Many terms in the trading world describe illegal actions, activities, and practices, including insider trading.
It often happens in the capital market; insider trading is a fraudulent practice by criminals to make a profit.
The importance of understanding insider trading practices in the capital and crypto markets
Therefore, it is important for anyone, especially traders and investors in the capital and crypto markets, to understand this insider trading practice.
This will enable the realization of a more trusted capital and crypto market for players in this industry.
So, to better understand the meaning, examples, and how to prevent insider trading, see the following review.
What is Insider Trading?
Definition of insider trading is an illegal practice carried out by a person or group of investors who have accurate information relating to profit opportunities in buying and selling transactions (trading) in the capital market.
Insiders of the company will trade the non-public information to outsiders to make quick profits.
Please note trading activities carried out by utilizing information from insiders are illegal practices in various countries.
The basic concept of insider trading is that there is internal and material information from the company used by perpetrators of this financial crime for personal gain.
Therefore, this practice is a form of ethical violation and can undermine the integrity of the financial market.
Understanding the difference between legal and illegal insider trading is also important. The difference depends on the rules and regulations in each country’s jurisdiction.
Legal insider trading will carry out trading activities according to public information and in which there is no misuse of confidential information.
Meanwhile, illegal insider trading usually uses confidential information and gains illegitimate advantages. In addition, this practice would certainly be included in the law’s violation category.
Insider Trading Elements
After knowing the definition, knowing the elements of insider trading is also important.
This understanding is important because it will help identify unlawful acts and maintain the integrity of financial markets.
These elements have been included in Law No. 8 of 1995 Article 95.
The following is an explanation of the elements involved in insider trading, namely:
1. Confidential Information
Confidential information referred to here is material internal facts that will affect the price of securities, shares, and others in the capital market.
In this case, insider trading actors will sell confidential information for quick personal gains.
Insiders are parties who have direct or indirect access to confidential information.
They could be employees, managers, directors, or parties related to the company.
3. Share Transactions
Another element is the stock transaction. In this case, the insider will buy or sell shares after referring to the confidential information.
Thus, insiders can also reap large profits and avoid losses after utilizing this confidential information.
4. Personal Gain
Personal gain is also another element of insider trading practices. This was also the goal of the crime.
Insider trading actors made illegal profits using the company’s internal confidential information.
5. Violation of the Law
As mentioned earlier, insider trading is a form of violation of the law in several countries.
This law violation occurred when an insider took advantage of confidential information in his pocket to transact stocks and gain personal gain.
Examples of Insider Trading Cases in the Capital Market
After understanding the elements of insider trading, now is the time to find out what cases have occurred in the capital market.
Several examples of insider trading cases in the capital market are very important to understand because they provide a clear picture of how this practice can take place and its impact on financial markets.
This is also important so that financial market industry players can increase their understanding of the risks and losses caused by this illegal practice.
Below are some examples of insider trading cases in the capital market that need to be known, including:
1. Martha Stewart
Insider trading cases involving well-known figures, one of which is the Martha Stewart case.
A popular American businessman and television personality was involved in an insider trading scandal in 2001.
This case is related to the shares of ImClone Systems, a biotechnology company. At that time, ImClone Systems submitted an application for the approval of a very important drug inspection.
However, the FDA rejected the ImClone Systems application as the United States Food and Drug Administration.
In this case, Martha Stewart is said to have sold all of her ImClone Systems shares after receiving information from her stock broker that the owner of ImClone Systems was selling shares of this company before an official announcement.
With her insider trading practice, Martha Stewart also obtained large profits, which were considered unreasonable, so she was accused of having previously obtained confidential information.
In 2004, he was indicted and found guilty, so he had to serve five months in prison and others.
2. Raj Rajaratnam
Meanwhile, there was also the biggest insider trading case involving Rajaratnam in history.
The man, a hedge fund manager and founder of Galleon Group, started his case in 2009.
This happened after he was arrested by law enforcement authorities and charged with insider trading.
The modus operandi is to take advantage of confidential information obtained from several internal sources within the company and its network of contacts.
Interestingly, Raj Rajaratnam used a systematic and extensive insider trading strategy and formed his insider network.
This network includes company executives to business partners who will provide confidential information about companies that will change drastically or regarding important announcements.
Through this information, he also traded stocks unfairly, then personally won big profits.
The disclosure of the Raj Rajaratnam case even involved the supervision of the United States Capital Market and Law Enforcement Agency (SEC) and the Federal Bureau of Investigation (FBI).
Finally, Raj Rajaratnam was found guilty of 14 charges of insider trading in 2011 and was jailed for 11 years, in addition to having to pay fines and demands for compensation.
Insider Trading in the Crypto Market
In the crypto market, insider trading is a transaction activity in a crypto asset using confidential information to gain big profits.
However, as happened in the capital market earlier, insider trading profits in the crypto market are also unfair because insider actors already know more than retail and other parties.
Therefore, this action is a crime because the practice is illegal, harmful, and rejects healthy trading ethics.
As for the crypto market, insider trading is likely the same as the traditional capital market, although there are still several differences.
This illegal activity can also occur due to open access to confidential information affecting asset prices.
Additionally, insider trading actors often exploit weak regulations and high price volatility to reap unfair personal gains.
One example of insider trading in the crypto industry involves Nathaniel “Nate” Chastain.
The former OpenSea employee is reportedly on trial soon regarding allegations of insider trading practices on non-fungible token assets (NFT).
This case started in September 2021 when Chastain was still working on the well-known NFT platform, OpenSea.
At that time, Chastain was responsible for selecting the NFT collection on the OpenSea home page.
However, after the collection appears (listing) on the NFT marketplace site, the price of the NFT collection will increase.
In this regard, many parties and communities accuse Chastain of causing this.
The mode of accusation is that Chastain will buy the NFT before it is published, then he will make sales through a secret wallet.
On the charge of carrying out the practice of insider trading, if proven guilty, Chastain could have been jailed for 20 years in prison.
Why is Insider Trading Harmful?
Insider trading is a very detrimental practice because there is injustice in this activity.
Therefore, it is important to understand why insider trading is detrimental because it will provide insight into the negative impact it can have.
This understanding is also important to increase compliance with market rules and regulations to prevent insider trading practices.
Insider trading will hurt the integrity and trust of the capital market.
The reason is these criminal acts can reduce—even eliminate—investor confidence and reduce capital market liquidity.
Companies and the industry will even feel the impact due to a drop in reputation.
Besides that, Insider trading can also cause huge losses to investors and the market.
Against investors, this practice will create large financial losses, triggering the fading of investor confidence and can lead to market instability in the long term.
Penalties for Insider Trading Practices
In addition to the harm it causes, it is also important to understand the penalties for this practice of insider trading.
The reason is it will be able to provide an understanding of the serious legal consequences for insider trading actors.
In the end, this will also strengthen the importance of complying with the rules and regulations that have been set regarding transparent and ethical buying and selling transactions.
It should be noted that insider trading actors can face serious criminal and administrative sanctions as a consequence of their criminal actions.
Criminal sanctions that will be imposed usually include imprisonment (prison) according to the level of violation and applicable law. Then, insider trading perpetrators will also be subject to large fines.
In addition, insider trading actors may also be required to pay compensation/restitution to the aggrieved party.
Meanwhile, insider trading actors may be disqualified for administrative sanctions, so they no longer participate in capital market activities/hold positions in registered companies.
Apart from that, there are also sanctions in the form of certain/permanent trade bans. Finally, there will be witnesses in the form of suspension/revocation of the license so that the perpetrator is no longer allowed to be involved in certain professional activities in the said industry.
Furthermore, the punishment for insider trading perpetrators can have a big impact, both personally and on the reputation of the perpetrators.
This impact not only affects insider trading actors personally but can also affect their families and the business relationships they have.
Of course, in the end, the purpose of this impact is to provide a deterrent effect and maintain the integrity of the capital market.
How to Prevent Insider Trading Practices
How to prevent insider trading practices is very important to understand as an effort to maintain the integrity of the capital market and protect the interests of investors.
Prevention of this crime also involves implementing strict rules and regulations, adequate training and education for market participants, and effective oversight by the authorities.
As for Indonesia, the crypto market is supervised by BAPPEBTI as the competent authority regarding futures and commodity trading.
It is also important that all parties in the financial market understand this to create a market full of transparency and uphold ethics and honesty.
The following are steps that can be taken to prevent insider trading practices, including:
First, it is important to provide education, both education, and training, for all parties involved in the capital market regarding insider trading practices and their consequences.
The right education will increase understanding of the rules and ethics related to insider trading so that this practice can be avoided.
2. Internal Policy
The second step is on internal policies. Companies must apply clear and strict internal policies regarding insider trading practices.
The policy must regulate the use of confidential information and other matters that can prevent insider trading.
Next is supervision, both from supervisory and regulatory authorities. These related parties must have an effective monitoring system for detecting and taking firm action against insider trading practices.
It should also be noted that one of the supervisory authorities responsible for the financial services sector is the OJK.
4. The Importance of Individual Awareness
Finally, awareness of active individuals in the capital market is important to prevent insider trading practices.
They must also be highly aware of the importance of complying with rules and ethics in trading.
In conclusion, it is very important to understand and prevent insider trading in the capital market.
The reason is, with this understanding, the integrity of the capital market can be maintained. In addition, it will also protect the interests of investors for transparency in the capital market.
Anyone must respect the principles of integrity and transparency in stock or crypto trading.
This is because these principles are important in maintaining fairness and trust in the capital market.
In the end, it is needed to create sustainable economic growth.