The board of directors should always act in the interest of shareholders. This is because there is an agency relationship between shareholders and the board of directors. Common law providers that, the resulting agency relationship between the shareholders and board of directors makes directors to have fiduciary duty which ensures all directors’ actions are for the interest of the principal (shareholders). Insider trading is buying and selling of securities while having non public material information about the securities. It also includes tipping secret information about securities to a person who uses such information to have an upper hand in stock exchange market. Therefore, insider trading breaches the fiduciary duty because shareholders do not benefit from the gains of the trade and it also makes members of public wary of such securities something which may lead to fall in market price of the shares (Donald, 2006). In addition, it is widely acknowledged that the reputation of a firm (a legal person) relies on that of board of directors (natural persons). Therefore, if the board of directors’ reputation is tainted by insider trading then it follows that the firm’s reputation will also suffer and this negatively affects the shareholders investing interests. This has made a lot of legislation across the globe to prohibit insider trading and to impose heavy fines and jail terms for directors involved in it so as to tame the civil wrong (U.S. Securities and Exchange Commission, 2009).
Stewart was accused of relying on non public information from Sam Waksal, Imclone’s CEO to sell nearly 400 Imclone shares. It is obvious that Ms Stewart was a shareholder and she did not have any fiduciary duty to the other shareholders. This is because it is only the management of accompanying who have a fiduciary duty to all shareholders but, the same does not exist among shareholders. All that withstanding, Ms Stewart did not receive any insider information directly from the company CEO but from her stock broker whom it coincidentally happened to be CEO’s brokers (Donald, 2006).
In accordance to misappropriation theory, if one is entrusted with confidential information he should not breach this fiduciary duty by tipping such information or trading (Donald, 2006). Therefore, the broker misappropriated by tipping information to Ms Stewart on the sale of securities made by the company CEO. It is further sickening to say that Ms Stewart was a purely a insider trader, because, by the time she ordered the sale of her shares the market price of the same had started falling an indication that several market players may have been aware of this information.
However, rule 10b5-1 stipulates that SEC inquires only the state of mind of the seller to prove her involvement on insider trading. In probing the Ms Stewart case it investigated her state of mind by: inquiring whether she had some non public information which she might have received from a private source in breach of fiduciary duty and whether she ascertained the state of public knowledge before her trading (Donald, 2006). It is for this regard that, Martha Stewart is quit of insider trading given that she actually knew that her action were morally wrong. This is proved by the false information she gave to government investigators regarding the reason behind her sale of the company’s share. In addition, the Chief Officer of the company was not sensitive enough to know that his actions would be licked to some people by his brokers (McGee, 2008). The CEO therefore, breached the fiduciary duty of the board to shareholders. In addition to this the chief officer may have done this deliberately for MS Martha Stewart to get the information given that they were friends. The facts discussed above give a very clear indication that shareholders interests where jeopardized by the action of the company’s CEO, that of the broker as well as by Ms Martha Stewart
This case has affected the society and business community in several ways. Firstly, it has stressed on the fiduciary duty of directors by revealing that their careless handling of sensitive company information may affect their close friends. Secondly, it has discouraged members of public from deceiving government investigators (McGee, 2008). This was the main basis for the prosecutor in convincing the jury to sentence Ms Martha Stewart. The defense could have easily proved MS Martha steward’s innocence if she had not fabricated a story behind her sale of the shares. It made it simple for the prosecutor to prove her moral wronging basing on the fabricated story. Finally, the business community has been made to become more sensitive of both their actions and statements they utter to fraud investigators because it has been proved that a lie can make the jury believe that you where part of insider trading or fraud.
Donald C.L (2006). Reflections on scienter (and the securities fraud
McGee, R. (2008). Applying ethics to insider trading. Journal of Business Ethics, 77(2), 205.
U.S. Securities and Exchange Commission. (2009). Insider Trading. Available from http://
www.sec.gov/answers/insider.htm
