Comments on “Disclosure of Inside Information”
Comments
on “Disclosure of Inside Information”
Written by Georgios Marios Roussos
US and
European laws always had a lot in common. Incidentally, the same can be claimed
about their legislation on disclosure of inside information. As Gevurtz (2018)
wrote, the differences regarding insider trading prohibition “are a
manifestation of a broader difference between
their cultural attitudes concerning income
inequality”. This essay will elaborate on the key points of the paper written
by Ms. Payne, by underpinning the elements of MAR and its contradictions with
the US legislation.
To begin with, the main points of divergence derive from their fundamentals. On one hand, US law is
based on the breach of fiduciary duty (Ventoruzzo, 2014). In the US, in most instances, it is necessary
to have solid proof of a breach in the law. In addition to that, as the US regulation
of insider trading is based on case law and administrative regulation enforced
by the SEC, it has become highly complex and sometimes contradictory, since it
is continuously evolving since the 1934 Exchange
Act was issued. US District Judge Rakoff
criticized the nature of the US legislation as being ambiguous, since not only
it is “judge made-law” but also there is no federal statute that defines the
concept of insider trading (Fisher,
2017).
On the other hand, EU
laws on disclosure are closely linked with the efficient market hypothesis.
According to Annunziata (2016)
the current EU market abuse discipline is based on the fact that investors are
rational and the market is semi-efficient, thus always in equilibrium and
sensitive to price changes. Nevertheless, this argument can be criticized for
various reasons. Firstly, a market which behaves efficiently has a rather low
volume of trading, a fact that is not supported by empirical evidence. In
addition to that, retail investors who can be considered “noise traders” do not
affect the market if it is efficient enough. However, nowadays retail investor
trading sums up to 20% of the total volume of equity trading in the US (Martin et al., 2021). The recent
example of GameStop underlines the inefficiency of the current market, and the
fact that it can easily be manipulated. Lastly, there is a branch named “behavioral
finance” which explains investor’s decisions, which at first glance may seem an
anomaly if tested against ECMH[TMLG1] . For
instance, overconfidence or belief perseverance are forms of cognitive bias, preventing
an investor from being rational.
A characteristic example that highlights the
divergence mentioned before, is the different treatment between two similar
cases, that of Einhorn and Cuban. In both cases, CEOs contacted the shareholder
to request
their contribution in the upcoming stock offering. Nevertheless, both
counterparties, after objecting to the plans, got rid of their shares in the
market before the announcement of the offering. To be more precise, Einhorn
sold a significant portion of its holdings in Punch Taverns. This sale helped
the fund he represented to avoid losses of 5.8 million pounds. Although no NDA
was signed, the FSA[TMLG2] imposed a
3.6 million pounds on Einhorn and
Greenlight, as it claimed that a professional’s
duty is not to benefit from information even though it may not be clearly
characterized as “inside”. In the latter case, the SEC was unable to convince
the jury that Cuban had committed not to sell his shares before the public offering,
since once again no NDA was signed. Thus, no violation of the law was proven,
and no sanctions were imposed (Gevurtz,
2018).
Another
vital point of conflict concerns the meaning of market abuse and their approach
towards preventing it. On one hand, the European law has a much broader sense,
which creates a few topics that need clarification. First, there is a lot of
uncertainty on the term “inside information”. To be more specific, the term is
considered vague, since it is sometimes impossible to determine what
constitutes inside information, thus frequently forcing issuers to costly
premature disclosures (Deutsches
Aktieninstitut, 2019). In addition,
the market egalitarianism promoted by European law leads
to the diminishment of analyst incentives since everyone would receive
information at the same time (Payne,
2019). Furthermore, the fact
that mandatory disclosure should be done “as early as possible” may not only
create litigation risks for companies but also potentially damage the company’s
ability to conduct its business. For instance, early disclosure may worsen the
negotiation power of a company in case of a M&A deal or a sale of its major
holdings. Lastly, MAR[TMLG3] is
criticized due to the grey area regarding the processing of financial and
accounting data (Annunziata, 2020).
In other words, MAR does not clearly specify the treatment – whether they are considered inside information or not – of the so called “raw” accounting, such as specific items
in the income or balance statement.
To assess
the efficacy of both market abuse regimes, it is of important to identify and
review some recent empirical evidence of regulatory failures. To start with,
the newest inside trading scandal in the US involves members of the United
States Senate (2020 congressional insider trading scandal - Wikipedia, 2021).
Multiple Senators allegedly violated the Stock Act, as they sold stocks just
before the global pandemic boom (they used the information they had received at
a closed Senate meeting). In total, 4 Senators disposed over 5 million worth of
shares as to avoid losses. Nevertheless, no sanctions were imposed to any of
them as there was no hard proof, which, as already mentioned, is required by
the US law. Moreover, what must be underlined is that only since 2013 has there
been a legislation issue – named “Stock Act” – that prohibits members of the
Congress from using non-public information. Lastly, it
is important to mention that although in general the US authorities are more
active on prosecuting insider trading, in 2019, the SEC charged only 46
defendants with inside trading: the lowest since 1994 (Dreisbach, 2020). This number is particularly worrying since not
only the SEC’s budget has quadrupled in the last three decades but also
according to experts there is no evidence that can justify a behavior shift in
the US which could explain the fewer cases.
With
regards to the European environment, there have recently been a few cases of
insider trading, mainly in the UK, involving employees in high profile
companies such as Goldman Sachs and UBS. It is important to specify that since
Brexit, “UK MAR”
has been imposed on the UK (like the European MAR). Furthermore, there has been
an abrupt increase in the red flags concerning potential market abuse since the
covid situation has provided both incentives (Avoidance
of huge loses) and the possibility (Work from home) to exploit inside information. In
more detail, the market was filled by suspicious trading, especially in the
case of equity trading, as investors were trying to cope with the high levels
of illiquidity and volatility (Martin
et al., 2021). Nevertheless, what must be pointed out is that the purpose
of this research is not to highlight all cases of inside trading but only those
that related to discrepancies in the legislation concerning market abuse.
Consequently, it requires much more extensive examination and maybe even
reviewing cases ex post to assess if the cases of inside trading are linked to
inefficiencies of the EU legislation and whether disruptive consequences were
prevented because of it.
Concluding, the aim of this paper was to
compare and criticize the market abuse regulation of Europe and US. We conclude
that to ensure equal opportunities and confidence in the market, the EU law
outweighs the US counterparty. Nevertheless, in our opinion it is important
that changes are made as to induce it with the knowledge gained from the branch
of behavioral finance. One final insight of this article is our proposal for another
change in the current legislation. Based on previous reasoning, we argue that
companies should be split in two tiers in accordance with their size. Tier 2
companies, composed my SMEs, should be imposed a more lenient disclosure
regulation as to relief them from the unsustainable costs.
References
1.
Annunziata, F., 2020. ‘Madamina, Il Catalogo E’ Questo…’. the
Duty to Disclose Inside Information and the Proper Organization of the Company:
The Market Abuse Regulation (‘MAR’) and Italian Company Law. SSRN
Electronic Journal.
2.
Annunziata,
F., 2016. Behavioural Finance
and Markets Efficiency: Is There a Dialogue? A Preliminary Reflection on
Regulation 596/2014/EU. [online] Ssrn.com. Available at:
<https://ssrn.com/abstract=2956245>
3. Dreisbach, T., 2020. Under
Trump, SEC Enforcement Of Insider Trading Dropped To Lowest Point In Decades.
[online] Npr.org. Available at:
<https://www.npr.org/2020/08/14/901862355/under-trump-sec-enforcement-of-insider-trading-dropped-to-lowest-point-in-decade?t=1616464304397>
4.
En.wikipedia.org.
2021. 2020 congressional insider trading scandal - Wikipedia.
[online] Available at:
<https://en.wikipedia.org/wiki/2020_congressional_insider_trading_scandal#>
5.
Deutsches
Aktieninstitut, 2019. Review of EU Market Abuse Regulation – Main
Issues from the Perspective of Listed Companies. [online] Esma.europa.eu.
Available at:
<https://www.esma.europa.eu/file/53585/download?token=2vQn44ij>
6.
Fisher,
D., 2017. U.S. Falling Behind
Europe On Insider Trading Law, Rakoff Says. [online] Forbes. Available at:
<https://www.forbes.com/sites/danielfisher/2017/03/01/u-s-falling-behind-europe-on-insider-trading-law-rakoff-says/?sh=7f3b8dbb7bfd>
7.
Gevurtz,
F., 2018. The Road Not Taken:
A Comparison of the E.U. and U.S. Insider Trading Prohibitions. [online]
Washington University Open Scholarship. Available at:
<https://openscholarship.wustl.edu/law_journal_law_policy/vol56/iss1/9/>
8.
Martin,
K. and Stafford, P., 2021. ‘Red flags’ over
market abuse rise at asset managers during lockdowns. [online] Ft.com.
Available at: <https://www.ft.com/content/d673e643-1f05-4071-af6e-f4089ed6bb3b>
9.
Martin,
K. and Wigglesworth, R., 2021. Rise of the retail
army: the amateur traders transforming markets. [online] Ft.com. Available
at: <https://www.ft.com/content/7a91e3ea-b9ec-4611-9a03-a8dd3b8bddb5>
10. Payne, J., 2019.
Disclosure of Inside Information. SSRN Electronic Journal.
11. Ventoruzzo, M.,
2014. Comparing Insider Trading in the United States and in the European Union:
History and Recent Developments. SSRN Electronic Journal.
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