Theoretically, Eugene Fama whos the one had developed overall concept of Efficient Market Hypothesis or EMH. Efficient Market Hypothesis shows on how the securities prices has been reflect by all known information about the future values. In other words, an efficient capital market is the one in which stock prices are fully reflects with available information in markets. In the long run, stock market prices had already being reflected by the consensus of beliefs of the investors towards particular securities and its future performance. There are three different forms of EMH which are Weak-form Efficiency, Semi-strong Form Efficiency, and Strong Form Efficiency. Weak form efficiency shows that investors can only predict the future stock prices by using historical prices or by using the past data such as annual report of the respective company. On the other hand, Semi-strong efficient market shows that future prices can be reflected by the past data and also the current data such as news announced in the media. In this form, everybody has same access to the news and information in securities markets. Therefore, fundamental analysis cannot be used in analyzing the value of the stocks. While in Strong form of efficient market, price can be reflected by all known information and no one can earn excess return. Thus it indicates issues on trading of corporate inside information whether it is legal or not.
Generally, insider trading has viewed as an activity by which those with access to non public information who seek for a profit from this 'inside' information (Dowie 1976). Insider trading also defined as trading by corporation officers with decision making authority and with fiduciary obligations to the shareholders. However, not all trading by insiders is illegal. This is depends on the information driven because of access of material information. Material information is defined as private information which investors could be utilized to enhance a personal wealth by trading the firm's security ahead of the release of corporate events such as merger announcements or an earnings surprise. In developed countries such as United States, trading on inside information is illegal and subject to punishment. Most of people also views trading on insider information as unethical because it is unfair to other investors and will give a bad reputation in future.
According to McGee (1988), insider trading acts as a method of disseminating information that makes the stock market more efficient. In other words, when insiders buy or sell shares it provides information to other market participants to buy or sell as well, and in the process the market moves towards fundamental values. In addition, according to Holden and Subrahmanyam (1992), all insiders received the same information and reveal it almost immediately as the market does. Therefore, the market becomes strong form efficiency for a reason that each insider tries to exploit their information before others do.
Under efficient market hypotheses, all share's traders have same expectation. Therefore, all new information is fully impounded in the share prices and no abnormal returns can be made. In theory, insider trading can only do their "business" in strong form of efficient market hypotheses. However, this is not being allowed in Malaysia. Moreover, the integrity of market efficiency has been damaged by insiders. Enforcement of insider trading laws has been emphasizing thoroughly and insider trading also has been blamed for introducing noise into financial market. By implementing laws and regulations for trading on inside information, it enables any market participants to be at par with the informed traders such as reduction in information asymmetry and reduction in abnormal returns.
There is hot news gathered from Accountancy Magazine (2010) states regarding issue on the "Former E&Y Partner Jailed for Insider Trading". In this case, Securities and Exchange Commission (SEC) had brought this case to the New York district court which against James Gansman. He is one of the partners in E&Y's transaction advisory services group in US firm. He was charged with tipping off Donna Murdoch, who was a stockbroker and their relationship can be described as "close relationship". The tip was about identifying of at least seven different acquisition targets of E&Y valuation client's services (Accountancy Magazine, 2010). From the tip given by Gansman, Murdoch had done a trading in the securities and also tipped off her father on the acquisitions of the securities. Besides that, she also had recommended of two other people on the trading in two of the acquisition targets. Hence, it can be conclude that, there are three people had do the securities trading based on Gansman's inside information and Murdoch's communication which had violating the securities laws. Finally, both Gansman and Murdoch have been given a fair judgement from the court. From the case, we can see that trading on inside information is an illegal in New York as one of the developed country.
LITERATURE REVIEWS
According to Dr Ameer R and Dr Othman R (2008), they claimed that corporate insiders of the industrial sector are most active in share market regards of purchases and sales. Besides industrial sectors, insiders in other sectors such as trading, property and construction are known as net sellers while insiders in plantation and technology sectors are net buyers. Moreover, the authors found that economic factors such as inflation, commodity prices and increasing in oil have give effect to insider's trading in Malaysia. Objective of the study is to examine the impact of year-end financial results on the directors' purchases and sales of their own firms' shares. Authors found that directors frequently involved in purchasing or selling their own firms' shares before and after the reporting of full year financial results. Besides that, authors argued that the timeliness of the information regarding insider trading given by Bursa Malaysia have material value to potential investors. In other word, lack of efficiency transparency in Malaysia capital market will affect investors by having loss due to delay in the information disclosure by Bursa Malaysia. For example, information regarding changes in director's shareholding due to acquisition or disposals of shares in the company should be announced by Bursa Malaysia within a mandatory time period of 14 days, so that all market participants experience less or no information asymmetry. Otherwise, investors will having a loss due to delay in disseminate of information. Furthermore, in that time insider traders can play a role in order to have a personal gain on the respective securities.
There are many studies and research has been done on the involvement of insider trading in the efficient market, whether it is legal or vice versa. Abdulmohammadi A and Sultan J (2002) suggested that there is a positive relationship between ethical reasoning and ethical behaviour. Current research indicates that ethical problems exist in personal investing. For example, a study reported that managers had traded type of the stocks of their own company after voluntary disclosures when doing so resulted in more favourable stock prices for them (Noe, 1999). In this study, researcher had identified an ethical behaviour as the dependent variable. It was being measured by using a binary scale, whether the subjects used insider information for trading of stock or not. In addition, the objective of this study is to investigate the ethical behaviour of the potential investors which are used insider information or not when they involve in personal stock trading in a simulated competitive stock trading market. Specifically, they were investigate whether an ethical reasoning has any effect on choosing to use insider information, which is illegal and unethical, or not to use insider information, which is legal and ethical for personal stock trading. Results from this study states that the day traders who risk their own money in a real market portfolio may be even more subject to lapses in ethical behaviour. This is because; insider information shows a real chance for having a financial gain in market place. Therefore, it is indicate that people with higher levels of ethical reasoning are less likely to use insider information in stock's trading. This findings lead to an importance of ethical training to the in stock's trading such as professional stockbrokers who have a potential for unethical lapses in investigating. Therefore, by ensuring that all day traders have high levels of ethical reasoning, it will provide fair and efficient market for the investors.
Generally, insider trading has classified as unethical or illegal. However in some cases insider trading can be known as legal. Therefore McGee RW (2009) studied and analyzed when and in what circumstances insider trading is ethical, based on two sets of ethical principles which are utilitarian ethics and rights theory. Modern utilitarian ethics identify insider trading is ethical or unethical by asking whether the gains exceed the losses. If yes, insider trading is ethical and vice versa. However, insider trading can be known as unethical if there has been a breach of fiduciary duty even if it would otherwise meet the utilitarian test. On the other hands, right based approach is an approach to analyzing and asking whether someone's right are violated. It means, if the rights are violated, the act is automatically turns to wrong. However, most of legal systems are made of the mixture of utilitarian and rights theory. One of the popular arguments about insider trading is; insider trading is kind of fraud since it's encourage greed while trading on corporate information (Strudler and Orts, 1999). In other words, insiders who profits from the use of inside information are called as breaching their fiduciary duty. As affect from the insider trading, stock prices are likely to move in the right direction quicker than would otherwise once information are released into the marketplace sooner than later. This situation was supported by Meulbroek (1992) and Cornell and Surri (1992). Author had found that not all insiders trading affect in violation of anyone's rights. In some cases, insider trading is purely the exercise of property rights. Therefore, based on rights theory, it cannot be said that there is necessarily anything wrong, but depends on the effect of the action whether good or bad.
In addition, there is one studied being done to examine whether insider trading really affect the movement stocks market price. There are three popular studies being done by Chakravaty S and McConnell (1997), Meulbroek (1992) and Cornell and Surri (1992) that support that insider trading is significantly correlated with the movement of stock prices. On the other hand, Chakravarty S and McConnell JJ (1999) argued that the prior test of this premise is whether insider trading has a different effect on prices than non insider trades. Based on this research, the researchers found that those three prior studies cannot be used as a basis for the insider trading legalization. In other words, it cannot be used to argue that insider trading leads to more rapid price than other trades done by any other investors. This is supported by test being done on the modified Cornell-Surri model which indicates that insider trader trading does not lead to more rapid price discovery than other trading. Besides that, analysis was done to the modified Meulbroek procedure. The results also support the test before which means that insider trading does not differentially influence market prices from non-insider trading. Therefore this study can be concluded that stock prices are undistinguishable affected by insider trading or non insider trading. In other words, insider trading is not specifically the only way to effect movement of the stocks market prices.
Besides that, O'hara PA (2001) had studied on the arguments supporting the practices in terms of the philosophy of ownership and enterprise that helps to still innovation and efficiency into the stock market and the corporate system. He also examined on the main ethical arguments that against the insider trading which asymmetrical information, in principle access to information, misappropriation and fiduciary duty. There are advantages of insider trading over other forms of compensation for innovators. Insider trading rewards are the right type of compensation package for risk taking. This is supported by Manne (1966), which states that this is because they relate to material information about specific developments in the corporation such as new process, corporate structure or market. However, the real challenge is to organise the corporate and managerial structure so that this inside information is directed to innovators rather than the free riders. Therefore, it is necessary to provide a suitable legal system to encourage such insider practices. According to O'Hara, there are many ethical arguments against insider trading which are problematic. He found out that the concept that traders should have equal information in the market is easily dismissed on the basis of the standard ethical and institutional workings of capitalism. In other words, becoming an insiders or professional traders is a skill like being engineers. Misappropriation theory was developed to prevent corporate outsiders from using the information for their own benefits. This is supported by the fact that they usually do not have a fiduciary duty to corporate shareholders. O'Hara believes that serious work needs to be done before a suitable assessment can be made about insider trading in the financial market.
Chau M and Vayanos D (2006) support that insider's information reflected in prices almost immediately when the market approaches continuously trade. This study examined market efficiency in an infinite-horizon model with a monopolistic insider. According to them, insiders can trade with competitive market makers and noise traders and observes privately the expected growth rate of asset dividends. In other words, without insiders, information would be reflected in prices only after a long series of dividend observation. Finding from this study is market with monopolistic insiders can be arbitrarily close to strong form efficiency. Besides that, they also show that insider's profits do not converge to zero despite the market's converging to efficiency and thus, market can be said almost efficient and yet offer sizeable returns to information acquisitions. In other words, insider's profit margin per shares will decrease as the market approaches become efficient. However, it can be offset by the fact that the insiders' trade more as trading opportunities become more frequent. Based on their finding, it can be conclude that insider trading is legally accepted and market can be close to strong form efficiency even in the presence of monopolistic insiders.
Semi strong form of efficient market hypotheses shows how market share prices reflect both all relevant information available from the past changes and all relevant knowledge pertaining to the share price that is publicly available. In addition, Ferreira EJ and Brooks LD (2000) examined how market response to re-release of previously announced public information. Thus, this condition represents a violation of traditional semi strong form of efficient market hypothesis. In contrast, outsiders can be said to earn significant abnormal profits by imitating insiders at the initial public release of the insider trading information (Finnerty, 1976 and Seyhun, 1986). It means, if a semi strong efficient market holds true, insider trading information previously released and already in published should be fully reflected in security prices. As a result, under abnormal return condition, the investor would buy the security if the prior insider trade were a purchased and sell it if the prior insider trade were sale. A violation of traditional semi strong form of efficient market hypotheses is evident.
Marginson D (2010) objective is to discuss the limitation of using the Shin measure of racetrack efficiency for detecting and measuring the incidence of insider trading in markets where traditional notions of bookmaking do not apply. Besides that, the second objective is to test for evidence of exchange based insider trading, especially insider activity aimed at profiting not from expected winners but from 'known losers'. From the prior studies, results indicate that insider activity aimed at profiting from 'known losers' may be commonplace on the exchange. According to Smith, Paton, and Vaughan Williams (2006), no market maker (bookmarking) is involved in maintaining the credible market structure. Thus, it supports that it maybe inappropriate to use the Shine measure to test for insider trading on the exchanges. Basically in other words, the Shin measure may not sufficiently sensitive to the characteristics of exchange betting. This is will lead to possible misinterpretation of the results obtained. In addition, results indicate that in enabling the form of betting, the exchanges may have being facilitated a relatively new form of insider trading which is based on information asymmetries or known as profiting from known losers. Thus, a potentially commonplace form of known loser activity on the exchanges may relate to the laying of un-fancied non-tries (out for a run).
Next we take a look into an impact of insider trading in hedging funds. In today's financial market, insider trading in hedge funds can be said as a serious problem. Hedging is one of the techniques in making good investment. Hedging can be thinking as insurance. Investors use hedging to ensure themselves against negative events that can be occurred during investment. The reason of using hedge funds is to avoid tax consequences and to limit their liability. Hedge funds have highly leveraged than other investment vehicles. However, in the case of loss, levering can lead to disastrous consequences. In order to guarantee a good return in doing funds hedging, investors would prefer to use insider trading which have an inside material information that relate to the investment. However, according to Strohmenger R (2010), insider trading and hedge funds is a dangerous pair. As hedge funds become popular, most of the hedge funds advisors would like to seek for a new method to deal with high competition (Gimein M, 2005). This would cause investment advisors to seek for illegal information in order to remain competitive. Advisors can gain an unfair advantage and directly increase their own personal profit by doing trading which based on insider information. This is lead to a less stringent of rules and regulations regarding used of insider trading in funds hedging. In addition, this is shows that markets are not really efficient anymore.
CONCLUSION
An efficient financial market processes the information available for investors and incorporates it into the prices securities. There are two general implications regards to market efficiency which are; first, a stock's abnormal return depends on news and information received by the market in the given period. Second, an investor who uses the same information as the market cannot expect to earn abnormal returns. In other words, systems for playing the market are dammed to fail. Theoretically, there are three forms of efficient market which are weak form, semi-strong form and also strong form. Much evidence from different financial markets supports weak form and semi-strong form but not strong form efficiency. In corporate finance view, market efficiency states that managers cannot fool the market through creative accounting, managers cannot profitably speculate in foreign currencies and other instruments, and there are no abnormal return can be made in strong form of efficient market. In other words, inside traders are not being able to obtain profit by trading on their material information or can be known as private information. Therefore, there are many studies had been done to examine fundamental of insider trading and how its affect in efficient market hypothesis.
Most of the studies being done results that insider trading is prohibited in order to ensure that integrity of the securities and it will not be compromised. Insider's information had reflected the stocks prices movement quicker than it suppose to be (Chau M and Vayanos D, 2006). Any suitable assessment regarding insider trading in the financial market can be taken into consideration in order to ensure market efficiency (O'Hara, 2001). In order to detect insider trading on private information, internal control mechanisms should be strengthened and implement thoroughly. It should be done by the company itself. In other words, any information that can affect the stocks prices must be disseminate to public fairly. Delay in information asymmetry will give a chance for insiders to create a personal gain (Dr Ameer R and Dr Othman R, 2008). So far as I can conclude that any actions relating to insider trading is illegal and had violated the securities laws. But it is depends on the respective countries; how they identify and classify insider trading is based on their judgment which can be based on Utilitarian perspectives or Right-based theory (McGee RW,2009). In addition, increases an enforcement action on the insider trading process can helps in ensure market efficiency. Self reporting of illegal activity can be a possible action in order to improve investor's compliance and cut down on insider trading leaks (Strohmenger R, 2010). Besides that, day traders should be educated about the fundamental of insider trading. Traders with higher levels of ethical reasoning are tend less likely to use private information while do stock's trading (Abdolmohammad M and Sultan J, 2002). They know which is ethical or unethical while involve in financial market. As conclusion, regulators must play important roles in order to curb this problem. Hence, investor's confidence can be restore and maintain in ensure market efficiency. Ultimately, the efficient markets hypotheses continue to be the best description of price movements in securities markets.
