In the increasingly interdependent national securities markets, the regulation of insider trading activity has taken on increasing importance. Universal recognition of the illegality of such activity may one day lead to universal prohibition and enforcement across national boundaries. However, today national regulation and enforcement regimes vary in their laws and enforcement of insider trading. The following is a description of cooperative efforts between national regulators to coordinate international efforts in this area.
PART I. INTRODUCTION
The securities markets(1) of both the advanced industrial and developing market economies have undergone dramatic change in recent years. This change has taken the form of both globalization(2) and integration(3) of these markets, creating "internationalized" markets(4) out of formerly purely national ones. While this development has been heralded as a boon to the investment community,(5) it has created a fundamental problem for the national regulators of securities markets on how to apply purely national securities laws and regulations to international securities transactions that may involve foreign national investors, foreign national issuers, and foreign national markets as well as those of the regulator's own country. This problem involves both issues of substance (e.g., the applicable body of law, the conduct of the investigation, and the gathering of evidence) as well as procedure (e.g., the existence of jurisdiction, the exercise of jurisdiction, and the service of process).
The problem of securities regulation and enforcement in international markets is particularly acute for the principal U.S. regulatory body, the
Securities and Exchange Commission (SEC). Because of the size and
sophistication of U.S. capital markets, the U.S. securities regulatory regime exerts substantial influence on the behavior and regulation of foreign and international securities markets.(6) Further, by allowing financial innovation and facilitating international capital mobility, the U.S. regulatory system has increased the operational efficiency of securities markets.(7) This has lead to increased international securities issuance and trading. "The SEC repeatedly has stated . . . that it is seeking to encourage and foster the development of international capital markets, and that it believes such development should occur in both the primary and secondary trading of securities."(8) The SEC and its fellow regulatory bodies have attempted to develop responses to deal with internationalized markets. This note will outline the responses to a particularly salient problem: insider trading in publicly registered securities.
Part II describes the internationalization of the securities markets. Part III discusses the regulation of insider trading in the United States and the problems that internationalization has caused for U.S. regulators. Part IV deals with the major regulatory responses, of both the SEC and foreign regulators, to the challenges posed by international insider trading. Part V concludes that the most advanced cooperative effort at insider trading
regulation, the European Economic Community Directive on Insider Trading (EEC Directive), while attempting a harmonized approach to regulation, falls short of its goal and represents primarily the mutual recognition of distinct national insider trading legislation.
A. The Phenomenon of Internationalization
The internationalization of commercial activity as a phenomenon has gained increasing currency in the economic, political, and legal discourse of our time. This is so because although international trade has been important historically, its rate of growth accelerated tremendously in the 1970's and 1980's, exceeding the underlying rate of economic growth. For example, while world commodity output grew at an average rate of just over four percent between 1963 and 1982, world exports grew at an average rate of just under six percent.(9) This may not seem dramatically different, but the compounding effect of small differences in growth rates can have large absolute effects over time.(10) Thus, exports grew from about 7.5 percent of global GNP in 1971 to over fifteen percent of global GNP by 1980.(11)
Accompanying this growth in international trade has been the emergence of the transnational actor or entity, which does not merely trade goods and services internationally, but rather, conducts its own operations in many different countries. These multinationals utilize local organizational-legal structures that are tied together by a shared capital structure.(12) As these shared capital structures have conducted financing activities, they have discovered that international securities offerings raising capital from investors of many different nationalities, provide access to more capital at lower costs.(13)
The increasing utilization and importance of international capital formation is apparent in a number of ways. The first is the sheer growth in international debt and equity issuance. Between 1980 and 1986, international bond issues(14) increased from $38.3 billion to $225.4 billion.(15) Although less important as a source of capital, international equity issuance also has grown dramatically. For example, offerings of equity in Europe by foreign issuers(16) amounted to $11.8 billion in 1986 compared to only about $200 million in 1983.(17)
Secondly, the importance of liquidity to successful capital formation(18) has led to increased secondary market activity by investors in markets outside the investor's home country.(19) This is represented by the increasing absolute value of international transactions. For example, foreign activity in U.S. stocks has grown from $26 billion in 1975 to $277 billion in 1986, while U.S. activity in foreign stocks has grown from $3 billion to $102 billion over the same period.(20) Likewise, foreign activity in U.S. debt securities has grown from $26 billion in 1975 to $2.3 trillion in 1986, while U.S. activity in foreign debt securities has grown from $11 billion to $336 billion over the same period.(21) This developing global market has been characterized as a market that: has no national boundaries, to which participants--be they investors, issuers, borrowers, or savers--from all over the world have access, in which price is established by supply and demand from around the world, not from a single domestic market, and in which transactions can be affected on a twenty-four hour basis or close to it.(22)
B. Factors Influencing the Internationalization of Global Securities
According to the SEC staff report on the internationalization of securities markets, the unprecedented pace of the internationalization of the world's securities markets is the result of a number of specific factors or developments in the global economy. These factors include: (1) the technological advances in communications and operations;(23) (2) the removal of restrictions on foreign participation by many of the world's securities markets;(24) (3) the rapid economic change that influenced investor and issuer behavior during the 1970s and 1980s;(25) and (4) the financial innovation in securities products and services.(26) Another factor not specified in the SEC staff report, but seen generally as a justification for internationalizing the world's securities market is the efficient markets hypothesis.(27)
The development and application of advanced technology in communications and computers to the securities industry has dramatically improved the conduct of international investment; more specifically, the trading systems of modern securities markets are being transformed.(28) The ability to trade the same security sequentially on Asian exchanges, European exchanges, and North American exchanges has created essentially a twenty-four hour trading day in certain "world class" securities.(29) Additionally, the ability to obtain price quotes and execute trades in a security simultaneously on different securities exchanges creates competition between and among national markets.(30) Finally, such inter-market competition has been recognized and formalized by inter-market linkages that transmit pricing between exchanges and execute trades at the most competitive prices available.(31)
The removal of restrictions on foreign participation in many of the major securities markets has also contributed to the globalization trend. This has been part of a process of liberalization and deregulation of advanced markets and economies generally, which has facilitated market access and attracted new investors.(32) Beginning with the "May Day" deregulation of commissions by the New York Stock Exchange on May 1, 1975, this process of deregulation and liberalization has spread globally, typified by London's "Big Bang" of October 1986. The "Big Bang" radically changed the structure of the British securities market, Europe's largest, by ending fixed commissions to encourage international investment.(33) Other examples of economic liberalization include foreign membership on international stock exchanges, the elimination of tax disincentives, the relaxation of foreign exchange controls, and the resultant easing on the international transfer of funds.(34)
The dislocations that the rapid economic change of the 1970s caused to financial markets, and the innovation in financial products and services that developed to deal with these dislocations on investors, provided further impetus to internationalization. First, the collaspe of the fixed exchange-rate system in 1972 created the need for currency management techniques like hedging to eliminate the currency risk in international business transactions.(35) Second, the great transfers of wealth that resulted from the rise of OPEC as a major force in oil pricing in the early 1970s necessitated the development of international investment mechanisms for OPEC member countries to recycle and increase real wealth in excess of their domestic investment needs.(36) At first, these countries turned to the private banks,(37) but in the 1980s, the trend toward securitization of capital financing, and away from bank loans, channelled much of the world's investment into securities markets.(38) This provided the liquidity lacking in the private banking relationships that had exacerbated the debt crises of the early 1980s.(39) AS the SEC Staff Report explained, "#r]educed inflation contributed to the desire by investors, particularly institutional investors, to hold bonds or equities rather than bank deposits.(40)
Such economic developments led to innovation in financial products and services:
In the 1970's and 1980's the world's capital markets were strained by significant macroeconomic events that resulted in greater volatility in interest rates, inflation and exchange rates. Large shifts in global investment preferences occured following the dramatic fluctuations in world oil prices. These events, which occurred over relatively short periods of time, spawned financial innovation as market participants sought to cope with changes in the world's capital markets.(41)
Various investment products arose from interest rate swaps, to currency swaps, floating rate notes, options and futures, stock and bond indexes, and index futures and options.(42) These products are frequently created on a competitive basis by national exchanges.(43) They allow international investors to reduce volatility and risk, but at the same time they represent a threat to national regulation as investors funnel investment to markets that permit product development in an unfettered environment.(44)
Increased investor demand explains this increased supply of innovative financial instruments. The volatility of exchange rates, interest rates, and equity prices resulting from rapid economic change causes the prudent investor to diversify internationally. The investor "will seek to spread investment exposure over various economies and thereby reduce portfolio risk. Globalization thus compensates for volatile markets."(45)
A final factor in the internationalization of securities markets has been the development of the financial theory that views internationl diversification of investment portfolios as an important means of risk reduction and return enhancement.(46) A period of significantly higher returns for U.S. investors in foreign markets bolstered this theory and increased its acceptance. In an address before the SEC Internationalization Roundtable on February 17, 1987, James M. Davin, of the National Association of Securities Dealers, noted that …