Bradley, Caroline

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Rethinking Insider Trading Regulation

Bradley, Caroline

University of Miami: Scholarship Miami

University of Miami School of Law

University of Miami Law SchoolUniversity of Miami School of Law Institutional RepositoryArticles Faculty and Deans2015Rethinking Insider Trading RegulationCaroline BradleyUniversity of Miami School of Law, cbradley@law.miami.eduFollow this and additional works at: https://repository.law.miami.edu/fac_articlesPart of the Securities Law CommonsThis Article is brought to you for free and open access by the Faculty and Deans at University of Miami School of Law Institutional Repository. It hasbeen accepted for inclusion in Articles by an authorized administrator of University of Miami School of Law Institutional Repository. For moreinformation, please contact library@law.miami.edu.Recommended CitationCaroline Bradley, Rethinking Insider Trading Regulation, JOTWELL (May 11, 2015) (reviewing Yesha Yadav, Insider Trading inDerivatives Markets, 103 Georgetown L.J. 381 (2015) and Yesha Yadav, Structural Insider Trading, Vanderbilt Law and EconomicsResearch Paper No. 15-8 (March 27, 2015)), http://corp.jotwell.com/rethinking-insider-trading-regulation/.Rethinking Insider Trading Regulationhttp://corp.jotwell.com/rethinking-insider-trading-regulation/* Yesha Yadav, Insider Trading in Derivatives Markets, 103 Georgetown L.J. 81 (2015)* Yesha Yadav, Structural Insider Trading, Vanderbilt Law and Economics Research Paper No. 15-8(March 27, 2015), available at SSRN.Caroline BradleyThe question of distinguishing between the informational advantages insiders and outsiders may and may notlegitimately exploit in trading in the financial markets is perennial: is securities regulation about achieving alevel playing field for investors or about imposing sanctions for certain fiduciary and fiduciary-like breaches ofduty which go beyond traditional remedies for such breaches. The Second Circuit's decision in US v Newmanemphasizes the fiduciary duty component of liability: at least in a criminal case involving tipping by insiders"the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosedconfidential information and that he did so in exchange for a personal benefit."In these papers Yesha Yadav focuses on two specific problem areas in insider trading regulation, relating totrading in credit default swaps (CDS) by lenders and "structural" trading using a combination of preferentialaccess to information and locational advantages. Both examples present arguments for a rethinking of howinsider trading regulation should address the realities of modem, complex, financial markets.The contexts of the two papers differ. With respect to Insider Trading in Derivatives Markets, Professor Yadavis addressing a context in which regulators have decided to extend insider trading prohibitions to derivativemarkets. In Structural Insider Trading, on the other hand, Professor Yadav identifies "cracks in regulation" (p.4).Congress extended the prohibition of insider trading to transactions in swaps and futures in the Dodd-Frank Actin 2010 and the CFTC . By 2010 concerns about the risk ofinsider trading in credit derivatives was not exclusively a US domestic concern: the Joint Forum of transnationalstandard setters for financial regulation had identified this as an issue in 2008. But Professor Yadav persuasivelyargues that trading on insider information in CDSs may improve the informational efficiency of the securitiesmarkets, benefiting shareholders. Lenders with access to inside information about their borrowers haveincentives to transfer the credit risk associated with their lending, and their ability to hedge risk encourageslending, which benefits shareholders "at least in the near term."(p. 416) The story is not all positive, however, aslender activity with respect to CDSs may harm shareholders, and shareholders have limited capacity to monitorlenders (p. 417). Lenders may transact in ways that over-emphasize bad news (p. 419).Professor Yadav suggests that lenders and borrowers might be able to contract around insider trading liability tofix the doctrinal problem. However, she notes that this fix might not work because corporate debtors suffer froma weak bargaining position and monitoring a lender's compliance with the terms of a contract would bechallenging. As usual in the insider trading context disclosure could play a role, although a borrower wouldhave limited options to respond to a lender's disclosed proposed CDS trades (p. 428). Insider CDS trading raisesmore general questions about the fit between established doctrine and the realities of the markets: the "tensionbetween law and reality.. .dismantles long-held assumptions in theory."Structural Insider Trading similarly focuses on realities of the financial markets to challenge establishedassumptions about insider trading law. High speed algorithmic trading strategies combined with geographicproximity to trading venues provides an informational edge (p5) (of course, this development, together with thecomplex harmonization-differentiation picture of financial regulation also challenges some of the thinking aboutthe decreasing relevance of geography to finance). The informational edge creates a tension between "speed intrading and the policy goal of ensuring broad and equal access to information."(p 5) Professor Yadav argues:structural insider trading inverts the traditional policy priority underpinning the prohibition againstinsider trading. Under Rule lOb-5, liability is justified as a way to protect insiders despite negativeeffects on market efficiency. By contrast, structural insider trading privileges market efficiencyover investor protection, in giving structural insiders the ability to trade on soon-to-be publicinformation despite costs to investors-at-large.These are two papers which demonstrate very clearly and usefully a need to rethink one area of financialregulation for a complex, evolving, market reality.Cite as: Caroline Bradley, Rethinking Insider Trading Regulation, JOTWELL (May 11, 2015) (reviewing YeshaYadav, Insider Trading in Derivatives Markets, 103 Georgetown L.J. 381 (2015) and Yesha Yadav, StructuralInsider Trading, Vanderbilt Law and Economics Research Paper No. 15-8 (March 27, 2015)),http://corp.jotwell.com/rethinking-insider-trading-regulation/.

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