By: R.M.B Senanayake
So Nimal Perera who combines both financial and political power has said that there is nothing wrong with insider trading in our market and that insider trading is inevitable in a market like Sri Lanka and that regulators should not apply rules pertaining to insider dealing to the letter.
Here is a new theory. Insider trading is prohibited and is a criminal offense in many countries. The rationale for the prohibition is to ensure fairness to the individual investor by preventing insiders who have privileged access to price sensitive information about the financial results of a company, from profiting by such information. If they trade before such price sensitive information is available to the public then such insiders can make a tidy profit or prevent a loss if the price sensitive information is adverse. The insider could buy or sell the share with such information before the market responds to it and thereby make a profit or prevent a loss. When the price sensitive information is known to the public through the press or an official communication, the market price of the share responds by moving up or down according to whether the information is positive or negative.
In most countries, trading by corporate insiders such as officers, key employees, directors, and large shareholders may be legal, if this trading is done in a way that does not take advantage of non-public information. Even if a company insider tells a member of the public such information and that person trades on such information he is guilty of the same offense as a tipster. The Rules are strict and Raj Rajaratnam was convicted of the offense in USA. Many of our corporate big names would be in jail for insider trading if they did there what they do here.
But there is an equally serious violation which is called front running and is practiced by employees in Stock Brokerage firms. When a broker is given an order to buy or sell a large volume of shares he knows that he cannot execute such order without an impact on the price of the particular share. If it is a buy order then as the order is executed by buying in small quantities or arranging a trade for the whole quantity with another brokerage house, the price must be above the current market price. The rise in price is called the impact cost. Similarly when there is a large order to sell, the market price comes down at least until the large order is executed. The more illiquid the share the larger is the impact cost of such share. The employees in brokerage houses can benefit from this situation if they buy or sell before executing the clients order. The employee can turn in a handsome profit since he is basically engaged in arbitrage. Once he buys or sells, the employee will give his friends in the brokerage trade the same information and then the price movement becomes a self fulfilling prophecy. This practice of front running is prohibited and employees who resort to it are punished and made to disgorge their unjust profits.
The Colombo Stock Exchange and the SEC are expected to enforce these rules to ensure a clean market which will be fair to all. (Courtesy News360.lk)
(The writer is an economist and is the General Manager of a Colombo based
stock brokering firm.
You can reach him via raja.
senanayake712@gmail.com)[b]
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