This week the New York Times reports that the Supreme Court has refused to review the ruling of the Second Circuit Court of Appeals in the case United States v Newman. The Second Circuit, in December, overturned the insider trading conviction of a pair of hedge fund managers because nothing of value was exchanged in return for the information and thus the managers could not have known that the information they received was improperly disclosed to them by the information source. The Supreme Court decision would seem to block insider trading prosecutions in the absence of clear financial gains to those who leak the information.
This, in turn, has energized some members of Congress to introduce legislation to make it illegal to trade on insider information regardless of how one obtains it. This standard would define insider trading far more broadly than the standard laid out in Newman, or, for that matter, even before Newman based on the precedent in Dirks v SEC.
In his article in the current issue of Regulation, Villanova University law professor Richard Booth explores the Newman ruling. He argues that ordinary diversified investors neither lose nor gain from insider trading because they own all stocks and don’t trade very often. The only investors who have an interest in the prosecution of insider trading are “activist investors – hedge funds and corporate raiders – who stand to benefit from slower reaction times as they buy up as many shares as possible before anyone notices.” “… [H]edge fund managers have a distinct interest in seeing other hedge fund managers prosecuted for insider trading.” They rather than ordinary investors are the beneficiaries of insider-trading prosecutions. Thus ordinary investors should applaud the Newman ruling and oppose the attempts by Congress to adopt a European-style law against all insider trading.
Research assistant Nick Zaiac contributed to this post.