Defining 'Material, Nonpublic': What Should Constitute Illegal Insider Information?

59 Pages Posted: 2 Oct 2015

See all articles by Cindy A. Schipani

Cindy A. Schipani

University of Michigan, Stephen M. Ross School of Business

H. Nejat Seyhun

University of Michigan, Stephen M. Ross School of Business

Date Written: September 2015

Abstract

The statutory penalties for illegal insider trading have become almost as severe as first-degree murder, yet we see insiders make tens of thousands of lucrative transactions every year. Moreover, the increase in penalties over time has done little to slow down insider trading. We argue that the resolution of their paradox lies in understanding the concept of material, non-public information. As long as there is no clear definition of what is illegal under the statutes, insiders and tippees will continue to trade profitably, with little to fear from seemingly draconian sanctions.

To prevent further abuse of insiders’ informational privileges, we offer a new evidentiary presumption. We propose that the a prima facie case for illegality be found upon proof that: 1) the information giving rise to the trade is of the type that requires an 8-K filing by the corporation; 2) upon announcement, it must lead to statistically significant abnormal stock returns; and 3) the insider trading must have occurred within two months prior to the announcement of the information. Of course, our presumption does not cover all possible instances of insider trading and it is not intended to be comprehensive. For instance, insiders may trade on material, nonpublic information and yet, they may still end up losing money due to unexpected circumstances. Insiders may also exploit long-lived information beyond two months. Our objective is to provide a prima facie presumption of what is always considered material, nonpublic information, similar to Rule 14e-3, which has declared takeover-related information to be always material and nonpublic. We expect that other types of trading will still fall in a grey area and will need to be resolved through a fact-finding process. Yet, we expect additional clarity will allow all insiders who want to be on the safe side of the law the ability to ensure that their transactions do not meet any of the conditions set forth above.

Keywords: insider trading, corporate and securities law, corporate governance

JEL Classification: K22, G30, G34, G38, K14, M14

Suggested Citation

Schipani, Cindy A. and Seyhun, H. Nejat, Defining 'Material, Nonpublic': What Should Constitute Illegal Insider Information? (September 2015). Fordham Journal of Corporate and Financial Law, Forthcoming, Ross School of Business Paper No. 1287, Available at SSRN: https://ssrn.com/abstract=2668162

Cindy A. Schipani (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI 48109
United States
(734) 763-2257 (Phone)
(734) 763-2257 (Fax)

H. Nejat Seyhun

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-763-5463 (Phone)

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