It came as a surprise for thousands of Americans when Martha Stewart — a household name famous for her versatile television personality and entrepreneurial prowess — was pushed into an insider trading case.

It was alleged that she had earned $0.228 million from the sale of more than 3,500 shares of a pharmaceutical company based on insider information from her stockbroker that the Food and Drug Administration had disapproved of the company’s new drug.

Although she was acquitted of insider trading, she was found guilty of other charges. The whole saga affected not only Stewart personally but also negatively impacted the American financial market.

In Pakistan, a well-known businessman who had access to insider information that the company was planning to take over another company bought its shares through a frontman (read: gardener and cook), allege media sources. Once the takeover was complete, the shares were sold at a higher price.

Insider trading is often committed by financial experts who know how to evade detection, making it hard for the SECP to track

In simple terms, he used exclusive information that was not publicly available to gain undue advantage for himself; in legalese, this amounts to insider trading. Eventually, he was penalised by the Security and Exchange Commission of Pakistan (SECP) with a fine as punishment.

Some argue insider trading should be legal as there is no easily identifiable person to whom the harm has been caused. However, this argument misses the fact that the victim can be the person not privy to the inside information, who may buy the shares the insider is trying to offload. The insider’s gain would be the loss of the trader on the other end. The market itself is a victim, as insider trading leads to a lack of investors’ confidence.

Moreover, an employee has a relationship of trust with the company, which means he has a duty to keep his interests above the interests of the company. The duty is breached when he shares the company’s information with a third party or uses it to profit himself. The idea of trust is of pivotal importance in the financial world; if individuals are allowed to violate it with impunity, the whole market may collapse.

To counter insider trading, the Securities Act 2015 — which had repealed the Security Exchange Ordinance of 1969 — widened the scope and definition of the offence. It also obligates companies to publicly disclose any information that it has shared with a third party.

The companies are also mandated to maintain a list of individuals — either employed on contract or otherwise — who may have access to inside information; the list shall be regularly revised and sent to the SECP whenever required.

The Securities Act tried to fill in the loopholes that the previous law had created, but it left some aspects uncovered that can help individuals go scot-free. It does not define the meaning of key terms, such as ‘material’, that are referred to in connection with the effect of insider information on share prices. There has been no time limit provided for the disclosure of information; in an ever-evolving digital landscape, would it suffice to share the information on the internet?

Insider trading — being a very sophisticated crime — is often committed by individuals who are well aware of the workings of the financial market and know how to cover their tracks, hence making it difficult for the SECP to track it.

In this aspect, we can take inspiration from the United States, where the Securities and Exchange Commission (SEC) vigilantly monitors market activity during times of key developments, such as the release of company reports or where there is buying or selling of shares in bulk. The SECP, operating with a limited budget, should prioritise and employ its market monitoring tools more vigorously in these times.

The SECP can also consider the establishment of a separate whistleblower officer similar to the whistleblower programme of the SEC. The latter aims to incentivise people with credible information regarding insider trading to come forward; a person reporting the crime is entitled to 10-30 per cent of the amount collected as a reward. This measure can assist the SECP a great deal in crime reporting and detection.

In a society where a large majority is financially illiterate, and there is already mistrust towards big corporations, it is even more important to take strict action against insider trading. The country’s economy is already in dire need of robust economic growth and business activity; a lack of investors’ trust because of insider trading will further aggravate our perils. It is high time that policymakers bring the anti-insider trading regime in accordance with the best international practices to restore public trust in the market.

The writers study law at the Lahore University of Management Science

Published in Dawn, The Business and Finance Weekly, November 18th, 2024