Two of my favorite corporate law scholars are jousting over insider trading. I like them both too much to try to referee, but both articles are well worth reading:
Verstein, Andrew, Mixed Motives Insider Trading (March 21, 2020). Iowa Law Review, Vol. 106, 2020, UCLA School of Law, Law-Econ Research Paper No. 20-05, Available at SSRN: https://ssrn.com/abstract=3558540 or http://dx.doi.org/10.2139/ssrn.3558540
If you trade securities on the basis of careful research, then you are a brilliant and shrewd investor. If you trade on the basis of a hot tip from your brother-in-law, an investment banker, then you are a criminal. What if you trade for both reasons?
There is no single answer, thanks to a three-way circuit split. Some courts would forgive you according to your lawful trading motives, some would convict you in keeping with your bad motives, and some would hand the issue to the jury. Sometimes called the “awareness/use” debate or the “possession/use” debate, the proper treatment of mixed motive traders has occupied dozens of law review articles over the last thirty years.
This Article demonstrates that courts and scholars have so far followed the wrong reasons to the wrong answers. Instead, this Article takes trader motives seriously, drawing on insights and solutions from the broader jurisprudence of mixed motive. This analysis generates a new legal test and demonstrates the test’s superiority.
Miller, Robert T., Market Practices and the Awareness/Use Problem in Insider Trading Law: A Response to Professor Verstein’s Mixed Motives Insider Trading (November 15, 2022). Iowa Law Review, Vol. 107, No. 162, 2022, U Iowa Legal Studies Research Paper No. 2022-41, Available at SSRN: https://ssrn.com/abstract=4277164
Professor Verstein suggests that we approach the awareness/use problem in insider-trading law by analyzing the mixed-motives of insider traders, and he argues that insider trading should be illegal only when the trader’s primary reason for trading involves proscribed material non-public information (MNPI). To reach this conclusion, he assumes what he calls the “Equal Profits Principle,” which holds that two traders alike in all respects except for their knowledge of MNPI should enjoy the same expected profits from trading. This Response argues that the Equal Profits Principle can be analyzed into the “No Greater Profits Principle” (traders with MNPI should not make more than other traders) and the “No Lesser Profits Principle” (traders with MNPI should not make less than other traders), and that while the No Greater Profits Principle is intuitively plausible, the No Lesser Profits Principle is not. In particular, both classical insiders and potential misappropriators are in contractual relationships with the sources of their MNPI, and the standard market practice is for such persons to agree with the source, in exchange for compensation, to refrain from trading while in possession of MNPI (not merely to refrain from using MNPI to trade). In fact, public companies and other firms regularly in possession of large amounts of MNPI typically adopt insider trading policies that not only prohibit their employees from trading when in possession of MNPI, but also go considerably further, imposing blackout periods (when all trading is prohibited) and pre-clearance rules (which require certain senior employees to pre-clear all their trades with a compliance officer, regardless of whether they are in possession of MNPI). Such policies are efficient in the sense that they produce benefits in excess of their costs, and since they are manifestly incompatible with the Equal Profits Principle (because they violate the No Lesser Profits Principle), that principle is inefficient and very likely untenable. A better way to deal with the awareness/use problem is to follow the market consensus, which strongly favors the awareness rule.
Although not taking sides, as a point of personal privilege, I must note that only Professor Verstein cites the work of yours truly. Tsk.
