How Fatal Ambiguity Undermines Effective Insider Trading Reform

The Journal of Corporation Law, forthcoming

Posted: 31 Aug 2021 Last revised: 18 Jul 2022

See all articles by Kevin Douglas

Kevin Douglas

Michigan State University - College of Law

Date Written: January 21, 2022

Abstract

Lawmakers are building momentum towards codifying our insider trading laws to clarify which kind of trading is illegal. In May 2021, the United States House of Representatives passed the Insider Trading Prohibition Act for the second time in two years. In January 2020, a Securities and Exchange Commission sponsored task force on insider trading released a report containing proposed legislation. Both the House Bill and the task force proposal would prohibit trading while in possession of “wrongfully obtained” information and prohibit trades that involve a “wrongful use” of information. This article explains why the concept of “wrongful” trading is too ambiguous to improve insider trading law and explores the requirements of effective legislative reform.

This article is the first to identify the confusion in the law as a symptom of two conceptual problems—one at the doctrinal level and one at the policy level. The doctrinal confusion is caused by the attempt to simultaneously invoke two conflicting concepts of “fairness.” One is a property-based fairness that protects exclusive use rights in inside information. The other is an equal opportunity-based fairness that expects equal access to all material information for all market participants. The policy confusion is caused by economic models that rely on two contradictory definitions of “economic efficiency.” One is “allocational efficiency,” which focuses on maximizing wealth. The other is “market efficiency,” which focuses on whether all investors (1) trade at the correct price (the same price), (2) have equal access to all available information, and (3) generate equal risk-adjusted profits. Conflating these incompatible doctrinal and policy concepts causes officials to unintentionally oscillate between protecting private rights and fostering specific forms of economic equality.

This article recommends clarifying insider trading law by specifying whether consent is a defense against liability. Making consent a defense against liability is in harmony with a property-based fairness doctrine and the policy goal of maximizing wealth. Barring consent as a defense against liability is in harmony with an equal opportunity-based fairness doctrine and the policy goal of correcting market prices. Enforcing only one fairness doctrine allows everyone to attempt to privately adhere to both principles while successfully applying one of the principles through law.

Keywords: insider trading, economic efficiency, allocational efficiency, market efficiency, fairness, securities regulations, unjust enrichment, business opportunities, economic equality, economic distribution

JEL Classification: B26, B30, B31, G14, G14

Suggested Citation

Douglas, Kevin, How Fatal Ambiguity Undermines Effective Insider Trading Reform (January 21, 2022). The Journal of Corporation Law, forthcoming , Available at SSRN: https://ssrn.com/abstract=3912868 or http://dx.doi.org/10.2139/ssrn.3912868

Kevin Douglas (Contact Author)

Michigan State University - College of Law ( email )

318 Law College Building
East Lansing, MI 48824-1300
United States

HOME PAGE: http://https://www.law.msu.edu/faculty_staff/profile.php?prof=1112

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