CalPERS (the world's largest pension fund) has proposed a new policy on insider trading by its employees (CalPERS is against it, of course). But Keith Paul Bishop is dubious. While I agree with Bishop's take that the policy is probably unnecessary and also badly designed, I suspect this is a case in which CalPERS is taking a belts-and-suspenders approach to ensuring that it has minimal organizational risk (e.g., control person liability) in the event that one of its employees goes rogue. As a client briefing letter from Pepper Hamilton explains:
As a result of the Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA), insider trading policies have become a mainstay of corporate compliance programs. Since the enactment of ITSFEA, federal regulations impacting insider trading have further evolved as a result of the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act. The heightened scrutiny of the insider trading landscape today compels consideration by public companies to adopt appropriate policies to prevent insider trading and to enforce compliance with these policies. ...
Controlling person liability would not apply where the "controlling person acted in good faith and did not directly or indirectly induce" the violation. However, such exposure to liability would exist where a "controlling person" allows access to material non-public information (about itself or another entity) without implementing procedures to prevent insider trading or improper disclosure by the "controlled person."
I have posted to SSRN a new essay An Overview of Insider Trading Law and Policy: An Introduction to the Insider Trading Research Handbook:Abstract: This essay will serve as the introduction to a collection of 23 newly commissioned articles on numerous aspects of insider trading law. The contributors cover a wide variety of topics, ranging from analyses of current issues in USA insider trading law, empirical analyses of insider trading both in the USA and around the globe, and global perspectives from China, Japan, Australia and New Zealand, Europe, and the UK.
Number of Pages in PDF File: 38
Keywords: insider trading, fiduciary duty, securities regulation
JEL Classification: K22
Citation: Bainbridge, Stephen M., An Overview of Insider Trading Law and Policy: An Introduction to the Insider Trading Research Handbook (September 4, 2012). Research Handbook on Insider Trading, Stephen Bainbridge, ed., Edward Elgar Publishing Ltd., 2013 ; UCLA School of Law, Law-Econ Research Paper No. 12-15. Available at SSRN: http://ssrn.com/abstract=2141457
Steven Davidoff recently reported that:
Federal securities regulators charged eight people in Georgia with insider trading on Tuesday, saying they bought stock in a company ahead of a merger announcement after one of them learned about a pending deal.
The Securities and Exchange Commission said that Thomas D. Melvin Jr., an accountant from Griffin, Ga., learned from a client that the drug giant Sanofi-Aventis was planning to buy Chattem, a pharmaceutical-products company that was then publicly traded. The client, who was a director of Chattem, was seeking Mr. Melvin’s advice on the deal’s tax implications on his stock options and made it clear that the discussion was confidential, the S.E.C. said.
Nevertheless, Mr. Melvin leaked the news of the possible deal to four of his friends — C. Roan Berry, Michael S. Cain, Joel C. Jinks and R. Jeffrey Rooks — the commission charged. That set off another chain of illegal tips as Mr. Berry passed the news onto Ashley J. Coots, who, in turn, tipped his friend Casey D. Jackson, according to the complaint. The S.E.C. also said that Mr. Cain, a stockbroker, told Peter C. Doffing about the secret transaction.
This prompted an email from my friend and hero Henry Manne, which he has kindly permitted me to reprint below:
Do we really want to police all such personal conversations? Do we really want the day-to-day conversations of people like the ones involved here to be threatened by SEC monitoring?
This is a good illustration of the civil liberties danger our insider trading law enforcement threatens.
Perhaps I am simply obsessed with a topic I've been around for too long, but I do indeed feel like shouting from the rooftops "Hey, the SEC is fucking us over." Why isn't the liberal community even taking notice?
Do people really believe that this sort of investigation, conducted on a scale required to stop insider trading would be completely benign or is worth more than the implied costs? But there is a paradox in all this, since the best response to the kinds of concerns I've just mentioned is that there really is no threat to our civil liberties because the whole thing is just Kabuki theater. No one in his right mind would believe that the SEC scratches more than a very bare tip (the parts easily spotted) of a very large iceberg. (An interesting movie could be made out of the story line implied by this case focusing on interpersonal relationships not generally considered a danger to the community.)
That in turn bears out my old argument (as well as Dooley's) that effective enforcement of these laws is impossible, and, therefore, it is better not to try. For 46 years I have tried to get the army of commentators on this topic to consider the problems (and the economics) of enforcement. To date only Dooley and Bainbridge have taken up my challenge. These show prosecutions do have an effect: they drive the right people out of the market for information and put it more and more into the hands of those willing to take risks (e.g. the Al Capones of the stock market) or of naifs such as are involved in the instant case.
The WSJ Law Blog reports that:
Doug Whitman, a former hedge-fund manager, doesn’t deny that he probed public companies for nonpublic information.
But when he goes on trial next week on charges of securities fraud and conspiracy, his lawyers plan to argue that his motives were pure, and that his conduct squared with the 1983 Supreme Court decision Dirks v. SEC, which protects certain trading on inside information, so long as there is no payoff, the WSJ’s Reed Albergotti reports in today’s paper. ...
During Wednesday’s hearing, U.S. District Judge Jed Rakoff, who is presiding over the case, was ... receptive to arguments challenging the law used to prosecute Mr. Whitman.
The government must prove that Mr. Whitman knew that the original sources of the inside stock tips were violating duties they owed to company shareholders to keep the information secret.
But Mr. Whitman’s attorneys argued in a motion to the court that the federal law that deals with the issue is vague, and that because all of the alleged conduct occurred in California, the court should consider the state laws there, where only high-level employees owe fiduciary duties.
Judge Rakoff said he was “impressed” Mr. Whitman’s lawyers raised the issue, adding that the question of which laws should apply has “been ducked” by courts for 25 years.
Might I repectfully encourage Judge Rakoff and the counsel to check out my article Incorporating State Law Fiduciary Duties into the Federal Insider Trading Prohibition, 52 Washington and Lee Law Review 1189 (1995)? You can download the full text of the paper here: Download INCORPORATING STATE LAW FIDUCIARY DUTIES INTO THE FEDERAL INSIDER TRADING PROHIBITION.pdf (568.4K).
The introduction follows:
Someone violates the federal insider trading prohibition only if his trading activity breached a fiduciary duty owed either to the investor with whom he trades or to the source of the information. [FN1] From a securities law perspective, the federal prohibition thus is an empty shell. It has no force or substance until it has been filled with fiduciary duty concepts.
Despite the centrality of the fiduciary duty element to the federal prohibition, the fiduciary element has received relatively little attention from courts or commentators. On close examination, however, requiring a breach of fiduciary duty as a prerequisite for insider trading liability raises two interesting questions: What is the precise fiduciary duty at issue? Is the source of that duty federal or state law? Despite over a decade of experience *1191 with the fiduciary duty requirement, neither of these questions has a clear and convincing answer.
The failure to resolve these issues has robbed the federal insider trading prohibition of coherence and predictability. [FN2] Perhaps this lack of coherence was acceptable when insider trading was a low priority item for federal prosecutors, and the major penalty was disgorgement of profits. Today, however, insider trading is a major Securities and Exchange Commission (SEC or Commission) enforcement target and carries penalties that can only be described as draconian. [FN3] Due process and simple fairness thus require that the fiduciary duty element be taken more seriously than it has been to date.
Perhaps the fiduciary duty requirement's substantive content is ignored because courts and commentators assume that there is a single fiduciary duty, applicable to all relevant market players, that proscribes the use of confidential information for personal gain. If so, this assumption's inherent invalidity was exposed by the SEC's enforcement effort directed at insider trading in corporate debt securities. [FN4] Under state law, corporate officers and directors generally owe no fiduciary duties to debt securityholders. As a result, assuming state law provides the requisite fiduciary duty, one can plausibly argue that insider trading in debt securities is not unlawful. As this Article will demonstrate, similar state law arguments can be made in a variety of contexts, including the very core of the federal prohibition -- its application to corporate officers and directors. This possibility has generated some critical commentary in the debt security context, [FN5] but its full implications remain largely unexplored. This Article seeks to fill that gap.
Part II of this Article briefly traces the evolution of the current insider trading regime, with particular emphasis on the fiduciary duty element. Part III then explores the content of the fiduciary duty element. Part III argues *1192 that liability is premised not on the mere existence of a fiduciary relationship, but rather on the breach of a specific fiduciary duty -- namely, the duty to refrain from self-dealing in confidential information owned by another party.
The inquiry then shifts to identifying the source of the requisite duty. As a preliminary matter, Part IV argues that the insider trading prohibition is a species of federal common law. Specifically, it is an example of interstitial lawmaking in which the courts are using common-law adjudicatory methods to flesh out Rule 10b-5's bare bones. Once this view of the prohibition is accepted, a choice of law question arises. In crafting a rule of decision for federal common-law cases, courts can either create a unique federal standard or incorporate state law into the federal rule. In the latter case, the cause of action remains federal, but the content of federal law is supplied by the incorporated state law principles. The decision to incorporate state law depends upon whether there are important federal interests that would be adversely affected by doing so. If so, the court will create a uniform federal standard, but if not, the court may incorporate state law.
In order to decide whether state fiduciary duties should be incorporated into the federal insider trading prohibition, we thus must ask two questions: Would incorporation adversely affect prosecution of insider trading under the federal securities laws and, if so, would any identifiable policy goal of those laws be frustrated thereby? Part V addresses the former concern, examining the implications of adopting state law fiduciary duty concepts as the rule of decision. It demonstrates that use of state law principles will at least complicate insider trading prosecutions and probably will substantially limit the prohibition's scope.
In light of that finding, Part VI then turns to the latter concern. Because a unique federal set of fiduciary duties applicable to insider trading is most easily justified if application of state law would frustrate an identifiable federal policy goal, Part VI examines the purported federal interests underlying the insider trading prohibition. As Part VI demonstrates, none of the commonly asserted federal policies requires creation of a unique set of federal fiduciary duties. Rather, the insider trading prohibition is justified solely by the need to protect property rights in valuable information.
Based on this analysis, Part VI argues that it is creation of a unique federal rule -- not incorporation of state law principles -- that would frustrate the policies of the securities laws. The Supreme Court has repeatedly made clear that the federal securities laws do not displace the much broader body of state corporate law. To the contrary, the Court has *1193 specifically indicated that questions of fiduciary duty are governed by state law. If the fiduciary duty necessary for insider trading liability is supplied by federal law, a substantial tension thus would develop between the insider trading prohibition and the federalism policies of the securities laws. Incorporating state law fiduciary duties into the prohibition would resolve that tension. Moreover, state law fiduciary duties are generally consistent with the property rights rationale for regulating insider trading. Accordingly, incorporating state law fiduciary duties would advance the federalism policies of the federal securities laws, without frustrating any of the other policies thereof.
Of course, as a dog lover, I would never swat a real dog with a rolled up newspaper. When it comes to Congress, however, I would have no such compunctions. Remember all the effort we put into getting the STOCK Act passed to ban Congressional insider trading? Remember how we suspected the House GOP leadership, especially Eric Cantor, were trying to kill it or at least water it down?
Well, I thought that was one battle won.
But now Broc Romanek reports that:
I guess Congress is not satisfied that it's approval rating is down to single digits. As noted in this CNN article, the House Ethics Committee came up with a 14-page memo to interpret the STOCK Act differently than its Senate counterpart and found that spouses and children are exempt from the new law that had banned insider trading in Congress. The Office of Government Ethics, which oversees all federal executive branch employees, sided with the House.
So there you have it. A different standard for Congress compared to other federal employees. A group of ethics officials who have no understanding of beneficial ownership (guess they should have read our new "Beneficial Ownership Table Handbook"). And back to Square #1 in providing some integrity on the Hill. House Majority Leader Eric Cantor now claims that his office inadvertently created the loophole.
Right. I don't believe Cantor for a minute. He's a bad pup who simply won't learn his lessons. I hope I never run into him with a rolled up newspaper in hand, or I'll be in big trouble.
Stephen Bainbridge has made the study of insider trading a very understandable law book, despite the complexity of the subject and reading this book could well assist UK prosecutors to understand the subject more comprehensively as it applies to the US and UK, especially with regard to disclosure where the issue of the property rights of the information is addressed in Part IV of the book ...
Insider trading edited by Stephen M Bainbridge is a most useful conglomeration of vital thoughts on the issues of insider trading as it applies across the world. The papers on inside information and on information withheld give much food for thought and will bring much imagination to prosecutors. It makes light reading of a very important matter and is a highly recommended book that must be included in law libraries everywhere ...
As the Amazon book description explains:
This timely collection, edited by a leading academic in the field, brings together seminal works of scholarship on insider trading over a 40 year period, with contributions from many prominent law professors and economists. Areas covered in the volume include the origins and development of insider trading law, insider trading statues and the policies surrounding insider trading. Along with an original introduction, Professor Bainbridge provides a comparative and international focus as well as coverage of important issues in the US law of insider trading. This volume will be of immense value to scholars and practitioners interested in this evolving and topical field of study.
In what ways do prediction markets fail? The paper provides some discouraging answers. First, they struggle when there is a high degree of insider information. On the question, "Will the mandate be struck down", for instance, only the Chief Justice himself could say for sure, and so the market was likely to be wrong. There must be information to aggregate. "Will there be WMDs in Iraq?" was the basis of one contract. But which Iraqi arms tattletale is trading predictions contracts? None, so the market was mistaken.
But if markets need information to predict accurately—as these two criteria entail—then so much is off limits. Who has information on next year's GDP? So much can change; so many things could happen. Sure, a merchant may have an idea, he may take a guess. But is that guess as reasonable as one's guess on WMDs? Is the future as foreign a realm as the far-off sands of Iraq? The thinking behind a market is that trading creates an incentive for players to develop the best possible information, to come up with new statistical models of the economy and place bets on their basis, for instance. The more dumb money in a market, the richer the pot for smart money, which should entice such money in and move the price in the right direction. But the very best processing of available information may still be wildly offbase where future events are concerned.
The third failure is a behavioural one. Individuals tend to overestimate low probabilities and underestimate high ones. (The former explains why so many play the lottery; the latter is just an inverse of the former.) But this means we have to rule out so many estimates as unreliable.
My friend Henry Manne would argue that one solution to the first and possibly third concerns would be to allow insider trading on the prediction market. I can see his point. If the prediction at issue is one that is either (a) known already by insiders or (b) uncertain but subject to much more accurate estimates by insiders, the contract will be far more accurately priced.
Henry discussed insider trading in prediction markets in his article Insider Trading: Hayek, Virtual Markets, and the Dog that Did Not Bark. Available at SSRN: http://ssrn.com/abstract=679662
Check it out.
GIVEN the tortured and time-consuming deliberations that can accompany white-collar criminal charges, the jury in the Rajat Gupta case moved with breathtaking speed. Only a day after receiving instructions from the judge, they convicted Mr Gupta on four out of six counts of conspiracy and securities fraud, all linked to information gleaned from his position as a board member of Goldman Sachs that was passed on to Raj Rajaratnam, a hedge-fund manager found guilty last year of insider trading in a separate trial. ...
Much of the trial featured mind-numbing recitations of phone and trading records. Various executives explained that information heard by boards was indeed confidential, and should not be shared with the public. To this dry factual base, the prosecutors added descriptions of discussions between Mr Gupta and Mr Rajaratnam, followed by frantic, lucrative trading at Galleon. “It was too coincidental,” said a juror.
Unlike some recent insider trading cases, such as those involving expert networks, there was nothing especially novel about the Gupta case. You had a classic insider--a director--tipping information to an outsider who used it to trade. There was evidence that Gupta got the requisite personal benefit, as required by Dirks, in the form of reputational gains and, as Schumpeter observes, "the creation of a new business venture in which Mr Rajaratnam was to play an important role."
The only thing remotely out of the ordinary about the Gupta case was the extent to which it relied almost exclusively on circumstantial evidence. There really is no smoking gun. But there is no legal requirement of a smoking gun. To the contrary, as the court held in United States v. Smith, 155 F.3d 1051 (9th Cir.1998), “It is certainly not necessary that the government present a smoking gun in every insider trading prosecution.” Id. at 1069. The fact that the jury declined to convict on two counts suggests that the did a good job of understanding how to apply the concept of reasonable doubt in a circumstantial evidence case.
WSJ Law Blog has an interesting take on the question of whether Gupta should have testified:
“I think him testifying may have resulted in shorter jury deliberation and not much else,” Roland Riopelle, a white-collar-crime defense lawyer in Manhattan. (The jury deliberated for eight hours after a month-long trial — a quick verdict if ever there was one.)
At the start of the trial Mr. Riopelle was more open to the idea, but as it progressed, he said he became convinced that putting Mr. Gupta on the stand would have played to the government’s case by allowing prosecutors to rehash much of its circumstantial evidence against him during cross-examination.
“It would have almost been like another summation,” he said. “One seemed enough in this case. Why give the government two?”
Which seems sensible enough.
Finally, Instapundit asks:
Everything comes back to politics these days, doesn't it?
And so my debate with former SEC Chairman Harvey Pitt (who you will recall got run out of office for his incompetent fumbling of the Enron era scandals) has come to an end. The closing arguments are here.
Throughout the debate, Pitt has relied on standard shopworn and fallacious defenses for the insider trading prohibition. In his closing argument, for example, he trots out two old chestnuts:
Mr Bainbridge's core argument, which focuses almost exclusively on the role played by market analysts, ignores the value of fairness and the importance of investor confidence in capital markets.
Poppycock. As I explain in my chapter on insider trading in the “Encyclopedia of Law and Economics":
[Because insider trading does not injure investors, as I demonstrated in my closing statement at The Economist], it is difficult to see why insider trading should undermine investor confidence in the integrity of the securities markets. As Bainbridge (1995, p.1241-42) observes, any anger investors feel over insider trading appears to arise mainly from envy of the insider’s greater access to information.
The loss of confidence argument is further undercut by the stock market’s performance since the insider trading scandals of the mid-1980s. The enormous publicity given those scandals put all investors on notice that insider trading is a common securities violation. If any investors believe that the SEC’s enforcement actions drove insider trading out of the markets, they are beyond mere legal help. At the same time, however, the years since the scandals have been one of the stock market’s most robust periods. One can but conclude that insider trading does not seriously threaten the confidence of investors in the securities markets.
Macey (1991, p. 44) contends that the experience of other countries confirms this conclusion. For example, Japan only recently began regulating insider trading and its rules are not enforced. The same appears to be true of India. Hong Kong has repealed its insider trading prohibition. Both have vigorous and highly liquid stock markets.
In sum, neither investor protection nor maintenance of confidence have much traction as theoretical justifications for any prohibition of insider trading. Nor do they have much explanatory power with respect to the prohibition currently on the books. An investor's rights vary widely depending on the nature of the insider trading transaction; the identity of the trader; and the source of the information. Yet, if the goal is investor protection, why should these considerations be relevant?
Consider, for example, United States v. Carpenter, 791 F.2d 1024, 1026–27 (2d Cir.1986), aff'd, 484 U.S. 19 (1987). R. Foster Winans wrote the Wall Street Journal's "Heard on the Street" column, a daily report on various stocks that is said to affect the price of the stocks discussed. Journal policy expressly treated the column's contents prior to publication as confidential information belonging to the newspaper. Despite that rule, Winans agreed to provide several co-conspirators with prepublication information as to the timing and contents of future columns. His fellow conspirators then traded in those stocks based on the expected impact of the column on the stocks' prices, sharing the profits. In affirming their convictions, the Second Circuit anticipated O'Hagan by holding that Winans's breach of his fiduciary duty to the Wall Street Journal satisfied the standards laid down in Chiarella and Dirks. From either an investor protection or confidence in the market perspective, however, this outcome seems bizarre at best. For example, any duties Winans owed in this situation ran to an entity that had neither issued the securities in question nor even participated in stock market transactions. What Winans's breach of his duties to the Wall Street Journal has to do with the federal securities laws, if anything, is not self-evident.
The incongruity of the misappropriation theory becomes even more apparent when one considers that its logic suggests that the Wall Street Journal could lawfully trade on the same information used by Winans. If we are really concerned with protecting investors and maintaining their confidence in the market's integrity, the inside trader's identity ought to be irrelevant. From the investors' point of view, insider trading is a matter of concern only because they have traded with someone who used their superior access to information to profit at the investor's expense. As such, it would not appear to matter whether it is Winans or the Journal on the opposite side of the transaction. Both have greater access to the relevant information than do investors.
The logic of the misappropriation theory also suggests that Winans would not have been liable if the Wall Street Journal had authorized his trades. In that instance, the Journal would not have been deceived, as O'Hagan requires. Winans' trades would not have constituted an improper conversion of nonpublic information, moreover, so that the essential breach of fiduciary duty would not be present. Again, however, from an investor's perspective, it would not seem to matter whether Winans's trades were authorized or not.
Finally, conduct that should be lawful under the misappropriation theory is clearly proscribed by Rule 14e–3. A takeover bidder may not authorize others to trade on information about a pending tender offer, for example, even though such trading might aid the bidder by putting stock in friendly hands. If the acquisition is to take place by means other than a tender offer, however, neither Rule 14e–3 nor the misappropriation theory should apply. From an investor's perspective, however, the form of the acquisition seems just as irrelevant as the identity of the insider trader.
All of these anomalies, oddities, and incongruities have crept into the federal insider trading prohibition as a direct result of Chiarella's imposition of a fiduciary duty requirement. None of them, however, are easily explicable from either an investor protection or a confidence in the market rationale.
Turning to Pitt's fairness argument, I concede that there is a widely shared view that there is something inherently sleazy about insider trading. Given the draconian penalties associated with insider trading, however, vague and poorly articulated notions of fairness surely provide an insufficient justification for the prohibition. Can we identify a standard of reference by which to demonstrate that insider trading ought to be prohibited on fairness grounds? In my judgment, we cannot.
Fairness can be defined in various ways. Most of these definitions, however, collapse into the various efficiency-based rationales for prohibiting insider trading. We might define fairness as fidelity, for example, by which I mean the notion that an agent should not cheat her principal. But this argument only has traction if insider trading is in fact a form of cheating, which in turn depends on how we assign the property right to confidential corporate information. Alternatively, we might define fairness as equality of access to information, as many courts and scholars have done, but this definition must be rejected in light of Chiarella's rejection of the Texas Gulf Sulphur equal access standard. Finally, we might define fairness as a prohibition of injuring another. But such a definition justifies an insider trading prohibition only if investors are injured by insider trading, which seems unlikely (as I explain in that final Economist post).
By all accounts Pitt's a pretty smart guy, despite his ineptitude as SEC Chairman. So why does he trot out arguments, like these, that have been debunked for decades?
Pitt is an SEC guy. In addition to his lamentable stint as Chairman, he had been general counsel at the Commission, a founder and first President of the SEC Historical Society, and remains a Commission cheerleader. In is closing argument, for example, he still lauds the Commission:
The SEC was created in the aftermath of the stockmarket crash of 1929 to restore investor confidence in America's capital markets, and it should be credited for advancing these same goals today.
Credited? For what? For botching the handling of the Enron-era scandals? For botching the handling of the Bernie Madoff investigation? For repeatedly having failed GAO evaluations of the Commission's internal controls? For impeding capital formation? For supervising the decline of US capital markets as they lost competitiveness with global markets?
It's important to see Pitt's support for aggressive insider trading prosecutions as being part and parcel of the way the Commission has used (make that, abused) insider trading for decades.
When viewed from a public choice perspective, the federal insider trading prohibition may be understood as the culmination of two SEC agenda items. First, as do all government agencies, the SEC desires to enlarge its jurisdiction and enhance its prestige. Administrators can maximize their salaries, power, and reputation by maximizing the size of their agency's budget. A vigorous enforcement program directed at a highly visible and unpopular law violation is surely an effective means of attracting political support for larger budgets. Given the substantial media attention directed towards insider trading prosecutions, and the public taste for prohibiting insider trading, it provides a very attractive subject for such a program.
Second, during the prohibition's formative years, there was a major effort to federalize corporation law. In order to maintain its budgetary priority over competing agencies, the SEC wanted to play a major role in federalizing matters previously within the state domain. Insider trading was an ideal target for federalization. Rapid expansion of the federal insider trading prohibition purportedly demonstrated the superiority of federal securities law over state corporate law. Because the states had shown little interest in insider trading for years, federal regulation demonstrated the modernity, flexibility, and innovativeness of the securities laws. The SEC's prominent role in attacking insider trading thus placed it in the vanguard of the movement to federalize corporate law and ensured that the SEC would have a leading role in any system of federal corporations law.
The validity of this hypothesis is suggested by its ability to explain the SEC's devotion of significant enforcement resources to insider trading during the 1980s. During that decade, the SEC embarked upon a limited program of deregulating the securities markets. Among other things, the SEC adopted a safe harbor for projections and other soft data, the shelf registration rule, the integrated disclosure system, and expanded the exemptions from registration under the Securities Act. At about the same time, however, the SEC adopted a vigorous enforcement campaign against insider trading. Not only did the number of cases increase substantially, but the SEC adopted a "big bang" approach under which it focused on high visibility cases that would produce substantial publicity. In part this may have been due to an increase in the frequency of insider trading, but the public choice story nicely explains the SEC's interest in insider trading as motivated by a desire to preserve its budget during an era of deregulation and spending restraint.
The public choice story also explains the SEC's continuing attachment to the equal access approach to insider trading. The equal access policy generates an expansive prohibition, which federalizes a broad range of conduct otherwise left to state corporate law, while also warranting a highly active enforcement program. As such, the SEC's use of Rule 14e–3 and the misappropriation theory to evade Chiarella and Dirks makes perfect sense. By these devices, the SEC restored much of the prohibition's pre-Chiarella breadth and thereby ensured that its budget-justifying enforcement program would continue unimpeded.
As a loyal SEC foot soldier, it's thus hardly surprising that Pitt continues to tell the SEC's bogus stories about insider trading. They are essential to the political success of the SEC. Indeed, it is hardly surprising the present crackdown on insider trading came along when it did. It's not that insider trading suddenly surged. Instead, it's because the SEC had so publicly screwed up in the Madoff case and in the financial crisis. Going after insider trading was a way of taking some of the heat off the agency by racking up some wins.
My essay Regulating Insider Trading in the Post-Fiduciary Duty Era: Equal Access or Property Rights? is now online. Here's the abstract:
This essay was prepared for a forthcoming book on the law and economics of insider trading.
In Chiarella and Dirks, the Supreme Court based insider trading liability on a breach of a disclosure obligations arising out of a fiduciary relationship. The resulting narrowing of the scope of insider trading liability met substantial resistance from the Securities and Exchange Commission (SEC) and the lower courts. Through both regulatory actions and judicial opinions, the SEC and the courts gradually chipped away at the fiduciary duty rationale. In recent years, the trend has accelerated, with several developments having substantially eviscerated the fiduciary duty requirement.
The current unsettled state of insider trading jurisprudence necessitates rethinking the foundational premises of that jurisprudence from first principles. This essay argues that the correct rationale for regulation insider trading is protecting property rights in information. Although that rationale obviously has little to do with the traditional concerns of securities regulation, this article further argues that the SEC has a sufficiently substantial advantage in detecting and prosecuting insider trading that it should retain jurisdiction over the offense.
Keywords: insider trading, fiduciary duty, securities regulation
JEL Classifications: K22
The second round of my debate with former SEC Chairman Harvey Pitt over whether the crackdown on insider trading has gone too far is now available at The Economist.
I'm getting slaughtered in the vote, so hop over and give a guy a hand.
The Economist has invited yours truly and former SEC Chairman Harvey Pitt to debate the following question:
I am arguing in favor of the motion. I am, of course, also correct. But so far the readers are voting with Pitt. Go forth, read the opening statements, and vote. (For me.)
Here's some analysis courtesy of Ken Gross and his team at Skadden Arps about how this might impact companies:
The version of the STOCK Act passed by Congress includes the provisions from the Senate's initial version that the insider trading provisions in Section 10(b) of the '34 Act and Rule 10b-5 apply to Congressional Members and staff, and federal executive and judicial branch officials, and that these Members, officials and employees owe a duty with respect to material, nonpublic information derived from the person's position with the federal government.
This raises an interesting question as to the companies with whom these Members, officials and employees share the nonpublic information. Do the companies become liable if they act on such information, similar to certain "tipees" in a traditional insider trading case? We believe that the STOCK Act could indeed create liability for the company under certain circumstances that are highly fact-specific. This also raises a question as to how extensive the protection is under the Speech or Debate Clause.
The Act includes a requirement (also in the Senate's initial version) that the Comptroller General submit a report to Congress within 12 months of the date of enactment on the role of "Political Intelligence" in financial markets. It does not include the provisions from the Senate's initial version that would have amended the Lobbying Disclosure Act of 1995 (by adding a new category of activities, "Political Intelligence Contacts," that would trigger registration and reporting) and the illegal gratuities statute (by broadening the scope of the statute).
Given that they do not specify an effective date or reference a date by which an implementing regulation must take effect, the insider trading provisions take effect upon the date of enactment.
A Barrister magazine review of my Insider Trading anthology:
Compiled in one handy hardback volume, this publication brings together some of the best learned commentary from the US on this often vexed and controversial subject.
Part of Edward Elgar's admirable 'Corporate Law' series, this engrossing collection of articles offers both a theoretical and historical perspective on insider trading. If you' re doing research, or need some background on this subject, editor Stephen J. Bainbridge has cherry picked a collection of some of the most interesting articles on insider trading published in the US over a period of forty years or so, so you don't have to. How handy is that? ...
Oddly, this book published in 2011 contains no articles, nor does its bibliography cite any article published after 2000 — or maybe we' ve missed something hence the view that this work is of historic importance to the ongoing debate.
A fair point. Two answers: (1) My next insider trading anthology for Elgar will have cutting edge modern scholarship and (2) this anthology was designed to collect pieces that had stood the test of time.