Villanova Law Review, Vol. 45, No. 27, 2000
41 Pages Posted: 17 Oct 2000
This Article discusses the following two questions: (1) Is the act of stock market insider trading (as opposed to the accompanying nondisclosure or lie) a victimless crime? (2) Is stock market insider trading fraud? The Article also briefly addresses two additional questions: (1) When does insider trading or tipping violate federal securities law? (Included is an analysis of the "classical relationship triangle.") (2) Under federal securities law, what are some remedies and sanctions against a stock market insider trader or tipper?
To demonstrate that each act of stock market insider trading has specific, although anonymous, victims, the Article employs two used car analogies: the solitary defect hypothetical and the generic defect hypothetical. In the solitary defect hypothetical, only one automobile is a lemon. In contrast, in the generic defect situation, many individuals are buying and selling cars, all the same year model and all with the same defect.
In the generic defect hypothetical, Mr. Greedie, an executive employed by General Motors, receives material, nonpublic information that all 1998 Cadillacs have a major defect. By coincidence, Greedie personally owns a 1998 Cadillac and immediately sells it to a car dealer.
Assume in the alternative that (1) the dealer does not ask Greedie about any defect, or (2) the dealer asks Greedie about defects, and Greedie LIES. With both alternatives, the problem of demonstrating injury is the same. During the period between Greedie's sale and the time of the defect's public announcement, many individuals are buying and selling 1998 Cadillacs, all with the same defect.
At the time of the defect's announcement, there are a fixed number of 1998 Cadillacs. If Greedie has one less Cadillac at the time of the public announcement, someone else must have one more. That someone is the victim of Greedie's sale. I call this "the law of conservation of used automobiles."
If Greedie's sale of one car on inside information to the automobile dealer causes even a slight lowering of the dealer's prices for 1998 Cadillacs, that decline may dissuade or induce a transaction. In other words, the dealer may pass the injury to another by altering prices and readjusting inventory to the level preferred. If the dealer's prices do not change (or if the price declines fail to dissuade or induce a trade), the loss falls on the car dealer (an induced buyer). Under the "law of conservation of used automobiles," Greedie's sale must induce a purchase or preempt a sale.
The generic defect example resembles stock market insider trading, especially large block trades between an institutional investor and a block positioner. Such block transactions have aspects of face-to-face dealing.
Stock market insider trading has some features of fraud, but differs from traditional fraud in several ways. Disclosure to the party on the other side or to the public may breach other duties. Also, such disclosure would not save the victim of the insider trade if the victim is a preempted trader. Whether a court classifies insider trading as fraud depends in part on whether the court is judicially conservative or activist.
JEL Classification: G18, G28, G38, K14, K22
Suggested Citation: Suggested Citation
Wang, William K. S., Stock Market Insider Trading: Victims, Violators And Remedies-Including An Analogy To Fraud In The Sale Of A Used Car With A Generic Defect. Villanova Law Review, Vol. 45, No. 27, 2000. Available at SSRN: https://ssrn.com/abstract=237803 or http://dx.doi.org/10.2139/ssrn.237803
By Lars Klöhn
By Eric Engle
By Klaus Hopt