When Should You Abstain? A Call for a Global Rule of Insider Trading

Abstract

The picture is so pervasive in the financial media—the CEOs of two major public corporations announcing the closure of a cross-border mega-merger—that one might be led to believe that securities regulations around the world, which govern the timing at which the information about the merger becomes material, are identical. However, this is an optical illusion that hides existing crucial differences in the determination of what constitutes material information. Although securities regulations tend to be generally harmonized, this Article sheds light on significant differences in the rules governing the definition of what is material information with regard to unfolding future events. Most notably, these rules determine the timing at which information about a potential future event becomes inside information and triggers insider trading prohibitions.

In the U.S., the probability/magnitude test has been developed to determine when a developing event becomes material information. In the E.U., a bright line test applies. The different tests imply that the same information can potentially be classified as material at different times depending on the applicable rule. Ultimately, the European regulation is more relaxed and consequently European insiders have the opportunity to trade in corporate securities based on their private information, thereby gaining an unfair advantage over uninformed market players. This Article shows that the interjurisdictional differences create a propensity for undesirable arbitrage and insider trading and undermine cross-border financial investments, as well as optimal corporate governance in transnational corporations. The Article also explains why a global test is much needed and why the U.S. probability/magnitude test should be adopted because it is the superior rule in terms of increasing investor confidence in the integrity of stock markets.

Keywords: insider trading, securities regulation, materiality, disclosure, cross-border mergers and acquisitions, corporate governance