Insider Trading and Martha Stewart Case Study
Insider trading is an illegal and unethical conduct which occurs when an insider accesses information which is not yet released to the public and acts on it in the stock market. This case study looks at the event related to Martha Stewart linked to insider trading where she was found guilty of lying to investigators and four accounts of hindering justice. The paper then illustrates the impact of insider trading and gives recommendation on how to avoid the unlawful act.
Factors contributing to ethical fail
Martha Stewart is the creator and previous CEO of Martha Stewart Living Omnimedia Inc. a business with interest in television, publishing and electronic commerce among others. The entrepreneur was involved in the ImClone System scandal where she was accused of insider trading. ImClone System is a biopharmaceutical company in which Martha Stewart owned shares. In 2001, Stewart traded all her shares of the biotech company and two days later, the prices of the shares fell by 16% after the company publicly announced that FDA did not approve its primary pharmaceutical product Erbitux (Hunter, 2015). Stewart sold 4,000 stocks of the company on December 27 and a similar situation occurred involving the company's vice president of marketing and other four executives who sold their shares before the information became public.
Investigations and the role of Martha Stewart
Investigations showed that after the company's executives learned that FDA would not review Erbitux, CEO Sam Waksal asked his broker Peter Bacanovic who was also Stewart's broker to handover Waksal's shares to his daughter's account. Waksal's daughter requested Bacanovic to sell her shares of $2.5 million (Hunter, 2015). Later on, Waksal tried to sell his remaining shares of the company but was blocked. According to phone records revealed by the authority, shortly after Waksal's daughter had dumped her shares, Bacanovic called Martha Stewart's office and ten minutes later, her shares were sold. Waksal was detained on charges of insider trading but denied the claims for years. Later on, he pleaded guilty and was sentenced to seven years after which he was released after serving for five years. Martha Stewart denied her involvement on insider trading. By selling her shares a day before they drastically fell, Stewart avoided a loss of $45,673 (Hunter, 2015). The coincidences of the occurrences and the close relationship between Stewart and Waksal led to Stewart's actions being termed as insider trading with the belief that she received insider information from Waksal through their common broker Bacanovic.
Impact of the ethical/legal fail on stakeholders
The effect of insider trading is harmful to employees, consumers, and shareholders as well as the organization. The act ensures there is no fair play involved and hence no unbiased demand and supply of shares which is unfavorable to healthy operation of capital market. The actions weaken the trust of investors in the stock market system and it prevents people from investing in capital markets which has the potential to harm the economy at large. Insider trading negatively affects the organization because if its executives are found guilty, they may be sentenced hence the company loses its top management team. Moreover, insider trading creates negative press which tarnishes the reputation of the company and makes its consumers, suppliers, investors and the market at large fail to trust it thus negatively affecting its business operation. Such a business faces difficulty in accessing funds in the capital markets due to reduced investor confidence. The employees are also negatively affected because their morale is reduced and with decline in sales, their job security is not guaranteed. Overall, insider trading has detrimental impacts on all the stakeholders of a corporation.
What happened to the Culprit?
Martha Stewart was the culprit in this case. Stewart was accused on insider trading charges which she denied claiming that she only sold her Imclone's shares because the share prices fell below $60 per share an order she had given her brokerage firm under stop-loss principle (Strader, 2014). Investigation to the case accessed Stewart's phone and email records which did not offer proof that Stewart gave the stop-loss initiative. Stewart declined from taking the stand to give her testimony under oath and both her and her spokespeople did not comment about the issue. SEC filed fraud charges against Stewart for her supposed part in insider trading and public declaration about the stop loss order. During the case hearing, Stewart's friend Pasternak revealed that Stewart claimed how good it was to have good brokers like Bacanovic who alert investors when shares are about to drastically fall. Stewart was found by the adjudicators to be guilty on four different instances of hindering justice and dishonest to investigators. On June 17, 2004, she was jailed for five months and two years of supervised release and a penalty of $30,000 (Strader, 2014). In addition to losing her freedom, Stewart's involvement in the scandal caused the share prices of Omnimedia to fall by 70% and almost a quarter of her net worth was drained (Strader, 2014). Stewart has held the innocent plea and although she went to jail early and served her sentence she did not address the public regarding the scandal. After her release, Stewart made her comeback through different ventures, her brand equity fell, although it started rising after her release. As for the other culprits in the case, the CEO was sentenced to seven years where he served five years and has admitted to being guilty.
Measures to rectify the situation
Insider trading despite being an illegal and unethical issue has become common. In addition to the Martha Stewart case, there have been other situations such as the Rajat Gupta of Goldman Sachs Group Inc. (Davidowitz, 2014). Insider trading is bad for all stakeholders especially to the company because it loses investors' confidence. For SEC and corporations to avoid the occurrence of insider trading, several additional measures are required. First, there needs to be a clear definition of insider and insider information. For instance, in the case of Martha Stewart, the fact that she did not work in ImClone and did not receive information directly from the company's executives helped her evade the accusation of insider trading crime although it is evident she acted upon insider information. Additionally, the rules should identify blackout phases when insiders are not permitted to trade stock. Companies should necessitate their top officers to inform the chief financial officer or legal departments before trading stocks. Additionally, they should have automatic share schemes for top executives which will only allow them to trade their stocks as per a pre-arranged schedule. The notion of these measures is to remove the preference to trade from the insider so that the trading decision does not rely on the insider or any incidence in the organization. Corporations also need to observe their third parties such as advisers and consultants. In the case of Martha Stewart, the broker Bacanovic's actions should have been monitored and restricted. Companies must also review analysts' reports for possible information leak. It is crucial for corporations to take their own steps in restricting insider trading because they suffer the most. Moreover, having an insider trading policy is not costly and the benefits are likely to be more than the expenses.
Theories of ethics
Utilitarian approach to moral decision making holds that every action and policy should be assessed on the base of the benefits and costs it imposes on the society (Mill, 2016). Individuals should, therefore, look at the different options and evaluate the costs and benefits of each before making a judgment. The selected alternative should offer a mutual and suitable norm for the society. Based on utilitarianism, it is, therefore, unethical to act on insider information or to conduct the act of insider trading because while it benefits one individual, it negatively affects all the other parties. Hence, when confronted with a situation similar to that of ImClone, CEOs and other executives should choose not to trade their shares because this way, they do not harm society.
Moreover, according to Kant's categorical imperative, the intention towards a course of action is more important than results (Aune, 2014). Kant explains that there are some widespread guidelines for goodness, fairness, and justice of the people and they are definite. Kant therefore, elucidates that in determining ethical conduct, human beings should reason out to create a consistent set of moral guidelines which cannot be superseded. Applying these two ethical principles will help business executives to avoid conduct of insider trading because the ethical principles will guide them on how to make the right decisions when confronted by an ethical issue.
Conclusion
Insider trading has detrimental impacts on all parties. While the management who perform the act are sentenced to jail and other fined, the reputation of the company is tarnished and investors shy from investing in capital market. Although SEC has executed some rules on the subject, corporations must execute some matters on their own such as monitoring their external parties and asking their executives to report to legal departments before selling their shares.
References
Aune, B. (2014). Kant's theory of morals (Vol. 264). Princeton University Press.
Davidowitz, A. S. (2014). Abandoning the Mosaic Theory: Why the Mosaic Theory of Securities
Analysis Constitutes Illegal Insider Trading and What to Do about It. Wash. UJL " Pol'y, 46, 281.
Hunter, B. (2015). White-Collar Offenders and Desistance from Crime: Future selves and the
constancy of change. Routledge.
Mill, J. S. (2016). Utilitarianism. In Seven Masterpieces of Philosophy (pp. 337-383). Routledge.
Strader, J. K. (2014). (Re) Conceptualizing Insider Trading: United States v. Newman and the
Intent to Defraud. Brook. L. Rev., 80, 1419.
