James Cox has a new paper on the famous Texas Gulf Sulphur decision, in which he explores various rationales for regulating insider trading that can be discerned from the factual background of the opinion (as opposed to the legal analysis in the opinion, which I have demonstrated elsewhere is completely bogus, as the court hopelessly misrepresented the precedents on which it relied):
... in TGS, two of the major defendants traded in the interval between the misleading April twelfth press release and the corrective April sixteenth press release. To be sure, each had purchased TGS shares before the misleading press release, but essentially doubled-down after the release. Indeed, the second largest block of shares traded by any of the TGS insiders occurred in the interval between the misleading release and the corrective public release.
Against this record, we can premise an important justification for insider trading: by proscribing insider trading and tipping that yields a personal benefit to the insider, the law removes an incentive that insiders may have to delay the release of inside information. Stated differently, with investors benefitting from the early rather than later release of information, legal rules can better implement that objective by proscribing insiders who delay the release of information to enable them to exploit their secret knowledge of the information by trading on it.
I disagree, as I explained in my insider trading text:
To be sure, insider trading could injure the firm if it creates incentives for managers to delay the transmission of information to superiors. Decision making in any entity requires accurate, timely information. In large, hierarchical organizations, such as publicly traded corporations, information must pass through many levels before reaching senior managers. The more levels, the greater the probability of distortion or delay intrinsic to the system. This inefficiency can be reduced by downward delegation of decision-making authority but not eliminated. Even with only minimal delay in the upward transmission of information at every level, where the information must pass through many levels before reaching a decision-maker, the net delay may be substantial.
If a manager discovers or obtains information (either beneficial or detrimental to the firm), she may delay disclosure of that information to other managers so as to assure herself sufficient time to trade on the basis of that information before the corporation acts upon it. Even if the period of delay by any one manager is brief, the net delay produced by successive trading managers may be substantial. Unnecessary delay of this sort harms the firm in several ways. The firm must monitor the manager’s conduct to ensure timely carrying out of her duties. It becomes more likely that outsiders will become aware of the information through snooping or leaks. Some outsider may even independently discover and utilize the information before the corporation acts upon it.
Although delay is a plausible source of harm to the issuer, its importance is easily exaggerated. I am unaware of any evidence that delay is frequent or lengthy. Given the rapidity with which securities transactions can be conducted in modern secondary trading markets, a manager need at most delay corporate action long enough for a five minute telephone conversation with her stockbroker. Delay (either in transmitting information or taking action) also often will be readily detectable by the employer. Finally, and perhaps most importantly, insider trading may create incentives to release information early just as often as it creates incentives to delay transmission and disclosure of information.
In addition, to the extent (if any) that premature disclosure threatens the firm’s interests, that threat has little to do with the insider trading regime. Instead, it is properly treated as a breach of the insider’s fiduciary duty.
Finally, concern for ensuring timely disclosure cannot justify a prohibition of the breadth it currently possesses. As we have seen, the prohibition encompasses a host of actors both within and outside the firm. In contrast, only a few actors are likely to have the power to affect the timing of disclosure. A much narrower prohibition thus would suffice if this were the principal rationale for regulating insider trading. Indeed, if this were the main concern, one need not prohibit insider trading at all. Instead, one could strike at the problem much more directly by proscribing failing to disclose material information in the absence of a legitimate corporate reason for doing so.
