Who Are the Victims of Stock Market Insider Trading? Is Insider Trading Fraud?

This Article is based on a May 2008 talk at Nihon College of Law in Tokyo. The lecture drew on my article, Stock Market Insider Trading: Victims, Violators, and Remedies - Including an Analogy to Fraud in the Sale of a Used Car with a Generic Defect, 45 Villanova Law Review 27 (2000). A. Who are the Victims of Stock Market Insider Trading? First, ex post, who are the specific victims of a particular stock market insider trade? Ex post, each act of stock market insider trading has specific, although anonymous, victims. The Nihon Article employs two used car analogies: the solitary defect hypothetical and the generic defect hypothetical. In the generic defect hypothetical, Mr. Greedie has nonpublic information that all 2006 Cadillacs have a major defect. Greedie personally owns a 2006 Cadillac and immediately sells it to a car dealer. At the time of the defect's public announcement, there are a fixed number of 2006 Cadillacs. If Greedie has one less Cadillac at the time of the public announcement, someone else must have one more. That someone is the victim of Greedie's sale. I call this "the law of conservation of used automobiles." If Greedie's sale of one car to the automobile dealer causes even a slight lowering of the dealer's prices for 2006 Cadillacs, that decline may dissuade or induce a transaction. If the dealer's prices do not change, or if the price declines fail to dissuade or induce a trade, the loss falls on the car dealer, an induced buyer. Under the "law of conservation of used automobiles," Greedie's sale must induce a purchase or preempt a sale. The generic defect used car analogy demonstrates two points: First, each act of insider trading has one or more particular victims. Second, these victims are anonymous. They exist, but, practically, cannot be identified. The "law of conservation of used automobiles" is similar to the "law of conservation of securities" and stock market insider trading. Society's antipathy toward stock market insider trading is based on the unjust enrichment of the insider trader at the cost of the anonymous victims of the trade. The law of conservation of securities demonstrates that the insider trade is a but-for cause of injury to specific victims. Whether the insider trade is a proximate cause of harm is a separate issue. Nevertheless, if the insider trade is not even a but-for cause of injury, liability is much less likely. Second, ex ante, who are some long-term victims of stock market insider trading? Ex ante, insider trading also has some long-term victims. Insider trading may increase the cost of raising capital of a particular company or the cost of raising capital for public corporations generally. Investors who trade frequently suffer disproportionate harm from insider trading. Because market-makers trade often, they may widen the spread between the prices at which they buy and sell. This increase in spread would harm all public investors, especially those who trade often. The increase in spread may also decrease liquidity. B. Is Stock Market Insider Trading Fraud? Stock market insider trading has some features of fraud, but differs from traditional fraud in several ways. Disclosure to the party on the other side or to the public may breach other duties, such as a duty to an employer or a duty not to tip material nonpublic information. Also, such disclosure would not necessarily save the victim of the insider trade if the victim is a preempted trader. Whether a court classifies insider trading as fraud depends in part on whether the court is judicially conservative or activist.