Insider Dealing by Outsiders in the US and EU

The prohibition of insider dealing has its origins in US law, the structural features of which have also influenced EU insider law. However, today the dogmatic approaches of the two systems of insider law are diametrically opposed. The European prohibition of insider dealing is based on an equal access theory and thus follows a market-based approach, which contrasts with the relationship-based approach in the US. Insider trading liability in the US is based on SEC-Rule 10b-5 and requires a breach of a fiduciary duty that corporate insiders owe to their company, the issuer, or shareholders (classical theory) or the misappropriation of confidential information, in breach of a duty owed to the source of the information (misappropriation theory). Despite these significant differences in their dogmatic starting points, US law and EU law will in many cases reach the same conclusions.

However, compared to most jurisdictions in the rest of the world, such as the EU which has implemented formal legislation banning insider dealing in accordance with the equal access theory, the US takes a unique approach to insider dealing. Empirical studies provide support for the enactment of formal insider dealing law and its vigorous enforcement. Evidence suggests that countries with stricter formal insider trading laws generally have more informative share prices and more fluid stock markets, while also enjoying a lower cost of capital. As a result, the EU's approach of information parity is generally preferred, as evidenced by the phenomenon of shadow trading.

Especially when dealing with external investors, also known as outsiders, the two legal systems vary in both the way and extent of covered transactions. In the US, the absence of a fiduciary duty for outsiders results in gaps that cannot all be filled through the misappropriation theory. Thus, outsiders such as financial analysts or whistleblowers are typically allowed to trade with confidential information as long as they do not violate any duty owed to the source of the information. This can be helpful for the proper function of capital markets: For instance, the spectacular German Wirecard scandal was uncovered not least because both a financial analyst in the so-called Zatarra Report in 2016 and the Financial Times since 2015 had repeatedly reported on possible balance sheet falsifications. The incentive to publish such information is greater if trading upon this information is permitted.

In contrast, in the EU, dealing in possession of inside information is generally prohibited. The prohibition stems from Art. 8 para. 4 of the Market Abuse Regulation (MAR), which states that investors, regardless of how they acquired the information, are prohibited from dealing upon this information. With this approach, EU insider law might hinder useful transactions by outsiders, such as financial analysts or whistleblowers. Critics argue that the European ban on all forms of insider trading has a negative impact on independent research and analysis. This is because the ban deems it illegal for ‘anyone who possesses inside information’ to exploit the information disparity, leading to a chilling effect. Consequently, the ban unconditionally restricts informed trading and eliminates incentives for further investigation or due diligence to earn profits.

However, financial analysts, whistleblowers, and other outsiders may rely on Recital 28 MAR, when they trade upon inside information which is the result of their research and analysis of publicly available information which other investors were able to obtain themselves. This is consistent with the principle that insider dealing should not be prohibited because another person does not have the same information, but because another person cannot have the same information. Recital 28 sent. 1 MAR thus considers the interest of the capital market in ensuring that market participants without privileged access to information search for price-sensitive information in order to identify arbitrage opportunities. Nevertheless, the impact of Recital 28 MAR is unclear, as the legal status of the Recitals themselves is ‘uncertain’ as opposed to the normative part of the Regulation. Moreover, Recital 28 MAR does not provide a definition of ‘public availability’ of data, which is why only the European Court of Justice (ECJ) can ultimately decide on the correct interpretation of Recital 28 sent. 1 MAR.

Apart from Recital 28, and despite various legislative efforts in the EU, such as Directive (EU) 2019/1937 on the protection of persons who report breaches of Union law or the rule for the reporting of infringements in Art. 32 MAR, whistleblowers still have weak incentives to search for unknown but material information, as they are not rewarded for exposing breaches of the law. Nevertheless, we find that generally allowing insider dealing for whistleblowers would not be an appropriate solution, since trading on non-public material information that is not available to other investors would violate the equal access principle of European insider trading law. The argument that negative information would be incorporated into share prices more quickly as a result of permitted insider trading by whistleblowers is questionable, as whistleblowers could delay the publication of the information until the highest profit potential is reached.

Hence, the European legislator should consider implementing a mandatory system of financial incentives for whistleblowers, where a reward should only be paid if the whistleblowing has resulted in a sanction. This would increase the motivation to report violations of the  MAR to the competent authorities, while also complying with the equal access principle of insider trading law.

While the EU insider dealing prohibition may be overly strict to some extent, its enforcement towards outsiders is sometimes too weak. This is particularly apparent among employees of supervisory authorities or politicians who are involved in legislation, as they often have access to privileged information of numerous issuers. In light of the Wirecard scandal in Germany, employees of the supervisory authority were barred, under Section 11a FinDAG, from trading in financial instruments on a domestic regulated market. However, the issue of insider dealing by politicians has barely been touched on in EU insider law. Contrary to the EU approach, US politicians must report financial transactions if they exceed $1,000. Furthermore, there are even discussions about prohibiting Members of Congress and their close relatives from trading in securities, commodities, and futures, among other things (see ie, the proposed ETHICS Act). These actions aim to bolster the public's confidence in government decisions.

Under EU law, implementing a ban on financial instrument trading for politicians, as proposed by the ETHICS Act, would potentially violate politicians' legal rights as individuals, especially those concerning property. Therefore, such a restriction does not seem to be warranted. It suffices for governments and parliaments to establish monitoring tools through a code of conduct to detect any breaches. One potential strategy could involve modifying the tools already established by EU market abuse laws to identify instances of insider trading and customizing them for politicians, such as developing industry-specific insider lists for politicians or implementing reporting requirements for politicians' transactions.

This post summarizes the key findings of the authors’ article ‘Insider Dealing in the U.S. and EU,’ which was published in the recent issue of the European Company and Financial Law Review (ECFR 2023, p. 692‑716). A working paper is available at SSRN, linked here.

The authors are especially grateful to Klaus J. Hopt and an unknown peer reviewer for their valuable comments.

Dörte Poelzig is a professor of Private Law, Commercial Law and Company Law at the University of Hamburg.

Paul Dittrich is a research assistant and doctoral candidate at the University of Hamburg.