The latest law changed one single section to 20 wide and complex sections, causing critique of Australia IT regulations . Henry G Manne argued that IT regulations should be abolished supported by three basic economic arguments. This essay will examine the pro and contra of each argument and shows that IT regulations have spoiled the notion of fairness at the expense of efficiency, despite the objective of any securities markets regulation to promote both aspects . 1. Insider trading could compensate corporate entrepreneurs . Pro and Contra
This argument is supported by Carlton and Fischel who argued that the IT regulations are the same with setting government regulation of terms and conditions of employment; similar to restrict salary bonuses, stock options, vacation leave, and the others which can motivate management for their entrepreneurial skills . However their assumptions ignore the difference between the volatile share price and a certain amount of normal compensation. As argued by Easterbrook, where there is a volatile share price, the management compensation argument reverts into a lottery-ticket argument .
Because in the volatile share price, even informed traders will hardly predict the increase or decrease of share price in the future. The high fluctuation equalizes the possibility of losing their investment and getting profit, which as called compensation. From the two extremes, It can be concluded that compensation argument can be valid if the share price is relatively stable otherwise not all insiders can get their compensation through insider trading. Directors fiduciary duty to Shareholder
However, if IT regulation were only applied for a liquid market, what is the role of fiduciary duty? In Exicoms case fiduciary argument was established where persons who are subject to a legal relationship of trust and confidence, arising from either a prior relationship with the securities issuer (typically directors, employees and corporate agents) or the other party to trade should not make a profit from that position or allow a conflict of interest to arise.
Moore supports IT regulation on the basis of fiduciary duty. He reasons that directors have some fiduciary duty to their shareholder to fully disclose all information they could benefit from. His idea is supported by the fact that although there is no general principal that directors owe fiduciary duty to shareholders (in addition to the company), with the purpose to prevent directors when in the position of holding confidential information to spread the it to outsiders , such duty in recognized in Hookers case .
Sub Conclusion Insider trading as a compensation for corporate executive is argued only happened in a stable market where they can use the information to predict the trend otherwise the profit compensation turn to be a lottery compensation. Here fiduciary duty of the insiders is questioned where in Hookers case it is possible that directors owe fiduciary duty to shareholder although there is no general principal on it. 2. Insider Trading Contributes to Market Efficiency Pro from Leland and Estrada
Manne argued that allowing an unfettered market in information will have salutary effects unheard of in connection with regulatory disclosure . Recently, Leland and Estrada also stated similar idea that insider trading contributes to market efficiency through signaling where signal-trading by insiders pushed share price more quickly towards its equilibrium price. Pro from Empirical Measures Theory Moreover, empirical measure presents a theory; the more information gets into market, the lower transaction cost, the more liquid the market and the smaller volatility produced.
Since investors get more helpful information to predict market trend, the transaction cost here is lower. Transaction cost is the cost to take the risk if the companies, which they invest in, somehow default. Thus lower transaction cost is equivalent to lower risk, which can encourage more investor to trade. As trading in the market occurs significantly in one flow (either buy or sell) based on the information they got, the volatility, which represented by the bid-ask (difference between the buy and sell quotes at any one time), decreases. Consequently liquidity increases. Evidence from Real Study
In practice, Dodd and Officer found evidence that no significant abnormal returns (return of a security over its average or expected return) occurred on the day take over rumour was published, although some abnormal returns typically occurred prior to the publicity of rumour. This prior abnormal return must be because of insider trading, as the unpublished information they possess allow them to predict the trend up to takeover bid, thus, at the date of take over published, market already reached equilibrium price. Contra from Cox and Georgakopoulos and Response from Wyatt
However, there are some disagreements on Manne argument. First, Cox claims that insider trading cannot make the price movement towards equilibrium price purely by their own actions . Also microstructure theory by Georgakopoulos, which states that whether support or against insider trading is depending on the market liquidity . A liquid market as discussed in the compensation arguments will give more benefit to insiders because the votality is lower and they can easily predict trend in stable price, hence, IT regulations in this case can be useful.
On the other hand, illiquid market leads both insider and outsider traders away regardless the information they received since the votality is high and even unpublished information may just let them gamble on the securitys price, hence, in such market the presence of IT regulations has no effect to the market. The idea is that the uninformed traders is discourage to involve in market because of unfairness arise from the profit making activity by informed traders, hence, reducing the market effectiveness.
For all that, both claims can be doubtful considering Wyatt suggestion that outsiders follow insiders action and further can encourage market liquidity . His suggestion is also supported by the fact that traders identity is kept confidential, thus, uninformed traders cannot be certain of the percentage of informed traders which make them discourage from trading. IT Regulation Distorts Market Efficiency Further issue is whether IT regulation increase market efficiency or it just increase the cost of compliance for companies and financial services firms?
If IT regulation inhibits market efficiency then it should be revised. IT regulations in Australia reinforces continous disclosure (CD) regulations such in Crown Casinos case where the chairman, who has no power on the companys behalf, disclosed information to outsiders before the board disclosed it to the Exchange. The court emphasized on the breach of continous disclosure specifically on the abuse of the term immediately . If IT regulation is just a flip-case of CD regulations, then it is obsolescent, as CD regulation already governs tardy disclosure . Sub Conclusion nsider trading contributes to market efficiency by moving the share price more quickly towards equilibrium price is supported by empirical measure which shows that insider trading increase market liquidity, and by Dodd and Officer finding on significance abnormal returns prior to take over rumour instead of on the date of publicity. Although Cox and Georgakopoulos go against the concept, Wyatt response that their arguments can be the contrary, that informed traders can be an opportunity for uninformed traders to get profit by following them instead of discourage them by unfairness. 3. Insider Trading and Long-term Investors
Pro and Contra Finally, insider trading does no significant harm for long-term investors , whose market decisions will be a function of time . In detail, Manne asserts that the less frequent someone trades, the less significant effect of the unfair use of valuable information from insider trading they receive. Such investors just make investment on the basis that they are timely and not affected by the share price, which is affected by insider trading. However, this view is questioned by Schotland . He argued that even long-term investor needs cash and when they need it they will consider to ait for a right price to sell it. Further, Manne suggest that long term investor can ignore price to avoid being harmed by the effect of insider trading, expect for one, which is the lost of not having inside information in the range of the buying and selling price so that it is insignificant. Here Manne only refers to one investment. Yet, how about when the investors have more than one (in which the common condition to diversify)? They may need to watch a series of share price otherwise they will end up will sell it with no profit after putting so much faith waiting for it.
Sub Conclusion Insider trading does no significant harm for long-term investors as they just invest on the basis of time instead of share price and only need to watch insignificant loss from the valuable information exploited by insider trading. The idea is fully objected by Schotland by arguing even long-term investors need cash and should consider the right price to sell the share. Also the insignificant loss only refers to one share, but in practice long-term investor such as retirees diversify shares by holding more than one. Conclusion
In summary, the essay demonstrates a number of both pros and contras of whether insider trading should be abolished. Looking the above discussion, insider trading should be outlawed as it can cause significant harm to investors. It is also contradict with fiduciary argument. However, Insider trading is also evidenced contribute to market efficiency. Moreover, as in Crown Casinos case, IT regulation is criticized to be a mere flip-case of CD regulation and the presence just increase the cost of compliance. Therefore, It would be better if IT regulations is revised in a way that promote both fairness and efficiency equally.