Question

Investigate a problem of negative social impact and using information/various concepts covered in the Business Communication course, write a formal report outlining the existing problem, make reference to current literature, and present a discussion on findings and proffer appropriate conclusions and recommendations

Answer 1

Negative Social Impact of Insider Trading

Insider trading is the practice of buying or selling securities of the company for personal gain, based on the non-public information about the company. Insider trading is considered illegal practice and any employee or shareholder getting involved in insider trading or tipping insider information will be convicted.

Social Impact of Insider Trading on the overall market:

• Insider trading has negative consequence on all types of investors, thus reducing the flow of funds and investments in the market
• Trust and relationship of the investor gets severely impacted by such incidents
• Risk of stock market crash increases considerably
• Fiduciary duty of stock companies get compromised
• May lead to unemployment and recession

Let’s understand the negative impact of insider trading with an example:

Enron Corp. was considered as America’s most innovative company since its integration in 1985. Enron was placed as the energy trader and supplier. At that time, there was deregulation in the energy market, which gave permission to the companies to bet on the future prices. Enron took advantage of this opportunity. This regulatory industry environment helped Enron to flourish.

With the commencement of dot-com bubble in 1990s, Enron also decided to participate in the market trend. Enron created Enron online i.e. EOL in 1999. This was an electronic trading website which had its focus on commodities. The conditional transactions through EOL had Enron, either as the buyer or the seller. Enron used to give credit to the participating companies to encourage trading. It was considered as America’s most innovative company for 6 years.

When recession hit USA in 2000, Enron resorted to mark-to market accounting., which helped the company to write off unprofitable activities without affecting the bottom line of the company. This led to introduction of pseudo schemes which hid the company’s losses and made company look profitable in the market. So, though the company was making losses, people were investing in it owing to the profitable mask dawned by the company in the market.

This was a clear case of fraud. The investors and the market was bluffed to consider that Enron Corp. was a very profitable company while in reality, it was struggling for mere existence.

Several of Enron’s executives were roped in for the fraud. The fraudulent activities included insider trading, conspiracy and securities fraud. The employees were charged personally as they had committed insider trading to facilitate their personal interests over the interests of the company. They had been falsely representing data to make personal profits. Enron’s founder was also convicted. He was convicted for 24-year sentence along with a hefty money penalty. The impact of the fraud led to Enron’s downfall. Shareholders and employees, all were in losses. There was panic situation in trading market as a whole.

Enron’s culture did not propagate a system of transparency in the business processes. The toxic culture of the company led to the downfall of the company. There was no open relationship between the employees and top management. The top management was never ready to answer any doubts of the employees and they never shared the thought process behind any decision taken for the company. The trust factor between the employees and management was nil. This toxicity ultimately got reflected in the overall downfall of the company.

So, we can conclude that negative impact of insider trading is quite worse and may sicken a healthy company. There are various laws passed by Governments to keep a check on insider trading, the SOX Act being one of them.

The Sarbanes-Oxley (SOX) Act was passed in the year 2002 after the Enron scandal, to protect shareholders against any type of accounting fraud. It requires the companies to have stringent audit policies and strict adherence to the audit schedule. Also it makes any director liable for maintaining accuracy in the financial statements of the company. The SOX Act helps in keeping such conflicting interests in check and give priority to the overall interest of the involved shareholders.

Following are the major impact that the Sarbanes-Oxley Act had on the corporate governance of a company:

• This act empowered the board of directors to hold accountability for the financial statements of the company.
• Corporate code of ethics got imbibed in the culture of the company with the introduction of this act.
• This act laid the importance of having a knowledgeable in house counsel in the company to monitor the legal adherence in all business processes.
• Shareholder activism got encouraged by introduction of this act.