for trust and refers to someone who is charged with the responsibility to act in the best interest of the other
party. In the case of businesses, fiduciaries are expected to act in the best interests of their investors.
However, they are often aware of information that the public is not. This knowledge has important
implications as addressed by Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, which
prohibits the purchase or sale of securities on the basis of "material nonpublic information,"; meaning
information of any kind that would impact the market price of securities that has not been disclosed to the
public, i.e., insider information. The directors, large shareholders, and officers of companies frequently have
access to nonpublic information that could affect the future value of a security. While an individual, as
opposed to an entire company, is often charged as an insider trader, such charges can affect the entire
company’s reputation, putting it in a negative light and eroding investor trust.
One instance of insider trading that received widespread media attention involved Martha Stewart, who in
2003 became the subject of legal scrutiny after selling her shares in the pharmaceutical company ImClone.
Following the advice of her broker, David Bacanovic, Stewart sold all of her shares of ImClone before it lost 16
percent of its value. Bacanovic represented ImClone CEO Sam Waksal, who was selling $5 million of his
ImClone shares. While Bacanovic claimed he did not know why, he shared this information with Stewart. As it
turned out, the FDA had not approved ImClone’s primary pharmaceutical product, Erbitux, which was a
setback that only insiders were privy to. Stewart avoided a $45,673 loss by selling her shares before the public
announcement. Even though Stewart may not have known exactly why ImClone would go down in value, the
court decided that her decision to act upon her broker’s suggestion constituted a wrongdoing. Stewart’s role
as a public figure was also relevant to this decision, as explained by SEC’s Director of Enforcement Stephen M.
Cutler, who said, “It is fundamentally unfair for someone to have an edge on the market just because she has
a stockbroker who is willing to break the rules and give her an illegal tip. It’s worse still when the individual
engaging in the insider trading is the Chairman and CEO of a public company.”
Figure 14.2
Insider trading can result in criminal conviction and possibly jail time. (Credit: Suzy Hazelwood/
pexels/ License: CC0)
Insider trading is not always illegal. In certain instances, individuals in possession of insider knowledge can
disclose their trading activity to the SEC. However, disclosure alone is not enough to make trading on the basis
of insider information legally acceptable. Another instance in which the officers of publicly held companies can
152
Chapter 14 Securities Regulation
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