Illegal insider trading is the buying or selling of a security by insiders who possess material that
is still not public. The act puts insiders in breach of their fiduciary duty. As you can imagine, this
is a definite faux pas for anyone closely involved with a company.
A common misconception is that only directors and upper management can be convicted of
insider trading. Anybody who has material and non-public information can commit such an act.
This means that nearly anybody - including brokers, family, friends and employees - can be
considered an insider.
The Securities and Exchange Commission of Pakistan (SECP) is extremely strict with those who
trade unfairly and thereby undermine investor confidence and the integrity of the financial
markets. Securities and Exchange Ordinance and Rules states in its section 15 A about illegal
insider trading as follows:
Prohibition:
A person shall not deal (directly or indirectly) or cause any person to deal in listed securities,
who has been listed with the company if he has inside information.
Insider Information:
b) Would, if it were so available, be likely to materially affect the price of those securities;
or
Where a person contravenes the provisions of section 15A, the authority may, by a notice in
writing, ask such person to show cause for compensating any person who has suffered loss for
such contravention and initiating prosecution against him.
Withdraw of Notice:
SECP may withdraw the notice if a person to whom the notice has been issued satisfy the
authority that:
a) any dealing on stock exchange or communication of any information was not made with
the intent of making any profit or causing a loss to any person or company; or
b) the dealing on stock exchange or any information was communicated in good faith in
discharge of his legal responsibilities.
Compensation:
If SECP is not satisfied of explanation, it may direct him to pay compensation not less than the
loss sustained. If amount of loss cannot be determined, compensation shall be equal to the gain
accrued or loss avoided.
The Securities and Exchange Commission of Pakistan (SECP) has proposed penalty on persons
indulged in insider trading that is fine of Rs 10 million. In addition to compensation payable the
person in contravention shall be liable to imprisonment up to 3 years and fine up to 3 times of
compensation amount or both. If such person is an executive officer, director, auditor, advisor,
consultant of a listed company, he will be removed from such office by an order of the
Commission and debarred from auditing any listed company for a period of up to three years or
if such person is registered as a broker or agent, be liable to cancellation of registration. Where
an insider person discloses inside information to any other person who is not required to possess
such information for any reason, the insider person shall be liable to fine, to be imposed by the
Commission, which may extend to Rs 30 million.
Recovery Method:
Any compensation payable under this section shall be recoverable as arrear of land revenue.
There is an important thing to emphasize here: insiders don't always have their hands tied. Legal
trades by insiders are common, as employees of publicly-traded corporations often have stock or
stock options.Insiders legally buy and sell stock in their own company all of the time; their
trading is restricted and illegal only at certain times and under certain conditions.
In SECP there is no such section regarding the legal insider trading but in SEC legal trading is
recognized and they have certain laws for it. The SEC considers insiders to be company
directors, officials or any individual with a stake of 10% or more in the company. Insiders are
required to report their insider transactions within two business days of the date the transaction
occurred (before the 2002 Sarbanes-Oxley Act it used to be the tenth day of the following
month). For example, if an insider sold 10,000 shares on Monday June 12th, he or she would
have to report this change by Wednesday June 14th. Changes in insider holdings are sent to the
SEC electronically as a Form 4, which details a company's insider trades or loans. A Form 14a,
also filed by the company, lists all the directors and officers along with the share interest they
have.
This kind of information is extremely valuable to individual investors. For example, if insiders
are buying shares in their own companies, they usually know something that normal investors do
not. They might buy because they see great potential, a merger, and acquisition or simply
because they think their stock is undervalued. One of the greatest investors of all time, Peter
Lynch, was noted as saying that "insiders might sell their shares for any number of reasons, but
they buy them for only one: they think the price will rise". Insiders are prevented from buying
and selling their company stock within a six-month period: therefore, insiders buy stock when
they feel the company will perform well over the long-term.
Research:
Nejat Seyhun, a renowned professor and researcher in the field of insider trading at the
University of Michigan found that when executives bought shares in their own companies, the
stock tended to outperform the total market by 8.9% over the next 12 months. Conversely when
they sold shares, the stock underperformed the market by 5.4%.
Global Prospective:
The US and the UK vary in the way the law is interpreted and applied with regard to insider
trading.