The Road Not Taken
A utility of comparative law is that it sometimes allows us to see the impacts of different choices regarding legal rules without performing a ‘Gedanken experiment’. In an essay written for a symposium on insider trading in the Washington University Journal of Law and Policy, I make this use of comparative law by exploring the different paths taken by the United States and the European Union with respect to who is subject to the prohibition on insider trading.
Early in the 1960s, the United States established what appears to be the world’s first prohibition of trading on inside information. While lower United States courts in the 1960s and 70s stated that ‘anyone in possession of material inside information’ must disclose the information or abstain from trading, the United States Supreme Court, in a series of decisions starting in 1980, cabined the prohibition under United States law to (i) insiders trading in their own company’s stock, (ii) parties trading on information they misappropriated through the pretense that they could be trusted not to abuse the information, and (iii) persons tipped by an insider or misappropriator when the insider or misappropriator received a benefit from providing the information for trading. By contrast, the 2003 European Union Market Abuse Directive and the 2014 European Union Market Abuse Regulation, much like earlier lower court decisions in the United States, prohibit trading on non-public price sensitive (material) information by anyone who knows or ought to have known that he or she is trading on such information.
The difference between US and EU law shows up in a number of cases over the last few years, including the prosecutions of Mark Cuban in the United States and David Einhorn in England. These prosecutions involved very similar facts, but produced diametrically opposite results. In both cases, the CEOs of companies planning to raise money by issuing more stock approached large current shareholders to gauge the shareholder’s reaction. Both Cuban and Einhorn objected to the dilution and sold prior to public announcement of the stock offerings. Cuban was exonerated because he had not agreed to abstain from selling (and hence had not misappropriated the information through the pretense of such an agreement), whereas the UK FSA (now FCA) fined Einhorn despite the undisputed lack of any such agreement by Einhorn, or an intent by the CEO to provide information for trading.
The difference between US and EU law raises the question of whose law will apply to a trade. The US prohibition reaches trades in the United States, but also, for government prosecutions, (i) situations in which conduct constituting a significant step in the furtherance of fraud occurs in the United States; or (ii) conduct outside the United States that has a foreseeable substantial effect in the United States. Application of these criteria to insider trading (which is considered to be fraud when illegal) is far from clear. The EU prohibition is geared to whether the trades either involve securities listed for trading on European exchanges or, more broadly, trading in securities whose price impacts, or is impacted by, the price of securities listed on European exchanges, as, for example, American Depository Receipts. Interestingly, in prohibiting insider trading outside of Europe when the trades involve securities whose price is impacted by the price of securities traded in Europe, the EU regulation goes beyond the accepted bases under international law for prescriptive jurisdiction, since it reaches situations in which there is neither conduct nor effect in Europe.
Finally, the difference between US and EU law allows some normative observations. The EU experience does not seem to show any readily apparent negative consequences for market efficiency, as often feared by opponents of an insider trading prohibition built on an equal access rule (although the search for more subtle effects would make an interesting project for financial economists employing empirical methods). From a broader societal fairness perspective, the difference between the US and EU approaches might be another instance in which the United States and Europe differ in dealing with forces (such as insider trading) contributing to the growing income inequality between the well-connected haves and the less connected have-nots in society.
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