| Insider Abstention |
| Jesse M. Fried [View as PDF] |
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113 Yale L.J. 455 (2003) Scholars writing on insider trading have long believed that insiders can beat the market simply by using nonpublic information to decide when not to trade. Using a simple model, this Essay has shown that the conventional wisdom is wrong. Insiders prevented from trading while in possession of nonpublic information cannot outperform public shareholders, even if they can use such information to abstain from trading. In fact, insiders unable to trade or abstain while in possession of nonpublic information would systematically earn lower trading profits than public shareholders. The Essay has also offered a preliminary analysis of the effects of insider abstention on managers' incentives. It explained why insider abstention is unlikely to create the same types of potential distortions as insider trading. Indeed, insider abstention tends to align managers' interests with those of shareholders, and is therefore likely to improve managers' incentives. This Essay's analysis has important implications for current issues in insider trading regulation. First, the analysis contributes to the "possession versus use" debate by demonstrating that the "possession" standard for Rule 10b-5 liability achieves greater parity between insiders and outsiders than does the "use" standard. Second, the SEC's safe harbor permitting insiders to buy or sell shares pursuant to prearranged trading plans while in possession of material nonpublic information and to cancel the plans while aware of material nonpublic information enables insiders to profit from their access to such information. The SEC could easily eliminate insiders' advantages over public shareholders by not allowing insiders to cancel their plans after becoming aware of material nonpublic information. More fundamentally, the analysis calls for reconsideration of established positions in the larger debate over insider trading. This Essay has shown that the failure of Rule 10b-5 to prevent insiders from using nonpublic information to abstain from trading should be seen neither as an undesirable "loophole" that needs to be closed nor as an embarrassing gap that proves the futility of insider trading regulation. I hope this work removes the shadow cast by insider abstention over the insider trading debate and helps refocus attention on the most important policy issue: the optimal regulation of insider trading. |