Governance and Ethics-Practitioner-Corporate Governance and the Information Content of Insider Trades.

JAGOLINZER A, LARCKER D, TAYLOR D. Corporate Governance and the Information Content of Insider Trades. Journal Of Accounting Research [serial online]. December 2011; 49(5):1249-1274. Available from: Business Source Complete, Ipswich, MA. Accessed June 18, 2012.

Insider trading is as old as share markets have been in operation (Herzel &Katz, 1987). Numerous studies on insider trading have reached different conclusions. The main argument for insider trading is that it promotes economic efficiency and enterprise, and thus should not be illegal (Seligman, 1983). On the other hand, there are those that argue that it is a breach of fiduciary duty to look after the interest of the shareholder. In fact, the SEC classifies insider trading as illegal based on “…breach of a fiduciary duty or other relationship of trust and confidence….”  The SEC supports that; insider trading will discourage the public in investing in an unfair market in which insiders have all the advantages. There have been critics against the stance taken by the SEC. First, some argue that illegal insider trading is so widely spread that the SEC can barely make a significant impact in stopping the practice, and thus not worth the efforts and resources spent. Second, insider trading has not discouraged investor interest in the stock market, even in the light of past (Michael Milken, Martha Stewart) and recent (Rajat Gupta) scandals.

Despite the arguments about insider trading, what stands as fact is that a breach of fiduciary duty by an insider, by SEC’s standards, is illegal. The penalty to violation of insider trading laws will range from criminal prosecutions, fines, to a negative public perception on the company’s reputation. Corporations listed in the U.S. stock market and under SEC’s jurisdiction, must come up with ways to prevent and avoid insider trading by its members. Companies have developed insider trade policies (ITP) to guide their members trading on company’s stock. There has also been research and publications on the methods managers and corporate executives should adopt to mitigate insider trading. Very few studies have investigated the role of the general counsel (GC) in reducing insider trading. 

Jagolinzer A. et al, examine the impact of the actions taken by the general counsel (GC) on mitigating the level of informed trade. This study represents an alternative view on insider trading as it relates to corporate governance. The role of the GC is often limited to legal advice, due diligence and making sure all members in the company uphold ethical standards. The authors investigate what happens when the GC authorized all insiders trading. That is imposing more restrictive governance on insider trading. They analyzed the ITP of several firms and the restrictive trading windows placed on insider trading. They found that trades made within the restrictive trading windows by themselves, are not effective in reducing informed trade. However, when the GC approval is required in trades inside the restrictive window, informed trade is reduced.

The article by Jagolinzer A. et al adds to contributions already made in mitigating insider trading. Firms could see an improvement in mitigating insider trading by incorporating recommendations by the authors to their ITPs’. Just as in preceding articles on insider trading, their findings leave unanswered the solution to insider trading. In fact, a majority of recent and past insider trading involves “tipping”-members of a corporation giving insider information to outside members to act upon and benefit from this superior information- which is not investigated by the authors.

While the debate on insider trading goes on and scholars analyze whether it is necessary or not to make insider trading illegal, it is time to look at alternative solutions. We recognize insider trading is here to stay. Governments can’t legislate information amongst individuals. It is already very difficult to regulate the different sources of the media.  Maybe the solution to insider trading could be on taxes. Taxing the basis and the proceeds from trades of a certain significant threshold, made just before a company makes a critical decision public, by 95% will dissuade insiders from acting on inside information. A solution like this definitely seems outrageous to some but we should all recognize there is no easy remedy to insider trading.