Academic journal article Fordham Journal of Corporate & Financial Law

Proposals for Insider Trading Regulation after the Fall of the House of Enron

Academic journal article Fordham Journal of Corporate & Financial Law

Proposals for Insider Trading Regulation after the Fall of the House of Enron

Article excerpt

"We have always known that heedless self-interest was bad morals; we know now that it is bad economics."

I. INTRODUCTION

In the landmark decision of SEC v. Texas Gulf Sulphur Co.,2 the United States Court of Appeals for the Second Circuit found that an elemental fraud had been committed when corporate insiders3 profited from securities transactions at the expense of an unwary and uninformed public.4 The court noted that trading by corporate insiders on the basis of material non-public information frustrated "the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information."5 But is this expectation realistic?

Certainly not all traders in the impersonal marketplace have the same ability, background, knowledge or sophistication in business and financial matters, nor do they have the same access to material corporate information.6 The ordinary day trader cannot call the chief financial officer of a major public company and chat with her about the affairs of the business, as can the securities analyst for a major brokerage house.7 Some traders have large, well-paid, sophisticated and talented staffs to study and investigate the intricacies of various businesses and industries.8 Some traders are more insightful, more skillful, and frankly better investors than others.9 Inequality among investors is a basic reality of the marketplace.

To attract and keep investors over the long term, however, securities markets must be perceived as taking place on a level playing field, with rules (securities laws) and referees (the Securities and Exchange Commission ("SEC")) to keep the game fair.10 To support this objective, securities laws have evolved to address the uneasy tension between marketplace confidence and the legitimate needs of corporate insiders to purchase and sell their company's securities.11 The reality is that corporate insiders will almost always have better insight into the affairs of their employers than will the average investor.12 Thus, the mere possession of material non-public information is not, in and of itself, a bar to trading.13 All learning on the bedrock law of insider trading flows from this principle.

II. HISTORICAL PERSPECTIVE

Insider trading has not always been limited by law. Prior to the New Deal reform legislation of the 1930s, specifically the Securities Act of 1933(14) ("Securities Act") and the Securities Exchange Act of 1934(15) ("Exchange Act"), legal prohibitions against trading by corporate insiders were either non-existent, covered by state securities laws, or founded on common law theories of fraud.16 Trading on United States securities markets, which dates from the earliest days of the republic, was an open, unregulated affair.17 As trading was predominantly limited to select groups of merchant and investment bankers, regulation was largely self imposed.18

The development of the impersonal securities market began gradually, but it is clear that it dates at least from the period after the Civil War.19 The growth of railroads and the large industrial enterprises of the industrial revolution necessitated obtaining capital from greater segments of the general population than just the big city investment and merchant bankers.20 Thus, by the turn of the twentieth century, securities markets had grown, largely unregulated by any statutory or administrative oversight.21 Just as a downhill skier gains speed, the pace of trading grew faster as greater numbers of investors, fueled by an increasing prosperity, flocked to the securities markets.22 By the 1920s "playing the market" had become a national obsession.23

As the obsession turned into the nightmare of the stock market crash of 1929, and the country slid from prosperity through recession to economic depression, some perspectives began to emerge from the debacle. One such perspective that endures to this day is that if confidence and trust are to be restored to the securities markets, the investing public must correctly perceive that the securities markets are indeed a level playing field, and that investors privy to information not available to the investing public will not use that information to gain an advantage. …

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