A Unified Theory of Insider Trading Law
51 Pages Posted: 3 Sep 2016
Date Written: August 31, 2016
When an insider trades in his own corporation’s stock while in possession of material non-public information, courts apply what is called the “classical theory” of insider trading. This theory is the foundation of U.S. insider trading law. It has been invoked in every court opinion on the subject for the past three decades. Yet, this Article argues that the theory is an unqualified failure. The reason? Because the theory fails to do what a theory must, which is to explain settled law and provide answers to unsettled law that are intuitively appealing.
We need a new theory for the classic case of insider trading, and the best candidate for the job is staring us in the face – the misappropriation theory, which historically has only applied to insider trading involving corporate “outsiders,” is superior to the classical theory. It does a better job explaining what courts actually do in classical insider trading cases. And with respect to those issues that are still open, it yields results that are more intuitively appealing. Replacing the classical theory with the misappropriation theory would have the effect of unifying insider trading law, resulting in a single theory applicable to both insiders and outsiders alike.
To be sure, for some commentators, the misappropriation theory's main drawback is its so-called “brazen fiduciary problem,” the fact that, under that theory, the trader can avoid insider trading liability by simply pre-disclosing to the board an intention to trade. However, I argue that this infirmity can be largely mitigated with a simple disclosure rule, promulgated by the SEC, which would require boards of public companies to disclose any such notice received by the board.
The unified (misappropriation) theory of insider trading law that I argue for here would bring much needed clarity to this doctrinal area. It would also promote values, including consistency and predictability, which are essential for the rule of law.
Keywords: insider trading, securities regulation
JEL Classification: G14, K22
Suggested Citation: Suggested Citation