Selective Disclosure by Issuers, Its Legality and Ex Ante Harm: Some Observations in Response to Professor Fox

Selective disclosure by issuers to analysts may sometimes violate rule 10b-5 if the issuer, as an entity, obtains an improper "personal benefit." Uncertain is the stock price accuracy benefit of the insider trading resulting from selective disclosure. The interval between the trading and public disclosure may be too short to produce a significant economic benefit. Furthermore, if share prices are already quite far from their fundamental value, the insider trading may sometimes move prices farther away from accuracy. Are U.S. residents injured when a foreign issuer listed in the United States engages in selective disclosure that results in insider trading? The answer may be yes, both ex post and ex ante. Ex post, the insider trading injures preempted and/or induced traders, including Americans. Professor Fox argues that, ex ante, induced or preempted traders are not injured because share prices will discount both the risk of becoming a victim of an insider trade and any loss of liquidity caused by a widening of bid-ask spreads by market makers and specialists. Presumably, this discount will harm issuers by lowering the price at which they issue shares. Nevertheless, ex ante, insider trading may still harm preempted and/or induced traders if the market is unable to determine an appropriate discount for the risk of becoming a victim. Assume arguendo that the market is able to determine this discount. If the Commission forbids selective disclosure by foreign issuers, the discount will decline. The prohibition transfers wealth from insider trading tippees (probably foreigners) to all shareholders, including Americans. Even if some investors receive a windfall because they originally bought at a discount, the SEC may decide that insider trading profits are an even less deserved benefit. In addition, even if stock prices discount the risk of harm from insider trading, American investors would benefit from the decline in the uncertainty of injury that would result from a broad SEC prohibition of selective disclosure. Because the risk is associated with trading, not holding stocks, a diversified portfolio does not eliminate the risk (even assuming investors are diversified). Furthermore, even ex ante, frequent traders are disproportionately harmed by insider trading, again because the risk is associated with trading. One might argue that, because of the deterrence of excessive stock trading and speculation, the nation might actually benefit from an increase in bid-ask spreads and disproportionate harm to frequent traders. Nevertheless, the SEC may disagree. It may view its mission as encouraging securities trading in this country to improve the liquidity of the domestic stock market. If so, the Commission may wish to forbid selective disclosure by all issuers, both domestic and foreign. Such a prohibition would reduce both bid-ask spreads in this country and the uncertainty Americans face in becoming victims of a stock market insider trade. As a result, the liquidity of U.S. markets would increase. In short, selective disclosure by foreign issuers listed in the United States may harm Americans, both ex post and ex ante.