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Insider trading liability and enforcement strategy.

On the grounds that insider trading undermines investor confidence in the fairness and integrity of the securities markets, the Securities and Exchange Commission (SEC) has made the detection and prosecution of illegal insider trading one of its enforcement priorities. To that end, the SEC has functioned both as the chief enforcer of the insider trading laws and as a powerful lobbyist behind new legislation to counter obstacles faced in prosecuting insider trading cases. This has provided the SEC with an unprecedented power not only to enforce the law but also to reshape it to fit its intended goal.

The restrictive regulatory environment and vigorous enforcement by the SEC create the expectation that illegal insider trading will be deterred. Surprisingly, the empirical literature in finance concludes otherwise. For example, Seyhun (1992) concludes that the statutes enacted during the 1980s did not provide additional effective constraints on insider trading. Meulbroek and Hart (1997) find that takeovers with detected illegal insider trading have takeover premia approximately 10 percentage points, or almost one-third, higher than that of a control sample. Arshadi and Eyssell (1993) summarize empirical findings in the literature and conclude that:

"1) despite six decades of anti-insider trading laws, transactions based on material non-public information have continued; 2) the profitability of insider trading has increased over time; 3) registered insiders whose trading is required by law to be disclosed regularly to the SEC have abstained from illegal trading at least in their own names; and 4) ...the evidence strongly supports the contention that insider trading has merely shifted from registered insiders to outside-insiders without a discernible decline in total volume" (p. 120).(1)

I contend that the somewhat puzzling empirical findings can be partially explained by consideration of the laws restricting insider trading. This paper examines legal theories of insider trading and government enforcement efforts in order to shed light on the intricacies of the law and to evaluate the ability of the regulatory structure to cope with the problem of illegal insider trading.

The remainder of the paper proceeds as follows. Section I examines legal theories of insider trading liability that are used by the regulatory authorities to prosecute insider traders. Section II explores the notion of regulation by enforcement where the SEC develops new legal standards as the need arises instead of establishing systematic regulations of the prohibited conduct. Section III presents hypothetical cases of insider trading and discusses the reasons they may or may not be legal under the current law. Section IV concludes the paper with recommendations for future research. The Appendix provides useful background information, including a definition of insider trading and categories of insiders.

I. Legal Theories of Insider Trading Liability

The principal laws that cover illegal insider trading include: 1) the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (the Exchange Act); 2) the SEC rules issued based on provisions of the Exchange Act; 3) amendments to the Exchange Act including the Insider Trading Sanctions Act (ITSA), and the Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA); 4) laws unrelated to securities laws that are used against insider trading, e.g., the Racketeer Influenced and Corrupt Organization Act of 1970 (RICO); and 5) the extant case law and Supreme Court rulings.(2)

A. Section 16(b)

Before the passage of the Exchange Act, no regulation prohibited insider trading. Cases against insider trading were decided on the basis of existing common law and were often unsuccessful. During this period, insider trading was treated as an acceptable perquisite for corporate insiders.

The Exchange Act dealt explicitly with the issue of corporate insider trading. Section 12(b) of the Exchange Act requires directors, officers, and large shareholders to register with the SEC and disclose their ownership in the firm. Section 16(a) requires registered insiders to file statements with the SEC within ten days of the close of each month of any changes in their holdings in the firm. Section 16(b) makes short-swing profits recoverable by the firm. A short-swing transaction involves a matching purchase and sale, or sale and purchase, within a six-month period. Section 16(c) prohibits short selling by insiders in their own firms' shares.

Section 16(b) is different from other anti-insider trading laws in that it does not require a finding of fraud, and its enforcement is in private hands. While the SEC has control over the content of the disclosure requirements under Section 16(a), it has no power to force the disgorgement of the short-swing profits. This leaves managers, directors, and shareholders to take legal actions for the disgorgement. Since managers and directors are often the beneficiaries in insider trading, they have little incentive to sue; given that most shareholders own a small fraction of the outstanding shares, they often cannot afford the cost of taking legal action. The principal incentive to the enforcement of this section is left with attorneys who track 16(a) filings and file suit on behalf of a small shareholder where the court grants fees for the plaintiff's attorneys.(3)

Section 16(b) is narrow in its scope as a deterrent to insider trading in three respects. First, it applies only to high-level executives or large investors who are required by Section 16(a) to disclose their ownership in the firm. Other insiders (e.g., tippees or temporary insiders) who may have access to material non-public information are not included. Second, the law requires the matching of two transactions (buy and sell or sell and buy) and does not involve only sales or only purchase transactions. Third, the matching transactions have to occur within a six-month period.

In 1991, the SEC made substantial revisions in the rules applied under Section 16. These changes occurred in response to developments in the trading of derivatives, growth of diverse employee benefit plans, and increases in filing delinquencies. A review of insider trading cases in recent years, however, suggests that government enforcement is often based on laws other than 16(b).

B. Section 10(b) and Rule 10b-5

While the Securities Act and the Exchange Act contain many anti-fraud provisions, none has received as much attention as Section 10(b) of the Exchange Act. Section 10(b) makes it unlawful "[t]o use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors." The SEC promulgated Rule 10b-5 pursuant to its authority under Section 10(b) as one of the most widely used legal rules against securities fraud and insider trading. Adopted in 1942, Rule 10b-5 states that:

"It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange, 1) to employ any device, scheme, or artifice to defraud, 2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, . . . or 3) to engage in any act, practice, or course of business which operates or would operate as fraud or deceit upon any person, in connection with the purchase or sale of any security."

The SEC has a more active role in the enforcement of Rule 10b-5. It can take administrative actions against registered broker-dealers; ask the federal courts to force disgorgement of profits and impose penalties; and refer violators of Rule 10b-5 to the Department of Justice for criminal prosecution.(4)

C. The Disclose-or-Abstain Theory Under Rule 10b-5

Rule 10b-5 was applied for the first time in the case of Cady, Roberts & Co. in 1961.(5) Administrative proceedings were brought to determine whether leakage of the news of an impending dividend cut by a board member to a stockbroker and subsequent sale of securities by the broker violated the rule. The broker was subsequently suspended from the New York Stock Exchange for 20 days. The case established what is now known as the "disclose-or-abstain" rule. This rule requires those who have access to material non-public information to either disclose it or else abstain from trading based on that information.

The disclose-or-abstain rule was later successfully applied in the case of the SEC v. Texas Gulf Sulphur Co.(6) in which the purchase of company stock by insiders prior to the announcement of a mineral discovery was ruled to have violated 10b-5. An insider's duty to disclose information or his duty to abstain from dealing in his company's securities arises only in "those situations which are essentially extraordinary in nature and which are reasonably certain to have a substantial effect on the market price of the security if disclosed."(7)

The Supreme Court has ruled on two occasions on the scope of Rule 10b-5. First, in 1980, it ruled in the case of Chiarella v. United States.(8) The case involved a printer, Vincent Chiarella, who as a markup-man in a printing firm, had identified the concealed names of several tender offer targets from documents submitted for printing. He subsequently traded in the target firms' shares and netted profits totaling $30,000. The SEC discovered the transactions and asked the Department of Justice to bring criminal charges against Chiarella for the violation of Rule 10b-5. The trial court convicted him and the Second Circuit Court affirmed the conviction. In an appeal to the U.S. Supreme Court, however, the conviction was overturned. The Court argued that the duty to disclose or abstain is only applicable when there is fiduciary duty involved.

In 1983, the Supreme Court ruled in Dirks v. SEC(9) by referring to its decision in the Chiarella case. The case involved a financial analyst who discovered massive fraud involving the Equity Funding Corporation, a large insurance firm. He attempted to disclose the information by contacting The Wall Street Journal, which chose to ignore it. Subsequently, he instructed his clients to sell their shares in the firm. Shortly thereafter, California insurance authorities discovered the fraud, and its disclosure lowered the share price from $26 to $15. The SEC censured Dirks for violating Rule 10b-5 and the District of Columbia Court of Appeals ruled against him. Upon his appeal to the Supreme Court, the Court emphasized its decision in the Chiarella case and ruled that the defendant did not have any fiduciary duty to the firm's stockholders and, therefore, had no obligation to either disclose the information or abstain from trading.

Under certain circumstances, however, a person who receives material non-public information (tippee) from an insider (tipper) may be required to disclose or abstain from trading under Rule 10b-5. The tippee is responsible for disclosing or abstaining if the following conditions hold: l) the insider tips the material nonpublic information for personal gains, hence, breaching fiduciary duty of loyalty; and 2) the tippee knows that by tipping, the insider has breached the duty of loyalty. If both conditions hold, the tipper and tippee are liable. The first condition is broadly defined to include not only the pecuniary benefits but also gains received through enhancements in reputation, or what comes from providing favors to friends and acquaintances.

D. The Misappropriation Theory Under Rule 10b-5

While the Chiarella and Dirk's decisions restricted the SEC's enforcement power by narrowing the coverage of anti-insider trading rules, a third case involving a Wall Street Journal reporter passed the rigid interpretation of the Supreme Court and popularized what is now known as the misappropriation theory. The theory holds that anyone who trades on information entrusted to them for personal gains in breach of fiduciary duty is in violation of the anti-fraud provision of Rule 10b-5. In contrast to the disclose-or-abstain rule in which fraud is committed through failure to disclose information to other market participants, the misappropriation theory applies to cases in which the fraud is on the parties who entrusted the information to the fiduciary.

The theory was developed in United States v. Carpenter(10) involving a Wall Street Journal reporter for the "Heard on the Street" column, R. Foster Winans, who leaked advance information concerning the names of the companies to be mentioned in forthcoming columns to a Kidder Peabody broker, Peter Brant. In a series of transactions based on the information, Brant netted $690,000, of which he paid $31,000 to Winans. The government alleged that Winans had misappropriated information that was the property of the Journal for personal profit. The misappropriation theory, first applied in 1982, had neither been legislated by Congress nor affirmed by the Supreme Court.(11) The Court ruled 8 to 0 in favor of mail and wire fraud convictions but 4 to 4 on the securities fraud (misappropriation) issue. Nonetheless, the tie was sufficient to affirm the earlier conviction. The Court ruled that "the object of the scheme was to take the Journal's confidential business information, the publication schedule, and contents of the Heard column and its intangible nature does not make it any less 'property' protected by the mail and wire fraud status." It further stated that the "Journal has been deprived of its right to exclusive use of the information, for exclusivity is an important aspect of confidential business information and most private property, for that matter." The fact that the Court did not overturn the misappropriation theory, even when it included a reporter, provided government prosecutors with a powerful new weapon against insider trading on the basis that misappropriation of information constitutes fraud.

In 1997, the Supreme Court finally made a clear ruling on the misappropriation theory.(12) The case involved James O'Hagan, a partner in a law firm in Minneapolis, MN. In 1988, the law firm represented Grand Metropolitan P.L.C., a company based in London, England. Grand Metropolitan retained O'Hagan's firm in a potential tender offer for the common stock of the Pillsbury Company, headquartered in Minneapolis. While O'Hagan did not work on the case, he was able to receive confidential information regarding an impending hostile tender offer for Pillsbury. He accumulated 2,500 call options on the target firm's stock. When Pillsbury became an actual target later that year, its share price increased by $20, netting O'Hagan a profit of $4.3 million. The SEC's investigation of O'Hagan culminated in a 57-count indictment including securities fraud in violation of Section 10(b) of the Exchange Act and SEC Rule 10b-5, and fraudulent trading in connection with a tender offer in violation of Section 14(e) of the Exchange Act and SEC Rule 14e-3. A jury convicted O'Hagan on all 57 counts and he received a 41-month jail sentence.

The Court of Appeals for the Eighth Circuit in St. Louis reversed O'Hagan's convictions arguing that liability under Section 10(b) and Rule 10b-5 may not be grounded on the misappropriation theory of securities fraud on which the prosecution had relied.(13) The Court of Appeals also held that Rule 14-3(a), which prohibits trading while in the possession of material non-public information relating to a tender offer, exceeded the SEC's rule-making authority.(14)

The Supreme Court faced two questions in the O'Hagan case. 1) Is a person who trades for personal profit in securities based on misappropriated confidential information in breach of a fiduciary duty and therefore guilty of violating Section 10(b) and Rule 10b-5? 2) Did the SEC exceed its rule-making authority by adopting Rule 14e-3(a)? In a 6-3 vote, the Supreme Court answered yes to the first question and no to the second. Writing on behalf of the majority, Justice Ruth Bader Ginsburg wrote "[t]he 'misappropriation theory' holds that a person commits fraud 'in connection with' a securities transaction, and thereby violates Section 10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of information." The majority agreed with the government that "misappropriation, as just defined, satisfies Section 10(b)'s requirement that chargeable conduct involves a 'deceptive device or contrivance' used 'in connection with' the purchase or sale of securities. We observe, first, that misappropriators, as the Government describes them, deal in deception...". In sum, the Supreme Court stated that "it makes scant sense to hold a lawyer like O'Hagan a Section 10(b) violator if he works for a law firm representing the target of a tender offer [as a temporary insider], but not if he works for a law firm representing the bidder." Considering that about 45% of the SEC's insider trading cases involve misappropriation, this was a major victory for the SEC in its fight against insider trading.

E. Section 14(e) and Rule 14e-3

Section 14(e) of the Exchange Act proscribes making misleading statements, and engaging in fraudulent, deceptive, or manipulative acts in connection with a tender offer.(15) Section 14(e) is modeled after Section 10(b) and is designed to address issues related to tender offers.

In 1980, the SEC promulgated Rule 14e-3, pursuant to its authority under Section 14(e), after the Supreme Court's Chiarella rule. Rule 14e-3 explicitly prohibits trading by any person (inside or outside the firm) with access to material non-public information about an impending tender offer. Since Rule 14e-3 is based on statutory authority independent of Section 10(b), the limitations imposed by the requirement to establish a breach of fiduciary duty under Rule 10b-5 do not apply. This provides a broader scope to the applicability of Rule 14e-3 than it does to Rule 10b-5. Rule 14e-3 was tested in United States v. Chestman.(16) In Chestman, a stockbroker was tipped about a tender offer by a person whose family owned the majority of the shares in the target firm. In a jury trial, the tippee was convicted under Section 14(e). On appeal, a divided panel of the Second Circuit Court reversed the conviction. On reheating, en banc, the court vacated the panel's decision and reinstated the Section 14(e) conviction. The court ruled that even though the tipper did not breach a duty of trust in relating the information to the tippee, the tippee was liable under Rule 14e-3, which was not dependent on breach of fiduciary duty by the tipper. While upholding the validity of Rule 14e-3, the court imposed new limits on Rule 10b-5. The Court ruled that trading based on material non-public information does not necessarily violate Rule 10b-5 unless the trader: 1) has explicitly agreed to keep the in formation confidential; 2) has misappropriated the information; and 3) has had a fiduciary duty to disclose or abstain.

The SEC's Rule 14e-3 received further support from the Supreme Court in the United States vs. O'Hagan decision, discussed earlier. The Supreme Court upheld Rule 14e-3 and rejected O'Hagan's argument that the SEC overstepped its authority in 14e-3 since it had not proved that a fiduciary duty was breached. The court stated that "the law does not require specific proof of a breach of fiduciary duty." O'Hagan's convictions under Rule 14-3 were reinstated.

The Supreme Court's O'Hagan ruling has dramatically increased the SEC's power in pursuing insider trading cases under Sections 10(b) and 14(e). No uncertainty remains regarding the treatment of misappropriation as a fraud under Rule 10b-5 when there is a breach of fiduciary duty. Even in the absence of a fiduciary duty, a trader with access to material non-public information related to a tender offer could be liable under Rule 14e-3. Table 1 summarizes the legal theories of insider trading liability.

II. Regulation Through Enforcement

In addition to the well-developed theories of insider trading liability, the SEC has, at times, resorted to the arbitrary enforcement of the federal securities laws without an effort to develop and maintain advance regulatory responses to specific issues. The SEC's rationale for its regulation by enforcement is that any specific regulation could be too narrow, thus allowing for easy evasion. In regulation through enforcement, the SEC does not have to define all the issues before they arise, leaving ample opportunity to tailor its response to each new case.

The success of the SEC's enforcement program in uncovering massive insider trading cases during the 1980s garnered much public support for the agency and earned significant backing from the legislature in the form of new and enhanced legislative powers to overcome earlier setbacks in court. This culminated in the passage of the SEC's legislative proposals in 1984 (ITSA), and in 1988 (ITSFEA).

A. The Dual Role of the SEC: Regulation vs. Enforcement

Administrative agencies like the SEC are established largely because Congress lacks the expertise to establish narrow stipulations concerning the conduct of the affected parties. Administrative agencies fill this gap by establishing detailed regulations within the statutory framework provided by Congress. The power of these agencies, however, is not limited to rulemaking. In addition, administrative agencies often carry enforcement power.

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The US common law system is based on the notion that broad rules are established by Congress and the courts are charged with interpreting the standards embodied in those laws. Furthermore, due process requires advance notice of what type of conduct is prohibited before anyone is prosecuted on civil or criminal charges for violating those standards. Accordingly, an administrative agency should specify the standards established by the law first, issue interpretive guidance with sufficient publicity about their scope second, and take enforcement measures as a last resort when those standards are clearly violated.

The mixture of regulatory and enforcement powers within a single agency often creates conflicts and affects the conduct of that agency. For example, the agency has to decide what degree of regulatory specificity is needed before enforcement. It is all too tempting to bypass the complex and often tedious task of specifying details of the prohibited conduct and to simply resort to ad hoc enforcement when faced with conduct that is commonly believed to be in violation of the spirit of the law. This leads to a practice of developing new legal standards as the need arises instead of establishing systematic regulations concerning the prohibited conduct. It is no surprise, therefore, that despite more than six decades of enforcing anti-insider trading rules, neither Congress nor the SEC has ever produced a clear definition of insider trading.

For its regulation through enforcement to succeed, the SEC has to devise an efficient and visible course in pursuing those who violate the spirit of the law and in discouraging similar conduct by others in the future. The efficacy of the SEC's enforcement program depends first and foremost on its selection of targets. The SEC has, in the past, pursued those who had traded securities using their "access" to material nonpublic information. Prominent among this group are securities professionals, attorneys, and accountants. A broader group of individuals may also become targets if their cases provide sufficient visibility for the enforcement program. For example, the SEC has often pursued prominent individuals on insider trading charges in the fields of religion, politics, entertainment, medicine, law, and finance. Targeting high profile individuals creates publicity and plays a potentially powerful role in deterring others from trading based on material non-public information.

Besides visibility, the SEC has used other tactics to make the public aware of its enforcement efforts to deter illegal insider trading. For example, every time the SEC begins a formal enforcement action against an individual or a corporation, it issues a litigation release that is catalogued and disseminated to the news media and those on the SEC's mailing list.

In addition to its own administrative proceedings against insider traders, the SEC also uses criminal law statutes against the most serious offenders of insider-trading rules. Prior to 1970s, the SEC's mode of operation involved preparing a detailed criminal reference report including an analysis of the evidence and legal theories that merited criminal prosecution. After the Commission's formal vote on this report, the agency would provide a criminal reference to the Department of Justice. As the number of insider-trading cases increased, the SEC ceased preparing criminal reference reports and began a closer collaboration with various United States Attorneys' Offices around the country, especially with those that were located in the same cities as the SEC regional offices and branches. Under the new arrangement, the Department of Justice investigators were given access to the information collected by the SEC in the early stages of building a case. While the Department of Justice made its own independent decision whether to bring criminal charges against an individual or a firm, both the SEC and the Department found it mutually beneficial to form a united front against what they considered to be flagrant violations of securities laws. The enforcement collaboration reached its peak during 1980s when the United States Attorney for the Southern District of New York and the Department of Justice cooperated with the SEC in bringing a large number of highly publicized cases against Wall Street professionals.

The prospect of criminal indictments also provides a powerful negotiating weapon to the SEC in its settlement efforts. When a defendant faces a difficult defense in a potential criminal indictment, the SEC could extract a settlement to redress the wrong deed without a lengthy trial. During 1980s and 1990s, a large number of insider-trading cases have indeed been settled. A trial is more likely when the SEC has a weak case and the defendant foresees a good chance of being cleared in court. The cases that end up in court provide an opportunity for the SEC to test its theories of insider-trading liability. When a court rules against the SEC because of conflict of the theory of liability with either an existing regulation or a statute, the agency refines its approach for future cases. If an existing regulation is the culprit, the SEC can unilaterally revise it. If a statute limits the SEC's regulatory reach, it could lobby Congress for the change.

In response to the Supreme Court's "Chiarella rule," which required the existence of a fiduciary duty in order to establish liability, the SEC promulgated Rule 14e-3, pursuant to its authority under Section 14(e). Rule 14e-3 prohibits trading by any person with access to material non-public information about an impending tender offer. Since Rule 14e-3 is based on statutory authority independent of Section 10(b), the requirement to establish a breach of fiduciary duty under Rule 10b-5 does not apply. This provides a broader scope to the applicability of Rule 14e-3 than it does to Rule 10b-5.

Despite the successful prosecutions of the early 1980s, the SEC was frustrated by the limitations of its enforcement activities due to weaknesses in the existing anti-insider trading laws. Until this point, the SEC had two remedies available to it in its enforcement efforts. It could seek an injunction against future violations, and it could force disgorgement of the profits made or losses avoided. These remedies, however, only brought the defendants to their previous financial position. Furthermore, up to this point no statutory authority in the securities laws allowed SEC to penalize insider trading other than asking the Department of Justice for a criminal prosecution. A criminal prosecution, which requires a jury trial and proof of guilt beyond a reasonable doubt, was deemed difficult to win in an insider-trading case. Moreover, the decision to prosecute is ultimately made by the Department of Justice and not by the SEC, which further restricted the SEC's enforcement efforts.

B. The SEC Lobbies Congress for the Passage of the ITSA (1984)

Dissatisfaction with the existing anti-insider-trading laws prompted the SEC to lobby Congress to pass the ITSA in 1984.(17) The new legislation provided the SEC with the authority to impose treble damage sanctions against anyone found to have tipped or traded based on material non-public information. The authorization of a civil penalty is a major shift in the approach taken by Congress in its handling of securities law violations and insider trading. Prior to the passage of ITSA, the only way to penalize illegal insider trading was through criminal prosecutions. It was only after a criminal conviction that a civil penalty could be imposed. In contrast to the stringent requirements of criminal prosecutions that demand guilt beyond a reasonable doubt, civil enforcement requires only a preponderance of the evidence as the standard of proof. Under ITSA, therefore, the SEC is the plaintiff, not the Department of Justice, and the defendant is entitled only to procedural protection rather than all the constitutional safeguards provided to the defendant under criminal prosecutions.

The legislation would apply to those who violate the specific provisions of ITSA as well as to those who violate the anti-fraud provisions of the Exchange Act. Furthermore, ITSA applies only to trading in the secondary market through national security exchanges or through broker-dealers. Purchase or sale of securities in the primary market and transactions conducted face-to-face are excluded from the coverage of ITSA. To measure the profits made, the court must calculate the difference between the price paid and the trading price within a reasonable period following the public dissemination of information. The court, therefore, will ignore the sale price if the transaction takes place long after public dissemination of the information. For example, if the purchase price is $10, and the price increases by $5 upon the public announcement of information, but the trader decides to sell it a year later at a price of $20, the profit made is only $5. Conversely, if a year later the price has fallen to its original level of $10, the trader still is assumed to have profited by $5. What constitutes a reasonable period of time to allow for full dissemination of information is determined in the context of case law and can vary from shortly after the public announcement to a much longer period depending on the nature of the information. At the extreme, if it is believed that dissemination will be gradual, it is possible that the court will use the sale price to determine the profit. Upon determining the profit, the SEC may ask for disgorgement of the profit and treble damages, thus amounting to a quadruple-profits sanction.

Problems, however, remain. Chief among them is the lack of a clearly defined notion of illegal insider trading. Civil prosecutions are conducted in the previous framework of illegal insider-trading definitions provided in the case law under sections 10(b) and 14(e). These definitions are vague, and the case law is far from uniform in its interpretation.

C. The SEC Lobbies Congress for the Passage of the ITSFEA of 1988

The SEC sought to restrict insider trading further by asking Congress to pass the ITSFEA, which was enacted on November 19, 1988.(18) The ITSFEA provided for bounties to informers of up to 10% of illegal insider-trading profits. The criminal penalties were increased tenfold for individuals, from $100,000 to $1,000,000, and fivefold for entities, from $500,000 to $2,500,000. The maximum jail term for criminal violations of the Securities Act was doubled, from five to ten years.

Perhaps the most striking aspect of this act was its requirement that public corporations adopt explicit policies to police employee insider trading. This created a strong economic incentive for such action "through the broadening of controlling person civil penalty liability to supervise vigorously their employees."(19) The ITSFEA granted authority to the SEC to impose penalties against controlling persons of up to $1 million, or three times the profits realized or losses avoided by insider traders, whichever is greater, if the SEC can establish that such persons knowingly or recklessly failed to take appropriate actions to prevent the violation before it occurred.(20)

ITSFEA also broadened the authority of the SEC to conduct investigations of foreign individuals and entities in the United States on behalf of, and for the sole benefit of, foreign authorities even though the conduct may not violate the United States securities laws. This is in line with the SEC's belief that a successful anti-insider trading campaign should not be limited to domestic boundaries; instead, the authority to reciprocate investigative requests with foreign agencies could substantially improve the SEC's reach beyond the US border. This is especially important since illegal insider trading could be easily disguised through foreign accounts and through trading in foreign markets.(21)

In sum, ITSFEA increased civil and criminal penalties against illegal insider trading. ITSFEA also imposed penalties against employers and eroded the so-called good faith defense for controlling persons if it is shown that they knew or recklessly disregarded the fact that their employees were likely to engage in insider trading and failed to take steps to prevent it.

D. Enforcement Through Laws Not Originally Intended for the Securities Industry: RICO

In addition to the existing anti-insider-trading laws, prosecutors have sought to use RICO to deter insider trading. Passed in 1970, RICO was to be used against criminal infiltration of legitimate businesses and labor unions by organized crime. In recent years, however, civil filings under RICO have increased substantially. Of nearly 1,000 cases filed per year, more than 90% were against legitimate businesses and individuals who were not involved in organized crime.(22)

During the late 1980s, the SEC and the Department of Justice waged a cooperative effort against insider trading. The ingenious application of RICO to securities violations was initiated by the Justice Department and used effectively to force the accused to settle the cases not only with the Justice Department but also with the SEC. A mere threat of indictment under RICO was a powerful weapon to force the defendant to settle on lesser charges. A good example of this approach involved the investment banking firm of Drexel Burnham Lambert, Inc. Faced with massive criminal RICO forfeitures, Drexel was forced to settle the criminal and civil proceedings brought against it by the Department of Justice and the SEC, respectively, by paying $650 million in fines and penalties. Shortly thereafter, despite the settlement and perhaps because of its financial burden, Drexel went out of business.

The application of RICO involves the establishment of a pattern of racketeering activity, followed by the use of the income derived from the racketeering activity to acquire an interest in or establish an enterprise involving interstate commerce. RICO can also be applied when a racketeering activity is used to acquire an interest in or to establish such an enterprise. A "pattern of racketeering activity" is predicated on a series of fraudulent activities involving an enterprise, which is defined as a corporation, a partnership, or an informal group of individuals working in concert for an illegal purpose.

Insider trading liability under RICO involves the purchase of securities by an insider (acquiring an interest in an enterprise). A tipper may also be liable under RICO as a co-conspirator in aiding and abetting the tippee's purchase of securities. An insider's or a tippee's sale of securities, however, does not trigger a RICO liability.

RICO violations bring both criminal and civil sanctions. Criminal sanctions include a prison sentence of up to 20 years and a fine of up to $25,000. More importantly, RICO requires forfeiture of any interest the person has acquired and any proceeds or property derived from activities in violation of the statute. The forfeiture remedy is especially important because a corporation or an individual may have so many assets forfeited that it becomes impossible to continue the business.

In addition to criminal prosecution, civil remedies are also available for a private action for damages. Civil RICO is an attractive alternative to other remedies in that it is easier to establish a RICO violation than violations under the securities laws. All it requires is that there be a pattern of racketeering activity and the person to be injured by it. Since there is no need to establish the plaintiff as a buyer or seller of securities, the owner of misappropriated non-public information can ask for recovery. In addition, civil RICO offers treble damages to injured parties, a remedy more generous than what is available under the securities laws.

The first RICO charges involving securities law violations occurred in 1987 when Rudolph Giuliani, then the US Attorney in New York City, dispatched 50 federal marshals equipped with weapons and bulletproof vests to raid Princeton/Newport's offices near the Princeton University campus. Subsequently, the firm and its five partners were indicted on charges of being involved in a racketeering criminal enterprise based on alleged tax fraud using bogus stock deals.

Those indicted under RICO must post a significant portion of their assets as security that the government will be entitled to if it wins a conviction. The size of the bond and the time between the indictment and trial may be long enough to pose great uncertainty for a business. In the case of Princeton/Newport, the prosecutors demanded pretrial forfeitures amounting to tens of millions of dollars. This led investors such as the Harvard endowment to withdraw its money, forcing Princeton/Newport into pretrial liquidation.

Perhaps the most significant securities-related RICO case to date is that brought against Michael Milken, formerly of Drexel Burnham Lambert. The 98-count indictment from a federal grand jury provided the government with a claim on over $1.2 billion of Milken's assets. This forced Milken to plead guilty to technical offenses rather than enduring a RICO trial. Table 2 summarizes the statutes applied to insider trading.

III. Summary of the Theories of Insider Trading Liability and a Legal Status Check List

The current state of insider-trading regulation can be summarized in the following manner. First, trading by registered insiders of the kind specified in Section 16 of the Securities Exchange Act of 1934 (short-swing transactions) is expressly forbidden. Second, registered insiders are forbidden from trading on material non-public information based on the disclose-or-abstain theory or the misappropriation theory under Rule 10b-5. Third, temporary insiders have liabilities similar to registered insiders. In takeover-related cases, the temporary insider status is accorded to those connected to both the target and bidding firms. Fourth, tippees and their insider tippers are also liable under Rule 10b-5. Since the information on registered insider trading is publicly available, it is reasonable to assume that this type of illegal insider trading can be successfully deterred by the current structure of regulation. Insider trading by temporary insiders can also be deterred. Tippee insider trading, however, may be more complicated to detect.

In order to establish liability under Rule 10b-5, there needs to be a breach of fiduciary duty. Without the presence of a fiduciary duty, liability may be established using Section 14(e) and Rule 14e-3. Applied to tender offer cases, Rule 14e-3 makes it illegal for anyone inside or outside the firm to trade in the shares of impending takeover targets.

Table 3 presents a list of hypothetical cases and determines their legal status. The first case involves an insider whose trade based on material non-public information is explicitly forbidden under the disclose-or-abstain and misappropriation theories of Rule 10b-5. The first successful application of this theory was in the case of SEC v. Texas Gulf Sulphur three decades ago.
Table 2. Statutes Applied to Insider Trading

This table provides a summary of the main statutes used against
illegal insider trading. The table also describes each statute and
shows how it is applied to insider-trading cases.

Statute Description of the Application to Insider Trading

Securities Act Section 17(a)(1) requires scienter and overlaps
of 1933 with Section 10b and Rule 10b-5 and prohibits
 insider trading. Section 17(a)(3) requires only
 negligence and contains broad anti-fraud
 language, which may be violated by those who tip
 or sell on the basis of material adverse
 information that they know or should have known
 to be material and non-public.

Securities Section 16(b) of the statute prohibits short
Exchange Act of swing profits by registered insiders. Section
1934 and its 10(b), the anti-fraud provision, is applied to
subsequent insider trading through Rule 10b-5.
amendments

Insider Trading ITSA allows the SEC to be a plaintiff in civil
Sanctions Act of cases against an insider trader. It imposes
1984 treble damages against anyone found to have
 tipped or traded based on material non-public
 information. It applies to violations of any
 provisions of this title as well as those of the
 anti-fraud provisions of the Exchange Act.

Insider Trading ITSFEA increased the criminal penalties tenfold
and Securities for individuals, from $100,000 to $1,000,000, and
Fraud fivefold for entities, from $500,000 to
Enforcement Act $2,500,000. The maximum jail term for criminal
of 1988 violations of the Securities Act was doubled,
 from five to ten years. It also provided for
 bounties to informers of up to 10% of insider
 trading profits. More significantly, it required
 public corporations to adopt explicit policies to
 police employee insider trading.

Racketeered The application of RICO to insider trading is
Influenced and predicated on a series of fraudulent securities
Corrupt activities, including the purchase of securities
Organization Act by an insider or tipping as a coconspirator in
of 1970 aiding and abetting the tippee's purchase of
 securities. Criminal sanctions include a prison
 sentence of up to 20 years, fine of up to
 $25,000, and forfeiture of any interest acquired
 and any proceeds or property derived from
 activities in violation of the statute. Civil
 RICO offers treble damages to injured parties.


The second scenario involves a party who is unintentionally exposed to material non-public information. Since there is no evidence of an advanced intent to misappropriate the information, the trading is deemed legal. The precedent was established in SEC v. Switzer, a case involving the former head football coach of the University of Oklahoma, Barry Switzer, who, at a post-game party, overheard the conversation between a corporate CEO and his wife and subsequently traded based on that information.

The third and the fourth scenarios involve temporary insiders who work for target and bidding firms, respectively. The liability for temporary insiders in the target firm is based on the misappropriation theory under Rule 10b-5, which requires a breach of fiduciary duty. The liability in the latter case is based on Rule 14e-3, which was clearly established in the 1997 ruling by the Supreme Court in US v. O'Hagan.

The next scenario deals with tippee and tipper liabilities under Rule 14e-3. The liability is established [TABULAR DATA FOR TABLE 3 OMITTED] when an insider knowingly, and in a breach of fiduciary duty, discloses material non-public information to another party who trades based on the information with the knowledge that a breach of fiduciary duty has occurred.

Finally, in the last case, an investor is advised by his broker to purchase shares in an obscure company. The investor has learned from previous experience that these tips often lead to significant profits. Since the investor pays for and expects to receive investment advice, he has no obligation to inquire about the source of the information; as long as the broker does not volunteer that it is inside information, there will be no liability accorded to the investor if he decides to go ahead with the purchase.

IV. Concluding Remarks and Recommendations for Future Research

The law of insider trading related to registered insiders is clear and comprehensive. Consequently, the empirical evidence suggests that, in recent years, registered insiders have either abstained from illegal insider trading or disguised their transactions using different names, various brokers, or, perhaps, other securities. The problem of Outside-insider trading is more complicated, however, because of legal and regulatory uncertainties and detection difficulties. At times, the SEC's regulatory pronouncements on outside-insider trading have been rebuffed by the lower courts and/or by the US Supreme Court, with one notable exception. After years of uncertainty, the Supreme Court finally ruled against insider trading based on information misappropriated by outsiders. The existing empirical literature is consistent with these conclusions.

Empirical research in finance suggests that the current legal environment has deterred registered insider trading. Total volume and profitability of insider trading, however, have not declined. Instead, illegal insider trading seems to have continued by those outside the firm who receive material non-public information from either registered or temporary insiders. Unlike registered insiders, whose trades are disclosed, and temporary insiders, whose trades are detectable, an effective surveillance of outside-insider trading has been illusive. Market surveillance by stock exchanges and dealer markets could detect unusual trading volume and price shifts prior to major news announcements, and the evidence could be turned over to the SEC. However, market fragmentation (due in part to a significant rise in trading volume cleared by alternative trading systems with no surveillance function), and inherent incentive problems in privately owned exchanges, which are virtually asked to spy on their own members, reduce the effectiveness of market surveillance as a mean of deterring illegal outside-insider trading.

I provide the following recommendations for future research. First, researchers should avoid focusing on only one piece of insider trading legislation to establish regulatory efficacy. The laws concerning insider trading are complex, and evolving legal framework including not only statutory enactments but also common law interpretations, and regulatory promulgations by the SEC, and the legal framework continues to evolve through case law. Moreover, the passage of a piece of insider-trading legislation often follows strong SEC lobbying to overcome legal obstacles in pursuing insider-trading cases in court. In fact, insider-trading provisions go through extensive deliberations in court and in the legal literature long before they are enacted; so their passage rarely conveys new information to market participants. Consequently, event studies around the passage of a single piece of legislation without due attention to its legislative history are unlikely to provide convincing evidence about the significance of its underlying provisions.

Second, researchers should consider testing insider-trading activities in markets other than the equity market. For example, insider trading in equity options provides more lucrative profit opportunities than those available in stock trading because only a relatively small amount of initial capital is required to purchase large quantities of out-of-the-money near-term options. Other strategies employed by insider traders may include trading in a combination of stocks and options on stocks and in junk bonds and other corporate bonds using material non-public information.

I thank Thomas Eyssell, Cathleen Leonard, Gordon Karels, the Editors, and two anonymous referees for their useful comments. Lisa Meulbroek and William K.S. Wang made available their related work for which I am grateful.

Appendix. Background

A. What is Insider Trading?

Insider trading has not been defined in the securities law. During the congressional hearings on ITSA, efforts were made to provide a statutory definition of insider trading. The SEC objected on the grounds that "[t]he flexibility which is gained by basing the imposition of the penalty on existing case law avoids the problems of freezing into law a definition which is too broad or too narrow to deal with newly emerging issues."(23) The House of Representatives agreed with the SEC that the case law on the subject was sufficiently well-developed to provide adequate guidance.

A definition, however, emerges from activities that are prohibited under the insider-trading provisions of the federal securities laws. First, the law prohibits buying and selling securities while in the possession of material non-public information relating to those securities. And second, the law bans "tipping," the act of communicating material non-public information to a second party for the purpose of either enabling that party to trade in the underlying security, or relating the information to another party.

What kind of information is deemed material? According to the Supreme Court, information is material if "a reasonable shareholder would consider it important in deciding how to vote."(24) Non-public information is defined as information that has not been disseminated to the investing public. Information is considered material non-public information if its release causes significant change in the price of the underlying security.

B. Who Are Insiders?

1. Registered Insiders

Section 16 of the Exchange Act defines registered insiders as officers,(25) directors,(26) and beneficial owners of 10% or more of a class of registered equity shares(27) in the corporation. Officers and directors with fiduciary duties toward the corporation and its shareholders routinely come across material non-public information in the course of their business functions within the corporation. Large shareholders, by virtue of their partial control over activities of the corporation through a nominee director, often become privy to material non-public information. Section 16(a) requires officers, directors, and beneficial owners of 10% or more of a class of equity securities to file a report with the SEC at the time this status is acquired and within 10 days of the close of any month in which ownership of such securities is altered due to purchase or sale.

2. Temporary Insiders

Individuals and firms that are not employed by the firm but are temporarily retained for a specific purpose, such as investment bankers, attorneys, and accountants, are considered temporary insiders. These parties may become privy to material non-public information in the course of their duties on behalf of the corporation. The definition of a temporary insider was established in Dirks v. SEC.(28) Footnote 14 of the opinion stated that:

"Under certain circumstances, such as where corporate information is revealed legitimately to an underwriter, accountant, lawyer, or consultant working for the corporation, these outsiders may become fiduciaries of the shareholders. The basis for recognizing this fiduciary duty is not simply that such persons acquired non-public information, but rather that they have entered into a special relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes . . . For such a duty to be imposed, however, the corporation must expect the outsider to keep the disclosed information confidential, and the relationship at least must imply such a duty."

3. Tippees and Tippers

A tippee is not an insider of the firm but receives material non-public information from either a registered or a temporary insider (the tipper) who passes the information to enable that party to trade on it. The act of "tipping" may be repeated several times through a chain of individuals. While the liabilities of registered and temporary insiders arise from their fiduciary duties toward shareholders, tippee trading does not violate, at least directly, any fiduciary responsibilities. A noninsider tippee's liability is predicated on the improper conduct of the initial insider tipper.

In Cady, Roberts & Co.,(29) a director tipped the inside information to a broker who subsequently traded for his clients. The SEC described two key elements to identify the liability in the case: 1) the existence of a relationship affording access to inside information intended only for corporate use and 2) the unfairness of allowing a corporate insider or its tippee to take advantage of the inside information before disclosing it.(30)

The question of tippee liability was further explored in two related cases. In the first case involving Investors Management Co.,(31) the SEC brought an administrative action against institutional investors who sold Douglas Aircraft Co. stock after being tipped on a downward revision of estimated earnings by Douglas. The tipper in this case was Merrill Lynch, which was the investment advisor for Douglas in connection with a debenture issue. The SEC argued, as it had done in Cady Roberts, that tippee liability is appropriate whenever the tippee knows or has reason to know that the information being used in trading is non-public and has been distributed improperly and on a selective basis. The focus is again on the tippee being in a position of access to inside information. While concurring with the decision, Commissioner Richard Smith favored making the liability conditioned upon whether the tippee knew that the information received was in breach of a duty by a person having a special relationship to the issuer not to disclose the information.(32)

In the second tippee case, Shapiro v. Merrill Lynch,(33) a private, class-action suit was brought against Merrill Lynch in connection with the sale of Douglas stock. The court ruled that Merrill Lynch and its tippees had the same liabilities as the insiders of the firm by virtue of the special access they had to inside information. Therefore, in tippee cases access, rather than fiduciary duty, is at issue.

1 The finance literature embodies a substantial amount of empirical research dealing with insider trading in securities markets. One line of research tests insider trading volume and profitability around announcements of firm events such as tender offers (Keown and Pinkerton, 1981; Keown, Pinkerton, Young, and Hansen, 1985; Seyhun, 1990; Meulbroek, 1992; Schwert, 1996; and Meulbroek and Hart, 1997), earnings reports (Penmann, 1982 and 1985; and Elliot, Morse, and Richardson, 1984), seasoned equity offerings (Karpoff and Lee, 1991; and Eyssell and Reburn, 1993), dividend policy shifts (John and Lang, 1991), and firm dissolutions (Loderer and Sheehan, 1989; Hirschey and Zaima, 1989; and Gosnell, Keown, and Pinkerton, 1992). Another line of research investigates the efficacy of anti-insider trading regulations. Early studies of regulatory efficacy were conducted by Lorie and Niederhoffer (1968) and Pratt and Devere (1978). Jaffe (1974a) provided the first major recent study on the impact of regulatory changes on insider trading. See also Finnerty (1976b), Arshadi and Eyssell (1991), and Seyhun (1992).

2 There is also an extensive legal literature related to insider trading. See, for example, Brodsky and Swanson (1988), Brudney (1979), Carlton and Fischel (1983), Carney (1987), Cox (1986), Dooley (1980), Easterbrook (1981), Easterbrook and Fischel (1991), Garten (1987), Haddock and Macey (1987), half (1982), Heller (1982), Janvey (1986, 1987), Karjala (1982), Macey (1991), Scott (1980), Silver (1985), and Wang and Steinberg (1996).

3 The precedent was set in the case of Smolowe v. Delendo Corp. (1943).

4 Section 17(a) of the Securities Act of 1933 has very similar language to that of Section 10(b) and Rule 10b-5 with one exception. While Section 10(b) and Rule 10b-5 refer to the purchase or sale of a security, Section 17(a) refers to the offer or sale of a security, including the initial public offering process of distributing a security and market trading afterward.

5 40 SEC 907 (1961).

6 401 F. 2d 833 (2d Cir. 1968).

7 Id.

8 445 U.S. 222 (1980).

9 463 U.S. 646 (1983).

10 108 S. Ct. 316 (1987).

11 Prior examples of the application of the misappropriation theory include United States v. Newman. 664 F. 2d 12 (2d Cir. 1981), and SEC v. Materia, 745 F. 2d 197 (2d Cir. 1984).

12 The Supreme Court's June 25, 1997 ruling reinstated the conviction of James O'Hagan in US vs. O'Hagan.

13 92 F. 3d 612 (1996).

14 The Court's ruling on 14e-3 will be discussed in a later section of the paper.

15 Id.

16 947 F.2d 551 (2d Cir. 1991)(en banc).

17 Public Law 98-376 (98 Congress, 1984).

18 Public Law No. 100-704, 102 Stat. 4677 (Nov. 19, 1988).

19 The controlling persons include employers, managers, or those with power to influence or control the activities of another person.

20 For a survey of corporate compliance programs, see Weinberger (1990).

21 For an interesting discussion of insider-trading issues in France see Lemieux (1991).

22 "Second Thoughts on RICO," Wall Street Journal, May 19, 1989, A10.

23 H.R. Rep. No. 355, 98th Congress, 1st Session (1983), the ITSA Report, at 32.

24 TSC Industries v. Northway, Inc., 426 U.S. 438 (1976) at 449.

25 The term "officer" refers to president, vice president, secretary, treasurer or financial officer, comptroller, principal accounting officer, or any person who perform such functions.

26 The term "director" refers to an individual who is a member of the board of directors that is established to meet the requirement of the state chartering agencies.

27 Any class of equity shares that are registered under the Securities Act of 1933 (the Securities Act).

28 463 US 646(1983).

29 40 SEC 907 (1961).

30 Id. at 912.

31 44 SEC 633 (1971)

32 44 SEC at 649-650.

33 495 F. 2d 228 (2d Cir. 1974).

References

Arshadi, N. and T.H. Eyssell, 1991, "Regulatory Deterrence and Registered Insider Trading: The Case of Tender Offers," Financial Management (Summer), 30-39.

Arshadi, N. and T.H. Eyssell, 1993. The Law and Finance of Corporate Insider Trading: Theory and Evidence, Boston, MA, Kluwer Academic Publishers.

Brodsky, E. and R.P. Swanson, 1988, "Insider Trading Litigation: The Obstacles to Recovery," Securities Regulation Law Journal (Spring), 31-53.

Brudney, V., 1979, "Insiders, Outsiders, and Informational Advantages Under the Federal Securities Laws," Harvard Law Review (December), 322-376.

Carlton, D.W. and D.R. Fischel, 1983, "The Regulation of Insider Trading," Stanford Law Review (May), 857-895.

Carney, W.J., 1987, "Signaling and Causation in Insider Trading," Catholic University Law Review (Summer), 863-898.

Cox, J.D., 1986, "Insider Trading and Contracting: A Critical Response to the Chicago School," Duke Law Journal (September), 628-659.

Dooley, M.P, 1980, "Enforcement of Insider Trading Restrictions," Virginia Law Review (February), 1-83.

Easterbrook, F.H., 1981, "Insider Trading, Secret Agents, Evidentiary Privileges, and the Production of Information," The Supreme Court Review, 309-365.

Easterbrook, F.H. and D. Fischel, 1991, The Economic Structure of Corporate Law, Cambridge, MA. Harvard University Press.

Elliot, J., D. Morse, and G. Richardson, 1984, "The Association Between Insider Trading and Information Announcements," Rand Journal of Economics (Winter), 521-536.

Eyssell, T.H. and J. Reburn, 1993, "The Effects of the Insider Trading Sanctions Act of 1984: The Case of Seasoned Equity Offerings," Journal of Financial Research (Summer), 163-172.

Finnerty, J.E., 1976a, "Insiders and Market Efficiency," Journal of Finance (September), 1141-1148.

Finnerty, J.E., 1976b, "Insiders' Activity and Inside Information: A Multivariate Analysis," Journal of Financial and Quantitative Analysis (June), 205-216.

Garten, H.A., 1987, "Insider Trading in the Corporate Interest," Wisconsin Law Review, 573-640.

Gosnell, T., A.J. Keown, and J.M. Pinkerton, 1992, "Bankruptcy and Insider Trading: Differences Between Exchange-Listed and OTC Firms," Journal of Finance (March), 349-362.

Haddock, D.D. and J.R. Macey, 1987, "Regulation on Demand: A Private Interest Model. with an Application to Insider Trading Regulation," The Journal of Law and Economics (October), 311-352.

Haft, R.J., 1982, "The Effect of Insider Trading Rules on the Internal Efficiency of the Large Corporation," Michigan Law Review (April), 1051-1071.

Heller, H., 1982, "Chiarella, SEC Rule 14eC3 and Dirks: 'Fairness' Versus Economic Theory," The Business Lawyer (January), 517-558.

Hirschey, M. and J. Zaima, 1989, "Insider Trading, Ownership Structure, and the Market Assessment of Corporate Sell-Offs," Journal of Finance (September), 971-980.

Jaffe, J., 1974a, "Special Information and Insider Trading," Journal of Business (July), 410-428.

Jaffe, J., 1974b, "The Effect of Regulation Changes on Insider Trading," Bell Journal of Economics and Management Science (Spring), 93-121.

Janvey, R.S., 1986, "SEC Investigation of Insider Trading," Securities Regulation Law Journal (Winter), 299-331.

Janvey, R.S., 1987, "Criminal Prosecution of Insider Trading," Securities Regulation Law Journal (Summer), 136-153.

John, K. and L.H.P. Lang, 1991, "Insider Trading Around Dividend Announcements: Theory and Evidence," Journal of Finance (September), 1361-1389.

Karjala, D.S., 1982, "Statutory Regulation of Insider Trading in Impersonal Markets," Duke Law Journal (September), 627-649.

Karpoff, J.M. and D. Lee, 1991, "Insider Trading Before New Issue Announcements," Financial Management (Spring), 18-26.

Keown, A.J. and J.M. Pinkerton, 1981, "Merger Announcements and Insider Trading Activity: An Empirical Investigation," Journal of Finance (September), 855-869.

Keown, A.J., J.M. Pinkerton, L. Young, and R.S. Hansen, 1985, "Recent SEC Prosecution and Insider Trading on Forthcoming Merger Announcements," Journal of Business Research (August), 329-337.

Lemieux, P., 1991, Apologie des Sorcieres Modernes. Paris, France, Les Belles Lettres.

Loderer, C. and D.P. Sheehan, 1989, "Corporate Bankruptcy and Managers' Self-Serving Behavior," Journal of Finance (September), 1059-1075.

Lorie, J.H. and V. Niederhoffer, 1968, "Predictive and Statistical Properties of Insider Trading," Journal of Law and Economics (April), 35-51.

Macey, J.R., 1991, Insider Trading: Economics, Politics, and Policy, Washington, DC, The AEI Press.

Meulbroek, L., 1992, "An Empirical Analysis of Illegal Insider Trading," Journal of Finance (December), 1661-1700.

Meulbroek, L. and C. Hart, 1997, "The Effect of Illegal Insider Trading on Takeover Premia," European Finance Review, forthcoming.

Penman, S.H., 1982, "Insider Trading and the Dissemination of Firms' Forecast Information," Journal of Business (October), 479-503.

Penman, S.H., 1985, "A Comparison of the Information Content of Insider Trading and Management Earnings Forecasts," Journal of Financial and Quantitative Analysis (March), 1-17.

Pratt, S.P. and C.W. Devere, 1978, "Relationship Between Insider Trading and Rates of Return for NYSE Common Stocks, 1960-66," in Modern Developments in Investment Management, J. Lorie and R. Brealey, Eds., Hinsdale, IL, Dryden Press.

Schwert, G.W., 1996, "Markup Pricing in Mergers and Acquisitions," Journal of Financial Economics (June), 153-192.

Scott, K.E., 1980, "Insider Trading, Rule 10b-5, Disclosure and Corporate Privacy," Journal of Legal Studies (December), 801-818.

Seyhun, N., 1990, "Overreaction or Fundamentals: Some Lessons From Insiders' Responses to the Market Crash of 1987," Journal of Finance (December), 1363-1388.

Seyhun, H., 1992, "The Effectiveness of the Insider Trading Sanctions," Journal of Law and Economics (April), 149182.

Silver, C.B., 1985, "Penalizing Insider Trading: A Critical Assessment of the Insider Trading Sanctions Act of 1984," Duke Law Journal (November), 960-1025.

Wang, W.K.S. and M.I. Steinberg, 1996, Insider Trading, Boston, MA, Little, Brown and Company.

Weinberger, A.M., 1990, "Preventing Insider Trading Violations: A Survey of Corporate Compliance Programs," Securities Regulation Law Journal (Summer), 180-193.

Nasser Arshadi is an Associate Professor of Finance at University of Missouri-St. Louis.
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