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The Missing Link between Insider Trading and Securities Fraud


Richard A. Booth


Villanova University School of Law

March 2007

U of Maryland Legal Studies Research Paper No. 2007-15

Abstract:     
In a recent article, I argued that diversified investors - the vast majority of investors - would prefer that securities fraud class actions under the 1934 Act and Rule 10b-5 be dismissed in the absence of insider trading or similar offenses during the fraud period. See Richard A. Booth, The End of the Securities Fraud Class Action as We Know It, 4 Berk. Bus. L. J. 1 (2007), http://ssrn.com/abstract=683197. In this article, I draw on the classic case, SEC v. Texas Gulf Sulfur Company, to show that the federal courts originally viewed securities fraud as inextricably connected to insider trading and that the recognition of separable causes of action has caused much of the difficulty in this area. I argue that the federal law of insider trading fails to capture many of ways that insiders can misappropriate stockholder wealth. For example, timing and backdating in connection with stock option grants likely do not constitute insider trading but likely do constitute misappropriation. Thus, I here address the question of how to define misappropriation of stockholder wealth in the context of a derivative action based on securities fraud. I conclude that the question is essentially one of state law fiduciary duty that should be decided by state courts under the emerging duty of candor. Although this solution raises potential conflicts with federal law in general and SLUSA in particular, I argue that these conflicts are no different from conflicts that arise in many state law cases that touch on issues of disclosure. Moreover, I argue that handling such claims under state law is more consistent with the federal statutory scheme and ultimately preferable to developing or maintaining a separate body of federal law addressing either securities fraud or insider trading.

Number of Pages in PDF File: 22

Keywords: securities fraud, class action, derivative action, direct action, stock options, timing, backdating, insider trading, misappropriation, fiduciary duty, diversification, disgorgement, SLUSA, duty of candor, zero sum, negative sum, deadweight loss, 1933 Act, 1934 Act, Rule 10b-5, 16(b)

JEL Classification: G3, K22, K41

working papers series


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Date posted: April 3, 2007  

Suggested Citation

Booth, Richard A., The Missing Link between Insider Trading and Securities Fraud (March 2007). U of Maryland Legal Studies Research Paper No. 2007-15. Available at SSRN: http://ssrn.com/abstract=975949 or http://dx.doi.org/10.2139/ssrn.975949

Contact Information

Richard A. Booth (Contact Author)
Villanova University School of Law ( email )
299 N. Spring Mill Road
Villanova, PA 19085
United States
6105197068 (Phone)
610595672 (Fax)
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