that violate securities law, plus civil monetary penalties and disgorgement of illegal profits. In an administrative action, the proceedings are heard by an administrative law judge who issues an initial decision that includes findings of fact and legal conclusions.

Administrative sanctions include cease and desist orders, suspension or revocation of financial industry registrations, censures, civil monetary penalties, and disgorgement. While the s was the decade of massive insider trading scandals by the likes of Ivan Boesky , Dennis Levine, and Michael Milken , two of the biggest insider trading cases in this Millennium include:.

Although US penalties for insider trading are among the stiffest in the world, the number of cases filed by the SEC in recent years shows that the practice may be impossible to stamp out entirely.

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This Mistake Could Cost You Guides Stock Basics Economics Basics Options Basics Exam Prep Series 7 Exam CFA Level 1 Series 65 Exam. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. How The SEC Tracks Insider Trading By Elvis Picardo, CFA February 18, — 9: What is Illegal Insider Trading? Over the years, the SEC has brought insider-trading cases against hundreds of parties, including Corporate insiders who traded the company's securities after learning of significant, confidential developments; Insiders' friends and family, as well as other recipients of tips who traded securities after receiving such information; Employees of service firms such as law, banking, brokerage, and printing companies who came across material nonpublic information on companies and traded on it; and Government employees who obtained inside information because of their jobs.

SEC Tracking In a September speech titled "Insider Trading — A US Perspective" by Thomas Newkirk and Melissa Robertson of the SEC's Division of Enforcement , Newkirk and Robertson pointed out that insider trading is a very difficult crime to prove. The SEC tracks insider trading in a number of ways: 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.

Insider trading is also revealed through tips and complaints from sources such as unhappy investors or traders on the wrong side of a trade. In the above-mentioned speech, Newkirk and Robertson noted that the SEC regularly receives phone calls from "angry" option writers who may have written hundreds of out-of-the-money OTM contracts on a stock shortly before another company launches a tender offer for it.

Insider and Liquidity Trading in Stock and Options Markets on JSTOR

They added that several important insider-trading cases have commenced with such a call from an irate trader. This tendency to leverage up the inside information as much as possible is another vulnerability that makes it easier to detect insider trading. Sources such as other SEC Divisions, self-regulatory organizations, and the media: Insider trading leads may also come from other SEC units such as the Division of Trading and Markets, as well as self-regulatory organizations like the Financial Industry Regulatory Authority FINRA.

Media reports are another source of leads for potential violations of securities laws. What does the SEC do next? Insider Trading Examples While the s was the decade of massive insider trading scandals by the likes of Ivan Boesky , Dennis Levine, and Michael Milken , two of the biggest insider trading cases in this Millennium include: The SEC alleged that insider trading was widespread at SAC Capital, and involved stocks of more than 20 public companies from to As many as eight traders or analysts who worked for SAC have either been convicted or have pleaded guilty to charges of insider trading.

This includes Matthew Martoma, a portfolio manager who worked for an affiliate of SAC. Martoma was sentenced to nine years in prison after a federal jury found him guilty of trading on material, nonpublic information concerning an Alzheimer's drug that was being developed by Elan Corporation and Wyeth.

Raj Rajaratnam and the Galleon Group — In , billionaire hedge fund manager Rajaratnam was sentenced to 11 years in prison for insider trading, the longest jail term imposed in such a case. The SEC alleged that Rajaratnam orchestrated a wide-ranging insider trading ring of 29 individuals and entities that included hedge fund advisers, corporate insiders which included former McKinsey CEO and Goldman Sachs board member Rajat Gupta and Anil Kumar, a McKinsey director , and other Wall Street professionals.

Some insider trading is actually legal - and can be extremely telling for investors. While often associated with illegal activity, insider trading actually encompasses both illegal and legal trading of securities. Insider trading can undermine the markets and damage reputations, so companies and regulators alike have instituted policies and actions to prevent it. Insider buying can be a sign that a company's stock prices will soon rise.

Here's how to keep track of insider buying on public databases and websites.

insider trading in options markets

Find out why the trading activity of owners and executives can be a valuable trade-confirmation tool. Insider tracking can inform your investment strategy, but it requires research and a level head. Find out what to look for.

The SEC's triple mandate of investor protection, maintenance of orderly markets and facilitation of capital formation makes it a vital player in capital markets. The three large penalties for insider trading in the United States have been handed down in recent years, leading to civil and criminal charges for the culprits. Insider trading can come in many forms, some of them even legal, with the benefits and costs often debated by practitioners and academics alike.

Check out these bizarre insider trading cases that helped define the SEC's laws against it. An "insider" is any person who possesses at least one of the following: Learn the definition of illegal insider trading while reviewing the people who can be involved and the regulations and consequences Learn why it's possible to commit insider trading by accident, and why insider trading laws create logical inconsistencies Learn about insider information and insider trading and the differences between the two; both involve nonpublic information Learn about some famous people who were convicted of illegal insider trading and find out about the reasons for their criminal Learn about whether writing a blog post about a stock you own is insider trading.

Cracking down on inside trading is an important An expense ratio is determined through an annual A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies.

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