Insider Trading: Should It Be Abolished?

Topics: Stock market, Stock, Economics Pages: 5 (1669 words) Published: August 15, 2010
Insider Trading: Should it be abolished?

Insider trading is defined as “ trading whilst in possession of non-public information and if known to the public, may lead to a substantial movement in a security’s price” . In Australia it is prohibited by insider trading regulation (IT regulations) in the Corporations Law (CL) 1991 , though it was initially established from recommendations made by the Rae committee in 1974 on the mining company scandals . The latest law changed one single section to 20 wide and complex sections, causing critique of Australia IT regulations . Henry G Manne argued that IT regulations should be abolished supported by three basic economic arguments. This essay will examine the pro and contra of each argument and shows that IT regulations have spoiled the notion of fairness at the expense of efficiency, despite the objective of any securities markets regulation to promote both aspects .

1. Insider trading could compensate corporate entrepreneurs . Pro and Contra
This argument is supported by Carlton and Fischel who argued that the IT regulations are the same with setting government regulation of terms and conditions of employment; similar to restrict salary bonuses, stock options, vacation leave, and the others which can motivate management for their entrepreneurial skills . However their assumptions ignore the difference between the volatile share price and a certain amount of normal compensation. As argued by Easterbrook, where there is a volatile share price, the management compensation argument reverts into a “lottery-ticket argument” . Because in the volatile share price, even informed traders will hardly predict the increase or decrease of share price in the future. The high fluctuation equalizes the possibility of losing their investment and getting profit, which as called ‘compensation’. From the two extremes, It can be concluded that compensation argument can be valid if the share price is relatively stable otherwise not all insiders can get their compensation through insider trading.

Director’s fiduciary duty to Shareholder
However, if IT regulation were only applied for a liquid market, what is the role of fiduciary duty? In Exicom’s case fiduciary argument was established where persons who are subject to a legal relationship of trust and confidence, arising from either a prior relationship with the securities issuer (typically directors, employees and corporate agents) or the other party to trade should not make a profit from that position or allow a conflict of interest to arise. Moore supports IT regulation on the basis of fiduciary duty. He reasons that directors have some fiduciary duty to their shareholder to fully disclose all information they could benefit from. His idea is supported by the fact that although there is no general principal that directors owe fiduciary duty to shareholders (in addition to the company), with the purpose to prevent directors when in the position of holding confidential information to spread the it to outsiders , such duty in recognized in Hooker’s case .

Sub Conclusion
Insider trading as a compensation for corporate executive is argued only happened in a stable market where they can use the information to predict the trend otherwise the profit compensation turn to be a lottery compensation. Here fiduciary duty of the insiders is questioned where in Hooker’s case it is possible that directors owe fiduciary duty to shareholder although there is no general principal on it.

2. Insider Trading Contributes to Market Efficiency
Pro from Leland and Estrada
Manne argued that ‘allowing an unfettered market in information will have salutary effects unheard of in connection with regulatory “disclosure”’ . Recently, Leland and Estrada also stated similar idea that insider trading contributes to market efficiency through signaling where signal-trading by insiders pushed share price more quickly towards its equilibrium price.

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