Illegal Insider Trading Undermines Market

Most of us create wealth through employment, entrepreneurship or invention. Once wealth is created, we become investors because money put to work for us often can make us even more money.

Depending on individual goals and objectives, and a calculus of desired returns versus anticipated risks, this invested wealth is put into stocks, bonds, real estate, money market funds, etc. What it's generally not put into is the mattress or a jar buried in the backyard. We invest, and into those investments literally go our hopes and dreams.

Fear plays at least a small part in most of our hopes and dreams, and investments are no exception. There are many traps that steal financial success from people: get-rich-quick schemes, poor budgeting, irrational spending and divorce, to name just a few. For investors of marketable securities (stocks, bonds, mutual funds, etc.), there are systems, rules, regulations and regulators, all designed to make sure an even playing field exists for all investors.

The biggest perceived injustice for the average investor is that the stock market is rigged so those on the inside, with big money, somehow have an unfair advantage through the "good ol' boy" network. This past week has given these speculative, perhaps cynical, people much to talk about with the news that golfer Phil Mickelson and high-profile Las Vegas gambler Billy Walters might have made several million dollars trading call options of Clorox Inc. using inside information obtained from billionaire investor Carl Icahn.

Legal vs. illegal conduct

Insider trading is a term most investors associate with scandals such as the one that landed Martha Stewart in federal prison. But insider trading actually refers to both legal and illegal conduct. The legal version happens routinely when corporate insiders — executives, board members, employees — buy and sell stock in their own company. These trades are required to be reported to the Securities and Exchange Commission.

Illegal insider trading occurs when someone buys or sells a security based on knowledge that he or she has of the company that is material but isn't publicly known. When anyone has information that can impact the price of a company's stock, positively or negatively, and the information is not publicly available, they are an insider. If they take action by either buying or selling the stock based upon this information, they can be found guilty of illegal insider trading.

Possessing information that isn't available to everyone else trading on the market gives that person an unfair advantage. For investors to have confidence in the markets — and, therefore, for markets to work — there must be a level playing field.

With a tournament on the line, a professional golfer would protest a competitor's bogus mark or illegal ball drop. With perhaps millions of dollars on the line, a professional sports gambler would resent an athlete intentionally throwing a playoff game. No one likes a cheater — and that is precisely why insider trading is such an anathema to investors. The average investor can take some comfort in the knowledge that the regulators are policing the investment world in order to provide a level playing field for all investors.

Phoebe Venable, chartered financial analyst, is president and chief operating officer of CapWealth Advisors LLC. Her column on women, families and building wealth appears each Saturday in The Tennessean.