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| | | The Origins of the Ban | |
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< | The United States was the first country to establish a prohibition on insider trading. Today, most legal systems have followed its example seeking to “strengthen their capital markets”. The common principle is that law should forbid individuals to trade on securities based on non-public information. It does not seem right that some people use informational advantages that are unavailable to the rest of the market. However, the problem is that it is unclear which are the fundaments and purpose of the prohibition. This situation is particularly evident in the U.S. as demonstrated by the case law dealing with the issue. The following analysis shows the efforts of the courts to protect an ideal that it is unachievable: a securities market that provides equal opportunities to all individuals. Apparently, this is another case of contradictory reasoning defending the creed of capital markets. | >
> | I think your paper would be stronger if you said that the reasons for prohibiting insider trading are contradictory but then said what YOU think the justification for the prohibition should or should not be. I think I understand what you're trying to say now - but it seems to me like calling the courts out on "transcendental nonsense" is easy as long as you see that courts have a difficult time trying to justify the law. What I think would make for a better paper would be 1) that recognition, that the courts are unclear as to their goals, and then 2) YOU making the strong clear legal arguments one way or the other.
I've begun to revise a lot of the writing with some of these thoughts in mind.
The United States was the first country to begin aggressively ferreting out insider trading. Today, many legal systems have followed its example in seeking to “strengthen their capital markets”. Presumably, each of their laws was enacted with goal of forbidding individuals to trade on securities based on non-public information. Americans are loath to the idea that some traders are afforded informational advantages that are unavailable to the rest of the market. However, U.S. courts have been unable to successfully ground this feeling of injustice in coherent legal arguments. The following analysis shows the efforts of the courts to protect an ideal that it is unachievable: a securities market that provides equal opportunities to all individuals. Apparently, the prohibition on insider trading is another case of contradictory reasoning defending the creed of capital markets. | | | Equality in the Market | |
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< | Initially, the Court of Appeals for the Second Circuit established the “Equal Access Theory” in SEC v Texas Gulf Sulphur Co. According to the Court, rule 10 b-5 of the SEC “is based in policy on the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information.” The reasoning was that capital markets are supposed to provide a level field for investors, increasing their confidence on it. The political purpose of such statement is obvious; in order to guarantee the survival of the market it is essential to encourage individuals and corporations to invest their resources on it. | >
> | In 1961, the SEC's chairman, a Columbia Law professor named William Cary, first articulated the "disclose and abstain rule," and argued that Rule 10 b-5 could be enforced through the prosecution of insider trading. Seven years later, the Court of Appeals for the Second Circuit shared a similar "Equal Access Theory" of trading in S.E.C. vs. Texas Gulf Sulphur Co. According to the Court, the enforcement of rule 10 b-5 is purposed on the idea that investors trading on impersonal exchanges should have relatively equal access to material information.” The Court explained that protecting a level playing field for investors increases their confidence in capital markets. Put another way, in order to guarantee the survival of the market it was essential to incentivize individuals and corporations to invest their resources in it. | | | | |
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< | The inaccuracy of the idea that securities markets provide symmetrical access to information is self evident. The design of capital markets is based on the inequality of individuals. If all investors had the same information, markets would not work. In such scenario, everybody would invest in the same securities and it would be impossible to make profits. A proof of this is that there are many professionals dedicated solely to gathering information and predicting future results. It is unreal to expect that the individual investor, solely relying on public information, can possibly access the same data as the sophisticated broker. | >
> | Because the design of capital markets is based on the inequality of individuals, the inaccuracy of the idea that securities markets provide equal access to information is self-evident. If all investors had the same information, they would invest in the same securities and it would be impossible for individuals to make profits. While our insider trading laws attempt to make relevant information available to all, only some investors have the tools with which to analyze it. Our securities markets are dominated by individuals whose professional solely to gathering information and predicting future results. The individual investor, solely relying on public information, cannot possibly access the same data as the sophisticated broker. | | | Approaching Reality, Inequality in the Markets | |
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< | The Supreme Court overruled the findings of the Second Circuit more than twelve years later holding that “neither the Congress, nor the [SEC] ever has adopted a parity-of-information rule.” Chiarella v. United States. The reason to prohibit insider trading now was the breach of a fiduciary duty to the corporation and its shareholders incurred on by insiders who traded securities based on material non-public information (“Fiduciary Duty Theory”). As this rule did not reach outsiders of a corporation, the Supreme Court had to go further in its reasoning seventeen years later. In United States v. O’Hagan, the Court held that insider trading liability was based on the misappropriation of confidential information with fraud to the source (“Misappropriation Theory”). The Court also stated that the corporation’s confidential information “qualifies as property to which the company has a right of exclusive use.” | >
> | The Supreme Court felt that in its vigorous enforcement of Rule 10 b-5, the SEC had been overstepped its bounds. It overruled S.E.C. vs. Texas Gulf Sulphur Co. more than twelve years later, holding that “neither the Congress, nor the [SEC] ever has adopted a parity-of-information rule.” Chiarella v. United States. According to the Supreme Court, the reason to prohibit insider trading was the breach of a fiduciary duty to the corporation and its shareholders incurred on by insiders who traded securities based on material non-public information (“Fiduciary Duty Theory”). As this rule did not reach outsiders of a corporation, the Supreme Court had to go further in its reasoning seventeen years later. In United States v. O’Hagan, the Court held that insider trading liability was based on the misappropriation of confidential information with fraud to the source (“Misappropriation Theory”). The Court also stated that the corporation’s confidential information “qualifies as property to which the company has a right of exclusive use.” | | | Arguably, property rights may justify a prohibition on using confidential information to trade in stocks without the acquiescence of the owner. However, as a consequence of this approach, it would be legally permitted to use such information with the consent of the owner. According to the Court “if the fiduciary discloses to the source that he plans to trade on the nonpublic information, there is no ‘deceptive device’ and thus no § 10 (b) violation.” Unfortunately, the Court did not provide further explanations, leaving the door open for lower courts to future interpretations. |
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