The WSJ has breathlessly reported:
Federal authorities, capping a three-year investigation, are preparing insider-trading charges that could ensnare consultants, investment bankers, hedge-fund and mutual-fund traders, and analysts across the nation, according to people familiar with the matter.
The criminal and civil probes, which authorities say could eclipse the impact on the financial industry of any previous such investigation, are examining whether multiple insider-trading rings reaped illegal profits totaling tens of millions of dollars, the people say. Some charges could be brought before year-end, they say.
The investigations, if they bear fruit, have the potential to expose a culture of pervasive insider trading in U.S. financial markets, including new ways nonpublic information is passed to traders through experts tied to specific industries or companies, federal authorities say.
Peter Lattman’s NYT story provides some perspective, noting that Justice and the SEC “have taken an increasingly aggressive — and public — stance in pursuing insider trading” and that the prosecutor in the latest case (as in the Galleon case), Manhattan U.S. attorney Preet Bharara, is among those taking the “hardest line.”
Larry goes on to argue that:
All of this theater can’t hide the dubious public policy underlying these prosecutions. Insider trading is, at worst, a breach of fiduciary duty which, like other such breaches, can be dealt with under state law. There’s only the thinnest basis for getting the federal government involved — that insider trading might increase trading spreads and therefore might reduce trading by outsiders. But sensible outsiders don’t do a lot of trading.
I don't agree. I think insider trading is theft of information and is punished for precisely the same reasons that we punish other forms of theft of property. I develop this argument at pages 78-82 of my monograph The Law and Economics of Insider Trading: A Comprehensive Primer.
To be sure, at first blush, the insider trading prohibition admittedly does not look very much like most property rights. Enforcement of the insider trading prohibition admittedly differs rather dramatically from enforcement of, say, trespassing laws. The existence of property rights in a variety of intangibles, including information, however, is well-established. Trademarks, copyrights, and patents are but a few of the better known examples of this phenomenon. There are striking doctrinal parallels, moreover, between insider trading and these other types of property rights in information. Using another’s trade secret, for example, is actionable only if taking the trade secret involved a breach of fiduciary duty, misrepresentation, or theft. This was an apt summary of the law of insider trading after the Supreme Court’s decisions in Chiarella and Dirks (although it is unclear whether liability for theft in the absence of a breach of fiduciary duty survives O’Hagan).
As for getting the federal government involved, I explain at page 78 that:
Where public policy argues for giving someone a property right, but the costs of enforcing such a right would be excessive, the state often uses its regulatory powers as a substitute for creating private property rights. Insider trading poses just such a situation.
On pages 83-84 I then elaborate on why I think the SEC has a comparative advantage over private parties in enforcing an insider trading prohibition.
Larry then argues that:
The vast majority of trading on non-public information does a lot of good by making stock prices more accurate and, occasionally, exposing fraud.
Again, I don't buy it. I address the issue in the section of my monograph entitled "Insider Trading and Efficient Pricing of Securities" (pages 65-68), which concludes that:
... if insider trading is to affect the price of securities, it is through the derivatively informed trading mechanism of market efficiency. ... The problem is that while derivatively informed trading can affect price, it functions slowly and sporadically. Given the inefficiency of derivatively informed trading, the market efficiency justification for insider trading loses much of its force.
I do agree with Larry that "criminalizing this conduct and unleashing aggressive publicity-seeking prosecutors to enforce the criminal laws is particularly dubious." The SEC has substantial civil penalties it can seek against inside traders, including treble money fines. When you add in the vagueness of what constitutes insider trading, criminal liability becomes very problematic. As I noted in connection with the Vizard case a few years ago:
... the SEC has vigorously resisted proposals to define insider trading in US law with anything like the precision of Australian law. As a result, as I pointed out in my article Insider Trading Regulation: The Path Dependent Choice between Property Rights and Securities Fraud, the definition of insider trading has been left to the courts to develop on a case-by-case basis, which in turn has left the law fairly vague on the margins, which gives significant advantages to prosecutors, especially in plea negotiations.
