Duty-Free Insider Trading?

Abstract

Until recently, the enforcement of insider trading violations was generally less robust outside the United States because of the limited sanctions, resources, and powers available to regulators abroad.  This situation is slowly changing, especially in the United Kingdom, where the Financial Services Authority has begun to police the offense vigorously.  However, the approaches to regulating insider trading and market abuse differ fundamentally across the Atlantic.

In the United States, the offense is not statutorily defined.   It is based on judicial and administrative interpretations of a broad securities antifraud statute and accompanying U.S. Securities and Exchange Commission rules, which is reminiscent of a common law approach.  The offense can be either criminal or civil, and because it is derived from an antifraud statute, it has been interpreted by courts as requiring a showing of intent.  In the European Union, the offense of insider dealing was defined in a detailed statutory directive known as the Market Abuse Directive, which has been implemented through legislation by the EU Member States.  In addition to defining the offense statutorily, the U.K. and EU regimes differ from the U.S. antifraud framework in that the offense is premised on the concept of parity of information; there is no requirement that there be deceptive or misleading conduct, or breach of a fiduciary duty or similar relationship of trust and confidence.  The parity-of-information approach was urged by the Securities and Exchange Commission but explicitly rejected by the U.S. Supreme Court in Chiarella v. United States as too broad in scope, given that Rule 10b-5, the rule allegedly violated, is grounded in fraud.  Under the parity-of-information approach, the focus is on the information the person trading has, not how he or she obtained it from his or her source, or whether or not he or she intended to violate the law.

Recent cases in the United Kingdom and in the United States highlight how punishable behavior in one regime may not constitute a violation in the other.  Given the inefficiency of overlapping and conflicting regulations, the growing globalization of markets, and the tendency to apply antifraud prohibitions extraterritorially, the strengths and weaknesses of the U.S. and U.K. regimes should be evaluated with an eye to adopting a common approach in an area critical to market integrity.  We conclude that the United States should enact a statutory rule of law based on the parity-of-information approach in the European Union, being sensitive, however, to protecting trading activity based on information obtained through legitimate and socially valuable independent research, a goal addressed by the U.K. framework.