Archives For Steve Bainbridge

Robert Jackson recently discussed an SEC staff ruling that the ordinary business exception for shareholder proposals under Rule 14a-8 did not justify excluding a proposal recommending that the board disclose and let shareholders vote on its policies related to corporate political spending. Jackson opines that “the decision will help bring corporate political speech decisions into line with the interests of shareholders” in the wake of the Supreme Court’s Citizens United decision. 

Meanwhile, Jackson’s article with Bebchuk, Corporate Political Speech: Who Decides? 124 Harv. L. Rev. 83 (2010), proposes going beyond merely permitting shareholder recommendations under 14a-8 to, among other things, majority shareholder voting on corporate speech decisions.

The idea of bringing corporate political speech into line shareholder interests sounds unobjectionable until you ask, “which shareholders?” As I discuss in my recent paper, First Amendment and Corporate Governance, shareholder voting on corporate speech could amplify activist business skeptics while muting the diversified shareholders who would prefer that business views be heard.  

There’s also the clash between diversified and non-diversified pro-business shareholders.  The latter may prefer rules that facilitate costly wealth transfers between firms, while the former want only corporate acts and legal rules that maximize the value of their entire portfolios.

And then we could ask why shareholders’ interests should matter more than those of other stakeholders, particularly including employees, whose political interests may sharply diverge from those of shareholders with broadly diversified portfolios.

The most likely effect (and possible intent) of requiring shareholder voting on corporate contributions would be to burden and therefore reduce corporations’ ability to speak at all.  This could promote government censorship of corporate speech, precisely what the Supreme Court said in CU the First Amendment didn’t permit.  

I note in my article that it’s far better to delegate business decisions regarding corporate political spending, like others, to the board. I, of course, cite Steve Bainbridge (who posts to similar effect).  Corporate law provides many ways to deal with directors who act contrary to corporate interests, including fiduciary duties and shareholder exit.  This discipline may be imperfect, but it doesn’t work worse for corporate speech than for other types of decisions where managers’ interests conflict even more directly with those of the corporation.   

The main point to emphasize here is that there is no special free speech reason to protect shareholders from managerial control of corporate speech.  If anything, the arguments cut the other way.  Government control of corporate speech surely raises some voices, and therefore some ideas, above others.  And legislators and regulators seek to promote their own interests, which is the First Amendment’s main concern.

The bottom line is that First Amendment should constrain government regulation not only directly of corporate political speech, but also of the governance processes that produce it. The SEC’s 14a-8 ruling and Bebchuk and Jackson’s proposals would move securities regulation toward a confrontation with the First Amendment that has been brewing since 1933.  See my article with Butler, Corporate Governance Speech and the First Amendment, 43 U. Kans. L. Rev. 163 (1994).

Steve Bainbridge discusses a Delaware chancery suit by a Berkshire-Hathaway shareholder against former B-H executive David Sokol for profits he earned by buying Lubrizol stock ahead of his former employer. Steve analyzes state law, concluding

I am unaware of any Delaware precedent holding that a state law cause of action for breach of fiduciary duty lies when the facts fit within the misappropriation framework. It would not be surprising if such a cause of action existed, however. In effect, when an executive misappropriates information and uses it to make a profit by trading in the stock of a potential takeover target the executive has usurped a corporate opportunity. 

Steve explains why this could be true even if Buffett knew about the trades because Sokol should have gotten board approval.

I basically agree with Steve’s analysis.  But this raises another question, as I noted when Sokol’s trades were disclosed:

[W]hat should federal law have to do with all this?  The “hook” for federal securities liability is the trading in Lubrizol — but the breach of duty that triggers liability has to do with the details of Sokol’s dealings with Buffett and Berkshire.  This, as I’ve said before, is appropriately a matter of state law.  See my article, Federalism and Insider Trading, 6 Supreme Court Economic Review, 123 (1998).

With all of the attention being given to insider trading by hedge funds and malfeasance by corporate executives, it’s worth reminding ourselves that the politicians who seek to impose discipline are themselves no angels.

An important study published seven years ago revealed that U.S. senators were reaping returns from stock trading that strongly suggested they were trading on an informational advantage. Profits depended on their seniority, and therefore, presumably, power to influence legislation.

This led to a legislative proposal (the STOCK Act) aimed at prohibiting this trading.  Steve Bainbridge has written an article supporting this prohibition with some modifications.  He argues (footnote omitted):

Congressional insider trading thus is undesirable, in the first instance, because it creates incentives for members and staffers to steal proprietary information for personal gain. The massive increase in federal involvement in financial markets and corporate governance as a result of the financial crisis of 2008 has made opportunities to steal such information even more widely available to government officials. Second, it gives members and staffers incentives to game the legislative process so as to maximize personal trading profits. Third, inside information can be utilized as a pay-off device. Fourth, it gives members and staffers incentives to help or hurt firms, which distorts market competition.

It will not surprise the cynical that the act was not swept to adoption by the regulatory fever with which Congress has been seized in recent years. Congress apparently is so worried about corruption by corporate money it can’t be bothered with its own conflicts of interest

When STOCK was originally proposed I wrote:

Congress’s insider trading is bad because it gives our lawmakers the wrong incentives. Do we really want to give Congress more reasons to hurt and help particular firms?  In fact, Congress’s trading is worse than trading by corporate insiders, which at least might be rationalized as a way to let employees cash in on their productive efforts.

Indeed, one might even argue that trading on non-public knowledge is bad mainly when it’s done by politicians.  As long as this trading doesn’t interfere with property rights in information, it encourages socially productive investigation and monitoring, as Bruce Kobayashi and I have argued. If it does interfere with property rights, it can be handled by contract and state law rather than by a sweeping federal law (see my Federalism and Insider Trading, 6 Supreme Court Economic Review, 123 (1998)).

But should we ban Congressional trading?  It’s not really classic insider trading because it doesn’t involve theft of information belonging to somebody else.  Also, as I said in my original post, “it might even be a good idea to require them to own stocks (say, index funds) to encourage them to think like shareholders rather than politicians.”  I also noted in a later post that “[f]rom a purely market standpoint, we should actually want this trading, because it brings information into the market.” 

I added in this post that there would be severe problems with any regulation of Congressional trading, just as there is with insider trading generally:

our dynamic and liquid markets provide infinite opportunities to use information; and the information Congress has is so damned useful. Just about everything Congress does has some implication for some part of the market, and possibly the whole market. (Is a legislator who knows about an impending GM bailout ok if he trades in any stock but GM?) Congress people can decide not to act as well as to legislate.  

Even if we prohibited all trading by Congressmen, what about tipping?  Richard Painter notes that there will still be private briefings for campaign contributors: 

If for example, the government is going to help labor at the expense of bondholders in a particular bailout, should government officials be permitted to tell allies in organized labor this information before it is disclosed to securities markets? If so, labor leaders and investment funds they control have a potential to gain a lot more than preferential treatment in the bailout.

Hedge funds, of course, will want to nose around these briefings. Even after the current hedge fund insider trading trial has been concluded, it will still be legal for traders to fit together “mosaics” of immaterial non-public facts.  

And who will enforce the law?  The highly tainted post-Madoff SEC?  Congress itself?  Its inaction on the STOCK Act after five years indicates Congress’s zest for regulating in this area.

As if we needed more complications, along comes new evidence (HT WSJ) (Eggers and Hainmueller, Political Capital: The (Mostly) Mediocre Performance of Congressional Stock Portfolios, 2004-2008). Here’s the abstract (emphasis added):

We examine stock portfolios held by members of Congress between 2004 and 2008. The average investor in Congress under-performs the market by 2-3% annually, a finding that contrasts with earlier research showing uncanny timing in Congressional trades. Members also invest disproportionately in local companies and campaign contributors, and these “political” investments outperform the rest of their portfolios (local investments beat the market by 4% annually). Our findings suggest that informational advantages enjoyed by Congressmen as investors arise primarily from their relationships with local companies, and that widespread concerns about corrupt and self-serving investing behavior in Congress have been misplaced.

The authors explain the discrepancy with the prior study primarily as a “result of a reduction in the informational advantages of members of Congress between the period they study (1993-1998) and the period we study (2004-2008), a decrease in members’ willingness to act on these informational advantages (perhaps because of increased scrutiny applied to their investments), or simply a change in luck.”

The authors argue that Congressmen’s advantage regarding local companies results from their ability “to make judgments about the quality of senior corporate management and other hard-to-observe characteristics of local and other connected firms by virtue of their extensive interactions with these firms in the course of campaigns and lobbying.

In other words, based on this study:

  1. Congress is making perfectly legal and efficiency-enhancing judgments about corporate management.
  2. “Our study does not inspire much confidence about the average financial savvy of members of Congress, outside of the performance of their local investments (which after all constitute only about 6% of the average member’s investments). Even considering the strong performance of members’ local investments, they could have conserved their own wealth, and insulated themselves from ethical questions as well, by cashing in their stock holdings and buying passive index funds instead.”

Based on all of the above, here’s what I would suggest:

  1. Let Congress invest. It not only gives them a stake in their regulation, but also takes advantage of their legitimate informational advantage.
  2. Educate Congress about the capital markets.  It would help their legislation and prevent them from dying poor.
  3. Protect against corruption by mandating disclosure not only of trades but also tips.  In other words, as little as I like Regulation FD, there might be some benefit to imposing something like it on Congress. It seems from comparing the two stock market study that Congress was deterred from the worst insider trading by the scandal of several years ago.  This indicates that disclosure will have an effect.  Moreover, a simple prohibition just drives the trading underground, inhibiting enforcement and losing the market efficiency benefits of the trade.
  4. Reduce opportunities for all kinds of corruption, including by trading.  In other words, as I said in my most recent post on Congressional trading, we should

decrease government involvement in the economy. That is, after all, the source of the insider trading problem, and it has been exacerbated by the government’s increasingly acting like a private firm in buying up huge chunks of the formerly private sector.

In short, the solution to this problem, like the solution to many other problems, is less government.

As Steve Bainbridge recently noted:

Obama said . . . that making the U.S. more competitive means investing in a more educated work force, committing more to research and technology, and improving everything from highways and airports to high-speed Internet.

He observes that a better way to increase U.S. competitiveness is by changing the law rather than spending money, and cites his own recent corporate law paper as one possible approach.

I agree and have my own papers on increasing competitiveness by changing process rules to foster jurisdictional competition:

Here’s the abstract of the second paper:  

This essay, prepared for a book on the effect of regulatory, liability, and litigation inefficiencies on the global competitive position of the U.S., focuses on the role of the US federal system. We show that, although multiple US states offer significant potential for jurisdictional choice to address misguided or inappropriate law, this system is only a partial solution to these problems and can itself be a source of bad law and excessive litigiousness. Federal law and enforcement of contractual choice-of-law, choice-of-court, and arbitration clauses provide some, but only partial, relief. As a result, choice of law and jurisdiction rules potentially expose firms that do business nationally or internationally to oppressive law in any of the US states. Without reform of the rules regarding jurisdictional choice the US is losing an opportunity to exploit the edge in international competition it might get from its federal system.

These process-related suggestions could create a more dynamic economy that encourages private markets to innovate, which can generate real growth over time.  Bureaucratic decisions to fill potholes and choose which research ideas are worth funding may or may not be productive and surely will be expensive.  Take your pick.

Henry G. Manne is Dean Emeritus of the George Mason University School of Law and Distinguished Visiting Professor at the Ave Maria School of Law.

The SEC is at it again, scandal mongering insider trading.  As usual this is the “biggest insider trading case yet,” as if they were trying for some Guinness record.  Since this story will be in the financial press for months and months to come, the well informed spectator – or participant – will want to understand that a lot of what is thought to be known about insider trading “ain’t necessarily so.”

1) Insider trading injures the stock traders who buy from or sell to the insider.

False: these outsiders are voluntarily transacting in an anonymous stock market and would be there and make or lose about the same amount regardless of the identity of the other party.

2) Legalizing insider trading would cause a great loss of confidence in the integrity of the stock market and thereby reduce capital investment, liquidity and trading.

False: Empirical studies strongly contradict this, and a robust stock market in the United States before the late 1960’s (when serious enforcement began) or in the rest of the world today (where serious enforcement has yet to begin) denies this.

3) Sensible enforcement of insider trading laws is feasible.

False: the ever larger, politically inspired, and inevitably unproductive SEC campaigns against insider trading demonstrate that significant enforcement is not only difficult, it is practically impossible.  And this is to say nothing of the logical impossibility of policing gains made by an insider’s knowing when not to buy or sell, a purely mental transaction that can never be policed.

4)  The SEC’s high-tech detection methods uncover illicit trading.

False: This claim has been made by the SEC from the beginning and is apparently not much more true today than it was fifty years ago.  Use of informants and wire tapping are the methods by which the SEC does most of its policing.

5)  There are no net social or economic costs to partial enforcement of these laws.

False:  The individuals who might be desirably motivated in their work by the right to trade on inside information are displaced (because they are so easily spotted and targeted by the SEC) by individuals with no claim to the value of the information but who are more difficult to identify and convict.

6)  We need regulation since the corporation itself has a property right in the information it produces, and the government can better protect this right than can the individual corporations.

False:  If the corporation had a real property right, then it could opt out of the regulation and allow its insiders to trade, something the SEC has steadfastly resisted.  And even if the government could enforce the rule more efficiently (highly dubious), there is no justification for this subsidy to certain companies.  (Even Steve Bainbridge gets this one wrong.)

7)  Insider trading does not contribute to the efficiency of stock market pricing.

False:  All trading has some marginal effect on price, and by definition any informed trading pushes the price in the correct direction, some of it quite noticeably and very quickly.  There are conflicting findings in the empirical literature on the strength of the short-term price effect of insider trading. But this probably reflects  differences in the pricing process resulting from varying trading and market conditions.  Further, nearly all empirical studies in this field are based on data representing legal and reported insider trading, a decidedly inappropriate way to measure the effect of illegal insider trading.

8)  If insiders are trading, market makers will have to broaden their bid-ask spreads and thus charge more to all traders.

False:  Careful research on this point concludes that market makers on stock exchanges do not feel harmed by the presence of insiders in the market and do not adjust their spreads in response.

9)  There is a clear definition of “insider trading” and of the level of “materiality” required for a violation of the law.

False:  Neither the SEC nor Congress has ever defined “inside information”, nor has either succeeded in specifying the level of significance the information must have to be the subject of a criminal violation.

10)  It is easy to distinguish the information insiders use illegally from that analysts secure in the legitimate course of their work.

False:  This line is so grey and the potential rewards so great that the line is easily and regularly overstepped, either inadvertently or intentionally.  The present prosecution is apparently based to some extent on the notion that assembling many small pieces of non-material information into a single “mosaic” of valuable information is illegal. Just what is it that the SEC wants analysts to do?

11)  Allowing trading on bad news as well as on good will create an incentive for executives to create bad news.

False:  All the motivating vectors in the market for managers point them in the direction of trying to increase their company’s stock price not lower it, and these pressures would overwhelm any slight increase in adverse motivation from insider trading.

12)  The criminalization of insider trading has no effect on the compensation of corporate employees.

False: Recent research demonstrates that when the right to trade on information is denied to executives, they must be paid additional compensating sums to substitute for this loss.  This must partially account for the enormous increases in executive salaries, bonuses and stock options we have witnessed in the past thirty years.

13)  Individuals within the company who were not responsible for the good news may profit from the knowledge and, therefore, insider trading serves no valuable reward function.

False: While it is very difficult to design an efficient compensation scheme to encourage innovation, allowing insider trading by everyone aware of new developments will create a corporate culture of innovation and risk taking without requiring the enormous option plans and bonuses currently used, which incidentally, and unlike insider trading, come out of the shareholders’ pockets.

14)  The SEC has studied the economics of insider trading and applied rigorous economic analysis to the phenomenon.

False:  If they have, they have certainly failed to disclose this significant bit of information to the public or to make any intellectual sophistication apparent.

15)  Fuzzy notions of fairness have a place in serious discussions of the economic costs and benefits of regulation.


Lynn Stout, writing in the Harvard Business Review’s blog, claims that hedge funds are uniquely “criminogenic” environments.  (Not surprisingly, Frank Pasquale seems reflexively to approve):

My research, shows that people’s circumstances affect whether they are likely to act prosocially. And some hedge funds provided the circumstances for encouraging an antisocial behavior like not obeying the laws against insider trading, according to these investigations.

* * *

Recognizing that some hedge funds present social environments that encourage unethical behavior allows us to identify new and better ways to address the perennial problem of insider trading. For example, because traders listen to instructions from their managers and investors, insider trading would be less of a problem if those managers and investors could be given greater incentive to urge their own traders to comply with the law, perhaps by holding the managers and investors — not just the individual traders — accountable for insider trading. Similarly, because traders mimic the behavior of other traders, devoting the enforcement resources necessary to discover and remove any “bad apples” before they spoil the rest of the barrel is essential; if the current round of investigations leads to convictions, it is likely to have a substantial impact on trader behavior, at least for a while. Finally, insider trading will be easier to deter if we combat the common but mistaken perception that it is a “victimless” crime.

Rather than re-post the whole article, I’ll direct you there to see why she thinks hedge funds are so uniquely anti-social.  Then I urge you to ask yourself whether she has actually demonstrated anything of the sort.  Really what she demonstrates, if anything, is that agency costs exist.  Oh, and people learn from their peers.  Remarkable!  And this is different than . . . the rest of the world, how?  There are Jewish people in the world, a lot of them work on Wall Street, and many of them attend synagogue.  No doubt Jews mimic the behavior of other Jews.  Bernie Madoff was Jewish.  The SEC should be raiding temples all across New York, New Jersey and Connecticut!

The point is that she has no point, and directing her pointless observations toward hedge funds in particular is just silly (and/or politically expedient).  There are bad apples everywhere.  There are agency costs everywhere.  A police state could probably reduce the consequences of these problems (but don’t forget corruption (i.e., bad apples) in the government!).  The question is whether it’s worth it, and that requires a far more subtle analysis than Stout provides here.

And all of this is because insider trading really needs to be eradicated, according to Stout:

Of course, insider trading isn’t really victimless: for every trader who reaps a gain using insider information, some investor on the other side of the trade must lose. But because the losing investor is distant and anonymous, it’s easy to mistakenly feel that insider trading isn’t really doing harm.

Actually, the reason most people feel that insider trading isn’t really doing harm is because it isn’t.

I’ll leave the synopsis of the argument to Steve Bainbridge.  On the adverse selection argument, see Stanislav Dolgopolov.  Sure, there is debate.  Empirics are hard to come by.  But the weight of the evidence and theory, especially accounting for enforcement costs (one study even seems to suggest that making insider trading illegal actually induces more insider trading to occur (and impedes M&A activity)), is decidedly against Stout’s naked assertion.  The follow on claim that, in essence, agency costs justify stepped up dawn raids at hedge funds is even more baseless.

Free to Choose: Day 1 Wrapup

Josh Wright —  6 December 2010

I’ve compiled links to the excellent posts from day 1 in here, or you can go to the Free to Choose Symposium tab at the top of the blog.

Tomorrow’s lineup should be more of the same, including posts from Claire Hill, Erin O’Hara, Todd Henderson, Tom Brown, Kevin McCabe, Steve Bainbridge, Christopher Sprigman & Christopher Buccafusco, Judd Stone, and myself (individually and jointly with Douglas Ginsburg).

Here are the posts thus far:

December 6th

Josh Wright, Introduction

David Friedman, Behavioral Economics: Intriguing Research Project, With Reservations

Larry Ribstein, Free to Lose

David Levine, Behavioral Economics: The Good, The Bad, and the Middle Ground

Henry G. Manne, Behavioral Overreach

Geoffrey A. Manne, Interesting Doesn’t Necessarily Mean Policy Relevant

Thom Lambert, Behavioral Economics and the Conflicting Quirks Problem: A “Realist” Critique

Christopher Sprigman & Christopher Buffafusco, Valuing Intellectual Property

Judd E. Stone, Misbehavioral Economics: The Misguided Imposition of Behavioral Economics on Antitrust

Ronald Mann, Nudging From Debt

Richard Epstein, The Dangerous Allure of Behavioral Economics: The Relationship Between Physical and Financial Products

One problem with a group blog is that you don’t always know what your co-bloggers are writing while you’re drafting a post.  I drafted the following post without realizing that Larry (and Steve Bainbridge) had already gone to town on the matter — in more detail than I, not surprisingly.  In any event, I’m posting my draft, which may be of interest to readers who aren’t as well-versed in insider trading law.  The excellent Ribstein and Bainbridge posts are here, here, and here.

The Wall Street Journal is reporting that the Feds (the SEC, the FBI, and federal prosecutors in New York) are about to bring a host of insider trading charges “that could ensnare consultants, investment bankers, hedge-fund and mutual-fund traders and analysts across the nation.”  The authorities, which have been investigating the situation for three years, are boasting that their criminal and civil probes “could eclipse the impact on the financial industry of any previous such investigation.”   

The charges haven’t been filed, so we don’t know exactly who’s being accused of what, but the Journal suggests that the probe has focused on at least three matters.  First, the Feds have examined whether traders received material, non-public information about pending merger deals.  Second, authorities have focused on the activities of independent analysts and research boutiques.  In addition, they have investigated firms that provide “expert network” services to hedge funds and mutual funds.  Such firms “set up meetings and calls with current and former managers from hundreds of companies for traders seeking an investing edge.”     

The first focus — insiders’ sharing of information about pending merger deals and tippees’ trading on the basis of such information — seems pretty uncontroversial.  As a legal matter, the insiders owe a fiduciary duty to the shareholders whose stock is being traded, and in trading that stock (or effectively enlisting an accomplice tippee to do so) without first disclosing the information at issue, the insiders are failing to speak in the presence of a duty to do so.  That’s fraud, and the tippee-traders are liable as accomplices.  While I would generally prefer an approach that permits companies to establish their own insider trading policies and leaves it to capital markets to punish the value-destructive ones and reward those that enhance value, the ban on this type of insider trading is easiest to defend as a matter of policy:  An insider or tippee who trades in advance of a merger may cause a price effect that thwarts or impairs the merger deal, thereby harming the corporation and its shareholders.  Even if we left insider trading to contract, as I would prefer, I imagine that most firms and shareholders would bargain for a policy that bans trading on the basis of non-public information about a forthcoming merger.

The second and third focuses (foci?) of the Feds’ current probe, though, are more troubling.  Again, we don’t know why the feds are currently going after independent analysts, research boutiques, and firms providing “expert network” services, but we do know that they have a long history of opposing legitimate stock analysis that gives certain traders an informational advantage over others.  In the 1968 Texas Gulf Sulphur case, for example, the SEC maintained (and convinced the Second Circuit to hold) that the mere possession of material, non-public information saddles an investor with a duty to disclose that information before trading or to refrain from trading altogether.  The Supreme Court ultimately rejected such a broad imposition of the so-called “disclose or abstain” duty, recognizing that the Texas Gulf Sulphur approach would ultimately hurt investors by disabling the securities analysis business.  Analysts, after all, make money by ferreting out material, non-public information and conferring informational advantages on their clients.  Their efforts, coupled with the trading of their informed clients, make stock markets more efficient, meaning that stock prices more accurately reflect the true value of the underlying companies.  By making stock prices more accurate, analysts help prevent uninformed investors from losing their shirts when undisclosed information shocks the market.  While I wouldn’t exactly call it the Lord’s work (not after the Lloyd Blankfein blunder, at least), securities analysis is awfully good for society and shouldn’t be discouraged.

The SEC, though, didn’t give up after its first Supreme Court smackdown.  Just three years later, the Commission went after a “tippee” (Dirks) who had shared inside information with others who traded.  The inside information concerned the fact that the corporation at issue had engaged in serious accounting fraud and was consequently overvalued.  The tippee had learned about the fraud from an insider who sought the tippee’s assistance in exposing the fraud (which, incidentally, the SEC had failed to discover on its own).  The SEC took the position that the tippee “inherited” the insider’s fiduciary duty not to trade (or tip to others who might trade) because he had received information from an insider — in other words, merely receiving non-public information from an insider essentially transforms one into an insider himself.  Again, the Supreme Court rejected the SEC’s broad liability net.  Noting again that the SEC’s rule would impair the securities analysis industry, the Court held that a tippee inherits an insider’s duty to disclose or abstain only if (1) the insider breaches his duty of loyalty in sharing the information (i.e., the insider shares the information to get a personal benefit) and (2) the tippee knows or should know of the breach.

The Supreme Court’s Dirks decision threw yet another wrench into the SEC’s campaign to put all investors on a level playing field when it comes to information (market efficiency be damned!) because it seemed to allow corporate insiders to share material, non-public information with stock analysts.  In sharing non-public information with the analysts following their firm, insiders aren’t generally seeking a personal benefit, so the test for tipping isn’t satisfied and the analysts and their clients wouldn’t inherit the insiders’ duties.  The SEC therefore responsed by promulgating Regulation FD, which requires corporate insiders who share data that could consitute material, non-public information to also share that information with the general public.  If the information-sharing is intentional, the public must be informed contemporaneously with analysts; if information is unintentionally given (i.e., a “slip-up”), the general public must be promptly informed.

That sounds fair enough, right?  Well, sure.  But that fairness comes at a cost.  Since Regulation FD was adopted, corporations have become more leery of sharing information with analysts — those folks whose efforts best protect investors by ensuring that stock prices accurately reflect underlying values.  Spontaneous analyst conversations are impossible because corporations now have to publicize calls, provide call-in information to the public, etc.   When analysts need help interpreting data, or if they have follow-up questions after an analyst conference, insiders generally won’t answer their questions.  And, of course, analysts are now less interested in participating in analyst conferences, since the information being shared (with the general public) is less valuable.  As Anup Agrawal, Sahiba Chadha, and Mark Chen have shown, the result has been a reduction in the accuracy of individual and consensus analyst forecasts on corporate performance and an increase in the dispersion among forecasts.  Again, the SEC’s attempt to put investors on a level playing field seems to have impaired one of the most effective form of investor protection out there — the sell-side analyst industry.  (NOTE:  Larry has written lots of good stuff on Reg FD.  Here‘s a link to a list of posts from Ideoblog.) 

So what to make of this latest SEC/FBI/DOJ investigation?  We won’t really know until we see the allegations.  But in light of the SEC’s relentless pursuit of the securities analysis business over the years, I’m a bit worried that the current probe is focusing largely on analysts, research boutiques, and firms providing expert network services.  We shall see….

Yesterday in criticizing a federal crackdown on insider trading I noted that “[a]ll of this theater can’t hide the dubious public policy underlying these prosecutions.  Insider trading is, at worst, a breach of fiduciary duty which, like other such breaches, can be dealt with under state law.”

Steve Bainbridge, an expert on insider trading, responds:

I think insider trading is theft of information and is punished for precisely the same reasons that we punish other forms of theft of property.

Yes, that’s what I said.  The question is whether we need federal criminal liability for this.  On this point Steve quotes his book:

Where public policy argues for giving someone a property right, but the costs of enforcing such a right would be excessive, the state often uses its regulatory powers as a substitute for creating private property rights. Insider trading poses just such a situation.

Firms’ self-enforcement would be excessive, Steve says, because “the police powers available to the SEC, but not to private parties, are essential to detecting insider trading.”

Not “essential.” Private firms could track trading, just as they now extensively track much market activity. They may pick up less than does the SEC, but then the question boils down to the costs and benefits of the SEC’s extra enforcement powers. Moreover, this argument still doesn’t justify the penalties the government can bring to bear once the insider trading is detected, and which were at the heart of my criticism of these prosecutions. 

It’s because of the weakness of the misappropriation basis of insider trading liability that I gave the government the benefit of the doubt and made the standard argument about increasing spreads.  But Steve doesn’t seem to buy that argument. 

In any event, it’s still necessary to determine whether any benefits of federal enforcement of insider trading liability are worth the cost.  I noted the information benefits of trading on non-public information.  Steve says “I don’t buy it,” and cites his book.  But in the cited pages the book says:

it is significant that a more recent and widely-cited study of insider trading cases brought by the SEC during the 1980s found that the defendants’ insider trading led to quick price changes.231

231: Lisa K. Meulbroek, An Empirical Analysis of Illegal Insider Trading, 47 J. Fin. 1661 (1992).

The problem, according to Steve, is that the insider trading’s mechanism for affecting securities prices “functions slowly and sporadically. Given the inefficiency of derivatively informed trading, the market efficiency justification for insider trading loses much of its force.”

There’s no cite for the “inefficiency of derivatively informed trading,” and I don’t know what it means.  If insider trading informs stock prices, the “force” of the argument depends on measuring this benefit against the cost of insider trading enforcement. 

Finally, Steve agrees with my main point that “criminalizing this conduct and unleashing aggressive publicity-seeking prosecutors to enforce the criminal laws is particularly dubious.”

What this debate with a leading expert on insider trading shows is that we’re a long way from the kind of clarity on the wrongfulness of insider trading that would justify the harsh government rhetoric and tactics discussed in my previous post.

Steve Bainbridge has a post on this Florida Supreme Court case, which has started a major debate on revising the LLC charging order remedy.  This might sound a bit arcane, but it actually has significant consequences for the use of LLCs as an asset protection device.  For the full LLC background, see my earlier post and my article on the general problem.

Al Franken buys the old idea that corporate managers have a duty to maximize shareholder value. Todd Henderson appropriately sets Franken (and others ignorant of corporate law) straight. Todd reminds them that the business judgment rule gives managers the flexibility to do pretty much what they want, including help society, as long as they don’t self-deal. Steve Bainbridge adds some detail and wonders whether good faith might qualify this conclusion.

The Franken misconception is widely espoused by those in the radical anti-corporate camp, such as the author of the widely read screed The Corporation. That book and its adherents characterize corporations as psychotic amoral monsters driven to a “pathological pursuit of profit” (the subtitle of the book). This bolsters their argument that corporations, being monsters, shouldn’t have First Amendment rights.

Todd notes that corporations are free to do pretty much what we, the owners, managers and other parties to corporate contracts, want them to do, subject to regulation. As I have argued extensively in my article, Accountability and Responsibility in Corporate Governance, the major constraint on corporations is not law but markets.

This is why the corporate social responsibility debate is largely empty. While many corporate social responsibility proponents argue for giving managers more legal freedom to serve society’s needs, managers already have that freedom.

What the proponents really want but don’t always say is to give managers freedom from market discipline. But as I show in the above article markets already discipline managers to act in society’s interests. Giving managers more freedom would give them more freedom to act in their own interests. Do we really need that?

David Zaring has noted

that courts have formed an unimportant part of the financial crisis interventions by the government, and that the end of the Supreme Court’s most recent term suggests that it gets to matters years, if not decades, after they have become settled law one way or the other.

Steve Bainbridge responds:

The very nature of their social role precludes judges from being proactive regulators. They can make law, of course, but they can’t do so without an actual case or controversy to use as a vehicle for doing so. Finding a case that has the right facts and the right procedural posture to make new law can take quite a while. This is especially true for the SCOTUS, of course, since it can take years for cases to find their way through the lower court system.* * * And, of course, the judiciary is the least accountable branch. If you’re going to be in a position to plunge the entire world economy into a depression, you ought to be democratically accountable.

I agree with Steve. Indeed, I find the view that the Supreme Court is “unimportant” because it doesn’t keep up with the news rather surprising. The Court lays general ground rules. It is not for many reasons the appropriate institution for setting social policy in reaction to current events.

But this doesn’t end the discussion, because the Court could still be unimportant if it does not serve its ground-rule-making role well – that is, if it shies away from making hard decisions for political reasons.

However, in my column this week for I argue that the Court has been important this term precisely because it has bucked anti-business political winds in making or reinforcing Constitutional rules that serve business’s long-term interests. After discussing the regulatory excesses that have followed the financial busts at the beginning and end of this decade, I summarize the Court’s actions this term, concluding:

In a single term, despite widespread popular support for punishing and restricting corporations and their agents, the Court admonished Congress that it had to respect the structure of government and draft criminal statutes clearly, noted the dangers of court interference in business decisions, restricted the international reach of the securities laws and, perhaps most importantly, ensured that business’s voice would be heard in future lawmaking. The Court demonstrated that it can be a good friend to business in bad times.

These decisions accord with my prediction last February in the course of a Federalist Society debate on Citizens United. Barry Friedman noted that the decision’s timing was “inauspicious as a public relations move,” coming just as “the public generally is up in arms about financial matters, corporations, money in politics, and the like.” I responded that “Justices Scalia and Kennedy are both approaching 74 and might not survive eight Obama years. Perhaps the time to correct Austin is now or never.” I continued:

[T]he very thing that makes the political moment wrong arguably makes the judicial moment right: corporations are under political siege and need the Constitution more than ever. This returns to my theme that this case is at least as much about corporations and business as it is about the First Amendment. It will be interesting to apply this political theory to decisions due later this term on mutual fund executive compensation (Jones v. Harris) and Sarbanes-Oxley (FEF v. PCAOB). The Citizens United majority might be inclined to ensure in the PCAOB case that separation of powers protects business from unwise regulation in a hostile political environment. On the other hand, the Court may go with the political environment on executive compensation in Jones where no strong Constitutional principle is at stake.

This is, of course, precisely what happened, not only in these cases but in the others I summarize in my Forbes post. At the same time, the Court did not ignore political considerations: Its decisions went no further than absolutely necessary to make the important structural points. The Court, for example, refused to completely throw out the “honest services” rule and preserved Sarbanes-Oxley. Although I complained about the latter decision at the time it came out, here I want to emphasize that the Chief Justice compensated rhetorically for the case’s modest result:

Our Constitution was adopted to enable the people to govern themselves, through their elected leaders. The growth of the Executive Branch, which now wields vast power and touches almost every aspect of daily life, heightens the concern that it may slip from the Executive’s control, and thus from that of the people.

This is precisely the sort of concern with general ground rules I predicted in the Federalist Society debate.

In short, in business cases at least, the Court has gotten its role exactly right, and this role has been far from unimportant.

Update: David Zaring thinks my post “is an interesting way to characterize what has been going on.”