Material Nonpublic Information Research Articles

Insider Trading in the Clinical Trial Setting

The Securities and Exchange Commission’s enforcement agenda regularly includes charges of trading based on material nonpublic information about a clinical drug trial conducted to obtain FDA approval to market a new drug. Almost half of the recent cases have been accompanied by a criminal indictment. In an academic setting, researchers and those who advise them, unlike employees of public companies, are not generally given training about the risks of securities trading. Recent developments in the law might be applied in connection with clinical trial information in ways that would not have been foreseen until recently. It is time for a comprehensive analysis of how the law of insider trading may be applied to the important endeavor of clinical drug trials. Clinical trials should not be sullied by conflicts created by unlawful trading. This Article begins with the basic principles of insider trading, followed by a summary of how clinical trials are conducted and regulated. It then turns to the ways in which nonpublic information material to the stock price of the sponsor of the trial might be used to trade or tip. The analysis that follows identifies a number of situations where use or disclosure of material nonpublic information about a trial could be unlawful. Employees of sponsors of the trial, clinical investigators, and even the subjectsparticipating in a trial could run afoul of the prohibition on insider trading, such as when information has been used in breach of a confidentiality agreement or exchanged between an investigator and a trial participant, exchanged among trial participants, gleaned from attending medical conferences, and obtained in other settings specific to this industry. Presenting the full potential reach of the law facilitates taking steps to avoid violating the law. The analysis demonstrates that anyone involved in a clinical drug trial must be attuned to the risks of misusing material nonpublic information, including in scenarios not yet pursued by the SEC. By understanding the potential reach of the law, those involved in or who learn information about a specific trial can take steps to avoid or minimize the risk of liability. The Article concludes with recommendations to achieve this end. The Article thus presents a complete case study of an industry-specific application of insider trading law, with recommendations that can be applied to other industries.

When and how are rule 10b5-1 plans used for insider stock sales?

SEC Rule10b5-1 plans are intended to limit the ability of insiders to trade opportunistically. We study insider stock sales by CEOs both under and outside of these plans. While both groups exhibit opportunism, this behavior is more limited in plan sales and non-plan sales in well-governed firms. Furthermore, opportunism in plan sales is greater for transactions representing a larger fraction of the CEO's firm-related wealth. CEOs can circumvent the intent of Rule 10b5-1 by exercising their discretion over financial reporting and real earnings management and appear to benefit from material nonpublic information by selectively cancelling plans or using limit orders.

Do Hedge Funds Exploit Material Nonpublic Information? Evidence from Corporate Bankruptcies

Do Hedge Funds Exploit Material Nonpublic Information? Evidence from Corporate Bankruptcies

Estimating Unobserved Soft Adjustment in Credit Rating Models: Before and after the Dodd–Frank Act

Abstract Credit Rating Agencies (CRAs) adjust preliminary bond ratings with knowledge beyond publicly available information. These unobserved “soft adjustments” may reflect material nonpublic information and rating biases due to conflicts of interest, making certain bond characteristics endogenous. We model and quantify soft adjustments as bond-specific thresholds in a semiparametric ordered-response model and exploit ownership structures of bond-issuers to control for endogeneity. Relying on the shift restrictions, we develop a location estimator for models of ordered choices with correlated heterogenous thresholds. Using Moody’s initial ratings from 2000 to 2016, we find a significant reduction of soft adjustment after the Dodd–Frank reform.

CEO Social Media Presence and Insider Trading

Prior research finds that online social media usage may lower self-control and encourage indulgent behavior in laboratory subjects. We find that corporate CEOs show similar tendencies: CEOs with online social media presence are more likely to succumb to lower self-control and abuse their information advantage to profit from unethical insider trades. Specifically, CEOs’ social media presence strongly predicts their insider trading activity in terms of incidence, intensity (amount and frequency), and profitability. We further find that the effect is driven by insider buys (not by sells) and is more pronounced for opportunistic buys which tend to contain more material non-public information.

The information content of managerial insider trading: evidence from analyst forecasts

PurposeThis paper examines the effect of managerial insider trading on analyst forecast accuracy, dispersion and bias. Specifically, the authors test whether insider-trading information is positively associated with the precision of earnings forecasts. In addition, this relationship between Regulation Fair Disclosure (FD) and the Galleon insider trading case is examined.Design/methodology/approachPooled ordinary least squares (Pooled OLS) rregressions with year-fixed effects, firm-fixed effects, and firm-level clustered standard errors are used. Our proxies for forecast precision are regressed on alternative measures of insider trading activities and a vector of control variables.FindingsInsider-trading information is positively associated with the precision of earnings forecasts. Analysts provide better forecast accuracy, less forecast dispersion and lower forecast bias among firms with insider trading in the six months leading to the forecast issues. In addition, bullish (bearish) insider trades are associated with increased (decreased) forecast bias. Insider trading information complements analysts' independent opinion and increases the precision of their forecast.Practical implicationsRegulators may pursue rules that promote the rapid disclosure of managerial insider trades, particularly given the increasing availability of Internet tools. Securities regulators may attempt to increase transparency and enhance the reporting procedures of corporate insiders, for example, using Internet sources with direct release to the public to ensure more timely information dissemination.Originality/valueThe authors document a positive association between earnings forecast precision and managerial insider trading up to six months prior to the forecast issue. This relationship is stronger after the Securities and Exchange Commission (SEC) prohibited the selective disclosure of material nonpublic information through Regulation FD. In addition, the association between insider trading and forecast accuracy has weakened after the Galleon insider trading case.

Differences in Ethical Perceptions of Insider Trading

This article examines ethical decision-making related to insider trading. Using case study scenarios, the authors shed light on differences in evaluating the use of material nonpublic information when the expected outcomes of insider trading benefit clients versus the investment professional trading on inside information. Participants perceive insider trading that is expected to benefit clients to be a less egregious ethical violation, even though it is as equally illegal as trading to benefit oneself directly. Although the judgment about insider trading should be independent of the benefit recipient, it is not. Given the increasing regulatory scrutiny of ethical behavior, this finding is important because professionals’ duties to (1) pursue clients’ best interests and (2) protect capital markets may represent conflicting obligations when evaluating whether to use material nonpublic information. In addition, the results show that individuals with a professional credential tend to view insider trading to be more unethical compared with others without a credential. <b>TOPICS:</b>Legal/regulatory/public policy, security analysis and valuation, risk management <b>Key Findings</b> ▪ In most jurisdictions, trading on material nonpublic information is prohibited, even when an investment manager is required to act in clients’ best interests. Instead, the requirement to maintain market integrity typically trumps clients’ interests. ▪ Our survey results show that trading on inside information for personal benefit is viewed as significantly more unethical than is trading on inside information for the benefit of clients. Professionals with a specialized investment credential are the most stringent in their views. ▪ Because protecting clients from potentially adverse market movements is desirable, and is viewed as somewhat ethical, our results suggest that the legal primacy of market integrity should be reexamined.

Ambiguity in Insider Trading Regulations: Saudi Arabia as a Case Study

Abstract The Saudi legal system recognises insider trading as a crime and has established laws in order to prevent it. Yet, the complicated nature of insider trading makes it challenging to enact regulations that cover all of the aspects of the crime and clearly identify criminal conduct. This article analyses insider trading regulations in Saudi Arabia and addresses their ambiguities. This article specifies current Saudi regulations pertaining to the crimes of insider trading and disclosing material information, as well as analysing both crimes. It addresses ambiguities found in the language of the law as well as in case law. This article also criticises the definition of insider information under the law. The issue of ‘use’ versus ‘possession’ is discussed: namely, whether what is prohibited is trading on the basis of material non-public information or trading while in possession of material non-public information.

Insider Trading in India in Comparison With USA

Insider trading, the most conspicuous misbehaviour of the stock market, is additionally one of the most troublesome & difficult one to crack by regulators around the globe. Insider trading is a term dependent upon numerous definitions and meanings and it envelops both lawful and disallowed action. Insider trading happens legitimately every day when corporate insiders – officials, directors or employees – purchase or sell stock in their own companies inside the bounds of company policy and the guidelines administering this trading. In basic terms 'insider trading' is purchasing or selling of a security, in breach of a trustee obligation or other relationship of trust, and confidence, while possessing material, non-public information about the security. Insider Trading essentially denotes dealing in a company’s securities on the basis of confidential information relating to the company which is not published or not known to the public (known as unpublished price sensitive information), used to make profits or avoid loss. It is fairly a breach of fiduciary duties of officers of a company or connected persons as defined under the Securities Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992, towards the shareholders. An ‘unpublished price sensitive information’ means information relating to the present or probable future state of the company, that can potentially affect the value of the securities of the company in the market, that has not been available to the public. By the use of such material non-public information, the insider himself, or the person to whom the information is made available to, can trade in the securities of the company for his own benefit, thus causing a loss to those who do not possess such information. An insider deals in shares of a company to make unwarranted gains by virtue of his employment or such other connection, thereby rendering the underlying principle of fair and free transferability of shares unaccomplished in the capital market. This is the primary reason for the formation of these regulations viz. to promote free and fair transferability of stocks in the capital market wherein the investors can deal in the securities in an unperturbed manner.

CEO Social Media Presence and Insider Trading Behavior

Prior research finds that online social media usage may lower self-control and encourage indulgent behavior. We find that corporate CEOs show similar tendencies: CEOs with online social media presence are more likely to succumb to lower self-control and abuse their information advantage to profit from unethical opportunistic inside trades. Specifically, social media presence strongly predicts the incidence, intensity, and profitability of CEO insider trading activity. Our results only reside in buys (not in sells), especially opportunistic buys which likely contain more material non-public information.

Envy, Jealousy and Insider Trading: The Case of Martha Stewart

Envy, Jealousy and Insider Trading: The Case of Martha Stewart

Credit Rating Agencies and Accounting Fraud Detection

This study examines whether and when credit rating agencies take negative rating actions against issuers that commit accounting fraud before the fraud is publicly revealed and investigates the economic effects of such rating actions. After controlling for firms’ economic fundamentals and other sources of information, we find that Standard & Poor’s (S&P), an issuer-paid rating agency, takes negative rating actions against fraud firms, including downgrades and negative credit watches, as early as four quarters before the revelation of fraud. Egan-Jones, an investor-paid rating agency with no access to management and material nonpublic information, is slower than S&P to downgrade fraud firms, especially when information uncertainty is high and when fraud firms are subject to private SEC investigations. Last, we find that S&P’s negative rating actions against fraud firms are informative to the market and are associated with a shorter fraud duration. Taken together, our results suggest that credit rating agencies use their information advantage to detect accounting fraud.

Insider Trading, Macroeconomic Risk and Network Theory

A company insider possessing material nonpublic information can profit by trading in the stocks of her company. Moreover, since in an interconnected economy shocks propagate from one firm to another, she can also profit by trading in stocks of connected firms (e.g. suppliers and customers). In this article, I will show that these “network trades” create a moral hazard problem because they allow insiders to profit from risk-creation. In particular, by investing in a riskier project an insider produces larger fluctuations in the stock price of her company and of the connected firms. She can then use her privileged position to obtain early information on the direction of these fluctuations and then profit by engaging in network trades. Most importantly, the insights from network theory reveal that risk creation is more profitable for insiders that operate in industries that have a larger impact on macroeconomic risk, and hence network trades can play a key role in increasing the overall level of risk to which the economy is exposed. Given the severity of the 2007-2009 crisis, this insight offers a new and powerful rationale for regulating trades made by insiders on private material information. In particular, I advocate a reform divided in two steps: In a first phase, disclosure of network trades should be mandated to investigate whether they are a pervasive phenomenon and whether they produce abnormal returns for the insiders. In a second phase, if the data suggests that network trades are indeed pervasive and lead to abnormal profits, the following reforms should be implemented: (i) network trades on private material information should be banned, at least in the most central sectors; (ii) the rule requiring insiders to disgorge short-term profits when trading in the stocks of their corporation should also be extended to network trades.

Ethics, Markets, and the Legalization of Insider Trading

In light of recent doctrinal changes, we examine the confused state of U.S. insider trading law, identifying gaps that permit certain market participants to trade on the basis of material nonpublic information, and contrast U.S. insider trading doctrine with the European approach. We then explore the ethical implications of the status quo in the U.S., explaining why the dominant legal justifications for prohibiting classical insider trading and misappropriation—the fiduciary duty and property rights theories—fail to account for the wrongfulness of insider trading by eavesdroppers and certain tippees. We refute common arguments for legalizing insider trading, including arguments that insider trading is a victimless crime and that the practice promotes efficiency. We explain why insider trading constitutes the moral wrong of cheating, grounding our theory in the legitimate expectations of market participants. Having considered Kantian deontology in other work, we find that virtue ethics theory offers a helpful albeit rough framework for assessing the morality of insider trading independent of its legality. We also find that social contract theories, with norms of equality of opportunity and moral desert, provide a compelling ethical basis for retaining, clarifying and broadening current legal prohibitions against insider trading.

Newman/Martoma: The Insider Trading Law's Impasse and the Promise of Congressional Action

The prohibition against insider trading is a judge-made law that has evolved for over 50 years, and reached a critical impasse in two recent decisions in the Second Circuit Court of Appeals: United States v. Newman and United States v. Martoma. Judges of the Second Circuit sharply divided over what conduct constitutes improper trading on material nonpublic information, leaving the law in profound disarray. At bottom, the disagreement stems from a decades-old split within the judiciary about how to ensure a fair securities marketplace while enabling institutional analysts to probe for corporate information in furtherance of efficient market valuation of securities. In 1983, the Supreme Court in SEC v. Dirks sought to strike a balance between these two interests by holding that trading on material nonpublic information is not illegal unless the information was disclosed in exchange for a personal benefit. But the effort to balance two competing economic and moral interests should never have been the province of the judiciary, nor did its formulation ever win uniform consensus among the judges. After decades of struggle, the Newman/Martoma impasse is the consequence. Congress appears finally poised to pass a law of insider trading that would break the deadlock, but the bill under consideration apparently ignores the market efficiency interests that undergirded the personal benefit element of insider trading. The Article suggests that before passing any law, Congress must undertake an empirical review of the impact that the insider trading bill would have on an efficient market to ensure that the final law is not only clear but good for the health of the capital markets.

Sinning by omission: Insider trading and ethical behavior

This article presents a theoretical model of ethical behavior, insider trading, and insider non-trading. We argue that, with this framework, it is possible to identify the relative importance of different motives, namely “fear of punishment” and “ethical behavior,” for abiding by insider trading laws. Active insider trading behavior is a situation where a portfolio reallocation decision is modified as a result of material nonpublic information received about the stock; passive insider trading, in contrast, happens when a portfolio reallocation decision is canceled as a result of such information; lastly, pure ethical trading behavior is where a portfolio reallocation decision remains unchanged despite inside information received about the stock. Using a two-period model with a portfolio reallocation decision between periods, we find that the roles of law abidance and ethical behavior may only be distinguished in the presence of passive insider trading, while pure ethical trading is but a remote possibility. Appeals to ethics, used alone in an effort to increase compliance with insider trading laws, are therefore likely to be insufficient to fully deter such behavior. Lastly, we derive from our framework testable predictions as to the extent of passive insider trading, and the importance of ethics in curbing such behavior.

Unintentional Irony in Landmark Decisions of the Delaware Supreme Court Regarding Corporate Law

Three landmark decisions of the Delaware Supreme Court exhibit unintentional irony: Beam v. Stewart, Smith v. Van Gorkom, and Paramount Communications Inc. v. Time Inc. In Beam, the court concluded that, regarding the decision of whether to seek remedy against Martha Stewart, her fellow directors would not have jeopardized their reputations for the minimal gain of continuing their business and personal relationships with her. Ironically, the court failed to acknowledge that Martha Stewart—in trading on material nonpublic information, which gave rise to the corporate claim against her—jeopardized her reputation (ultimately losing hundreds of millions of dollars and her freedom) for minimal gain (less than $50,000). Having failed to acknowledge that internal inconsistency and unintentional irony, the court offered no explanation why some directors would jeopardize their reputations for minimal gain, but others would not do so. Part I attempts to fill the void and suggests that Stewart suffered from cognitive biases, which would not have affected her fellow directors. In Van Gorkom, the court famously concluded that the plaintiff carried his burden of proving that the board was grossly negligent in informing itself when selling the corporation, although, during a multi-month period, no bidder stepped forward with a superior proposal. The irony of the court’s conclusion is virtually self-evident. Part II further discusses subsequent precedent, which suggests that, viewed in retrospect, the board could have carried its burden that it reasonably informed itself, turning the conclusion of Van Gorkom on its head, and furthering the irony. In Time, the court held that Time’s board did not preclude Paramount from hostilely acquiring Time when it affected an acquisition of Warner. According to the consensus, Time’s board in fact precluded Paramount, so the Time court could not have meant what it wrote. As described in Part III, examining for the presence of preclusive action sometimes may enlighten the ultimate inquiry of reasonableness, but other times, an examination into preclusion proves misleading. In dicta, the Delaware Supreme Court has acknowledged that preclusive conduct may be reasonable. As the inquiry into preclusion has yielded misleading, if not ironic, results, and as the Delaware Supreme Court has indicated that preclusive action may be reasonable, the court should re-examine the utility of the preclusion inquiry as an outcome-determinative filtering device regarding the ultimate inquiry of reasonableness. In these foundational decisions of corporate law, the Delaware Supreme Court could not have meant what it wrote. Each section incorporates clarifying concepts for consideration, and Part IV briefly concludes.

SEC announces new guidance for public company disclosures on cybersecurity risks

PurposeTo discuss the new guidance on public companies’ disclosure obligations regarding cybersecurity risks and incidents, which was recently unanimously approved by the Securities and Exchange Commission (SEC).Design/methodology/approachOutlines the general disclose requirements and the materiality standard set forth by the SEC, explains specific guidance on public company cybersecurity disclosure, and discusses cybersecurity risk management and insider trading policies.FindingsIn addition to clarifying the disclosure requirements with respect to cybersecurity issues, the article discusses two additional areas of concern identified by the New Guidance that public companies should consider in the context of cybersecurity and related disclosure. First, public companies must design and maintain policies and procedures to help manage cybersecurity risks and respond to incidents as they occur. Second, public companies should consider adopting insider trading policies that specifically prohibit management and other corporate insiders from trading on the basis of material non-public information regarding a cybersecurity risk or incident.Originality/valuePractical analysis of the guidance on disclosure obligations regarding cybersecurity risks and incidents, including discussion surrounding two aspects of cybersecurity not previously addressed in prior SEC staff guidance on the topic.

Hacking Wall Street: Reconceptualizing Insider Trading Law for Computer Hacking and Trading Schemes

This paper explores how insider trading law addresses computer hackers who employ cyberattacks in connection with the purchase or sale of securities. Current securities law is ill-equipped to deal with such hackers because, unlike the typical defendants in insider trading cases, hackers owe no fiduciary duty to shareholders and no duty of confidentiality to insiders that provide material non-public information. In order to bring hacker-traders within the ambit of federal securities law, the U.S. Securities and Exchange Commission (SEC) developed a novel theory of liability that treats and trading as a form of deception in violation of Section 10(b) of the Securities Exchange Act of 1934. However, the viability of the SEC’s theory remains to be seen as only one decision has endorsed it—SEC v. Dorozhko, 574 F.3d 42 (2d Cir. 2009). This paper argues that, from a normative perspective, the Second Circuit correctly expanded Section 10(b) to and trading. However, this paper takes issue with the Second Circuit's proposition that amounts to deception only when the hacker misrepresents his or her “identity in order to gain access to information that is otherwise off limits, and then steal[s] that information” for purposes of securities trading. Currently, there is little scholarship that thoroughly explores the potential for hackers to use innovative cyberattacks in order to avoid liability for securities fraud. This paper adds to the existing literature by arguing that even if the judiciary were to adopt the SEC’s reconceptualization of insider trading, it is unlikely that the theory would apply to certain sophisticated cybersecurity schemes—such as informed cyber-trading, whereby investors trade “on the basis of advanced knowledge of a cybersecurity breach.” In addition, it is unlikely that Dorozhko would apply to schemes in which a group of hackers short a corporation’s stock and then initiate a cyberattack, such as a distributed denial of service (DDoS) attack, in order to cause a decline in the stock price. Such conduct would not amount to deceptive hacking under Dorozhko because even though the hackers masqueraded their identities, they did not do so in order to obtain the type of confidential information typically at issue in illegal insider trading schemes.

Did that meeting discuss ‘inside information’? Insights from the USA and EU on when confidential information becomes material

This paper aims to provide insights into the moment in which a piece of information becomes ‘inside information’; that is, information that cannot be abused by trading in the market, what in the USA is called ‘material non-public information’. In the EU, the notion of ‘inside information’ is also relevant to establish the disclosure duties for listed companies, which have to publish such information almost immediately (‘as soon as possible’), unless several conditions that allow the delay of disclosure are continuously met. In addition, if listed companies decide to delay, they have to record inside information, protect it, establish and update an ‘insiders list’, suspend buy-back programmes and monitor that the delay of disclosure does not result in misleading investors. Therefore, in such a framework, a crucial question listed companies have to ask themselves is whether confidential information circulating within the company is already ‘inside information’ or not. In this respect, owing to the twofold notion of inside information, an analysis of US cases of insider trading investigated by the Securities and Exchange Commission (SEC) over the decades is addressed here and insights from the related economic literature are offered in order to develop a concrete understanding of when information becomes ‘inside information’.