Insider trading without trading
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Before a person can be prosecuted and convicted for insider trading, he must first execute the overt act of trading. If no sale of security is consummated, no crime is also consummated. However, through a complex and insidious combination of various financial instruments, one can capture the same amount of gains from insider trading without undertaking an actual trade. Since the crime of insider trading involves buying or selling a security, a more sophisticated insider can circumvent the language of the Securities Regulation Code by replicating the economic equivalent of a sale without consummating a sale as defined by law. Through the use of financial derivatives in the form of options, swaps, and forwards, an insider who is not a shareholder in a company can obtain economic exposure to changes in the market value or price of shares of stock, without purchasing or obtaining ownership of the shares. The actual stockholder or dealer of security transfers his economic exposure to the insider, but retains all stockholder rights. The insider obtains returns associated with the share of stock by assuming the financial risks inherent in stock ownership, while the person holding the shares of stock is insulated from such risks. This paper demonstrates how constructive trades circumvent the insider trading law by allowing an insider to obtain economic exposure over a share of stock without obtaining or divesting his title over the stock.
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