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This chapter discusses an example of individual corruption—insider trading in securities markets on the basis of information misappropriated from the government. It also addresses the taxation of capital gains from assets that need to be sold to avoid financial conflicts of interest. In each of these contexts, unique challenges are posed if federal employees are regulated by both federal ethics law and other areas of law. Lack of coordination can cause a government employee, who is affected by both areas of law, to be pulled in two inconsistent directions.

The law of insider trading demonstrates the doctrinal relevance of the concept of moral wrongfulness. The question of whether and how insider trading wrongs its victims bears directly on the scope of the doctrine. In the United States, the dominant, Supreme Court-formulated theory has been that insider trading is wrongful because it involves a breach of fiduciary duty. This chapter argues that rather than thinking of insider trading as involving a breach of fiduciary duty, we would do better to think of it in terms of cheating. Confidence in the stock market depends on investors feeling that the highly formalized, rule-governed game is being played fairly. The fact that some investors have better information than others is not viewed as unfair. What is viewed as unfair is the possibility that some investors might have access to information to which other investors do not. Market participants who trade on undisclosed inside information in these circumstances are viewed as cheaters, and punishment is viewed as warranted.

Insider trading is bad, even if it is not deceptive in any meaningful sense of that word. The lines the courts have drawn make little coherent sense, but do have the flexibility to enable a campaign against insider trading that has gradually come to be an egalitarian brand symbol for American-style securities regulation. In hypercompetitive financial markets, the doctrinal limits are stretched by both traders (hedge funds in particular) and regulators. While insider trading is probably characterized by more deliberateness than in the kind of corporate fraud explored earlier, the emotional aspects of insider trading can distort judgment here as well.

This chapter reviews the regulation of trading activity in financial markets, focusing on three particular forms of regulated conduct in the market, namely market manipulation, insider trading, and short selling. Market manipulation (in the form of trade-based manipulation and information-based manipulation, or securities fraud) and insider trading are prohibited in all major jurisdictions. If permitted to occur, these activities would be likely to cause systematic losses to market makers, who will increase their bid–ask spreads in order to compensate themselves. These costs will in turn be passed on to investors, making it more costly for them to buy and sell securities, which will correspondingly reduce investors’ willingness to participate in the market, meaning issuers will face a higher cost of capital. On the other hand, restrictions on short selling—which have been introduced, following the financial crisis, in a number of jurisdictions—are much harder to justify.

This chapter examines, from a traditional perspective, several areas where the Securities and Exchange Commission (SEC) has impacted corporate governance in a meaningful way. By way of example, these subjects include insider trading, qualitative materiality, the role of gatekeepers (such as outside directors, attorneys, and accountants), the Commission’s use of disclosure to influence conduct, the implementation by subject companies of undertakings pursuant to SEC enforcement proceedings, and mergers and acquisitions (including tender offers and going-private transactions). This chapter’s focus is on the manner in which the SEC for well over 50 years has impacted corporate governance by means of exercising its rule-making and oversight authority.

Crises reveal the vulnerabilities of governance regimes. Analysis of a crisis and strategies adopted in response can therefore highlight forces that shape these regimes. China Aviation Oil (CAO), a Singapore subsidiary of a Chinese government controlled oil holding company failed spectacularly within weeks of receiving a new loan from the parent company. That loan comprised the payment for shares in CAO the parent company sold at a time when CAO already faced financial difficulties–and violated Singapore’s insider trading rules. The case sheds light on the governance of government controlled entities in China: Parents take care of “their children”, even if this puts them at odds with regulatory norms at home or abroad. The case also illustrates the constraints of foreign enforcement authorities that operate in the shadow of China’s increasing economic power.

Chapter 3 outlines the primary ways in which hedge funds have been regulated around the world prior to the financial crisis. Hedge fund taxation and the recent regulatory changes in the U.S., particularly in reference to the Dodd Frank Act, and Europe, are also explained. The regulation of trading activities are explained and conjectures about future developments in the regulation of hedge funds are also provided in this chapter.

This chapter argues that employee and professional confidentiality rules coerce silence, generally for good purposes. Confidentiality is an arena of justified information privacy coercion. Keeping appropriate silences has been recognized as a challenging goal of personal virtue since Aristotle. When employees and professionals obtain knowledge of others in the course of their work, they incur ethical responsibility to comply with a complex set of civility rules, including those of confidentiality. Rules of silence are spelled out in ethical codes and are enacted into law. The people who manage corporations are duty bound to maintain trade secrets and to not disclose information that may lead to trading on insider information. The laws of confidentiality for health care professionals are open to criticism but are generally popular. The laws that require confidentiality of lawyers are also open to criticism, and are somewhat less popular. Many people are ambivalent about the adversary system that enables lawyers to profit handsomely from keeping the secrets of despicable criminals. Financial incentives exist for voluntarily assuming difficult legal burdens of silence. Payment for secrecy is not the whole story of why confidentiality is justly coerced. The larger story involves dignity and respect for moral agency, moral autonomy and the welfare of citizens of liberal democracies. Laws that demand confidence-keeping of professionals (lawyers, doctors, corporate insiders) are generally popular -- that is, they are generally applauded by the public and embraced by practitioners in the field along with experts who study the field.

This chapter discusses mainstream research as it relates to positive financial ethics. The first part discusses ethical risk in the context of the functioning of capital markets. Here the focus is on legal protections and regulatory supervision as ways of mitigating ethical risks. The studies examined focus primarily on differing legal régimes across countries, the attendant size and relative values of capital markets across countries, and cross-sectional variation in share values attributable to governance mechanisms across firms within countries. Next, the chapter discusses ethical risk pertinent to corporate finance and the financial ethical technologies employed to safeguard against them.

This chapter considers the role of private litigation, public enforcement and public surveillance in policing the integrity of information flows. It first discusses longstanding threats to integrity (such as fraud, insider trading and other forms of market abuse, and manipulative and disruptive trading practices), as well as emerging threats to reliability of information flows, (such disruptions to market continuity, operational capability, and systemic risk). It then considers the traditional role of private antifraud litigation in the United States in deterring and remediating fraud, as well as the trend to limit class action litigation in favor of public enforcement and other remedial mechanisms. It concludes with a discussion of self-regulatory surveillance mechanisms and efforts to enhance direct regulatory surveillance after the recent financial crisis.

This chapter analyzes and recommends federal corporate governance enhancements that should be implemented. These enhancements, which should be adopted in a measured and directed manner, are necessary to remediate certain deficiencies that currently exist. Consistent therewith, this chapter focuses on several important matters that merit attention, including the undue deference by federal courts to state law, the appropriate application of federal law to tactics undertaken in tender offers, the need for a federal statute encompassing insider trading, and the propriety of more vigorous oversight by the Securities and Exchange Commission (such as with respect to the “current” disclosure regime, the SEC’s Standards of Professional Conduct for Attorneys, and the Commission’s neglecting at times to invoke its statutory resources). Thus, the analysis set forth in this chapter identifies significant deficiencies that currently exist and recommends measures that should be implemented on the federal level to enhance corporate governance standards.

This chapter centers on a technique that managers and controlling shareholders may use to divert value from the corporation: related-party transactions. These transactions range from traditional self-dealing to more subtle forms of potential misappropriation of company value, such as compensation agreements, intercompany guarantees, insider trading, and the usurpation of corporate opportunities. Despite the potential for abuse, related party-transactions provide countervailing economic benefits and are rarely outlawed. Instead, the representative “core jurisdictions” employ a variety of legal strategies to police them, including: applying affiliation strategies through disclosure requirements and dissolution rights; intervening on agent incentives by requiring disinterested board approval; granting decision rights to shareholders; and imposing legal constraints such as prohibitions, the duty of loyalty, and the special regime of group law. The chapter concludes by analyzing the effectiveness of the different approaches to related-party transactions in core jurisdictions in view of their enforcement, and their relationship to the underlying ownership structures.

Thus far, this book has focused on concepts which have played a crucial role in formulating the debate between economically minded and progressively minded scholars about the policy and content of corporate reorganization law. In contrast with these earlier chapters, Chapter 8 is concerned with a concept which has not divided corporate reorganization law scholars to date, but which now interacts with another corporate law field in a new way. The relevant concept is the concept of transparency and disclosure, and the proximate field in question is the law of insider trading. Chapter 8 explores why shifts in identities in the finance field raise entirely new questions about the implications of transparency and disclosure for insider trading and market abuse liability in both the US and England.

This chapter focuses on the regulation of corporations as “issuers,” that is, as tools to raise finance from the public. All representative “core jurisdictions” have specific rules applying to the offer of securities to the public and to the ongoing governance and disclosure of companies whose securities are held by the investing public. While motivated by the need to protect investors, their economic function is rather in supporting capital markets as an efficient tool to allocate capital among corporations. This requires that markets are informationally efficient and prices are sufficiently informative. After reviewing the reasons why legal rules are held to be necessary to attain of the goal of price informativeness, the chapter examines mandatory disclosure frameworks. It highlights similarities and differences in issuer disclosure rules, assesses the degree of convergence in accounting law, and describes the use of other strategies, including banning insider trading and market manipulation (i.e., securities fraud). Public and private enforcement and gatekeeper control are examined, highlighting the gap in enforcement intensity between the U.S. and other jurisdictions.

Operationally efficient markets are those in which transactions are executed in a timely manner at minimal costs. If the costs are prohibitive, domestic and foreign investors will be deterred from participating, the markets will be shallower and less vibrant, and capital formation will be adversely impacted. Growth in emerging markets with severe operational inefficiencies may be stunted, even if the capacity of the markets appears to be sufficiently large. This chapter focuses on both explicit and implicit costs of trading. Explicit costs are directly calculable and include commissions paid to brokers, fees paid to exchanges, bid-ask spreads, and taxes. Implicit costs are more difficult to pin down, and reflect any salient market features that prevent traders from executing their trades at the prices they want when they want to do so. This category includes market impact costs, various proxy variables for market illiquidity, and even the existence of restrictions on certain kinds of trades.

This chapter considers the different forms and bases of liabilities and regulatory actions in respect of public offering of corporate securities—civil liability, criminal liability, pecuniary penalty, and regulatory actions. The dominant theme of all forms of liabilities and regulatory actions is checking misstatements, in particular fraudulent misstatement. It is the dominant theme of all forms of liabilities and regulatory actions because the common feature of most activities in a public offering programme is making of statements—by the company to the investors either in the prospectus or outside it; by investors to the company in the application form; by intermediaries and other participants either to the company or to other persons such as the regulatory authorities, etc. Misstatement (or misrepresentation, under contract law) broadly means a false statement. Both misstatement and fraud do not have a single definition or meaning in the context of liability. As this chapter explains, under each form of liability the elements of what constitutes misstatement and fraud somewhat differ.

This introductory chapter sets out the purpose of the book, namely to study economic morality in relation to both individual morality and public issues such as the regulation of advertising, insider trading, and cell phone use while driving. It focuses on welfare economics in relation with the roles of the government, the philosophy of consequentialism, and public policy. It also describes Jewish law as a deontological ethical system, dwelling on concepts of prohibition against falsehood, duties of an obligor, and policies designed to maximize wealth.

The hedge fund industry has grown to nearly $3 trillion over the last 20 years. High-net-worth individuals and institutional investors expect high returns and low correlation with traditional asset classes in exchange for the fees paid. The standard fee structure is “2 and 20,” 2 percent of assets under management and 20 percent of profits, representing high fees for active management. Hedge funds are largely unregulated and somewhat mysterious. As a result, they are the subject of debates and controversies among market participants and policymakers alike. Debates focus on fee structures, alpha versus alternative beta, weakening returns, activist investors, and leverage. The Securities and Exchange Commission has targeted hedge fund misconduct and malfeasance, pursuing perpetrators of fraud, insider trading, and conflicts of interest in the industry. Several high-ranking Wall Street hedge fund executives have been charged with, and in some cases convicted of, breaking securities laws.

No survey of dubious financial behavior could be complete without a discussion of insider trading, and this chapter shows how mutual funds have their equivalent in selective disclosure. Selective disclosure requires the intimate collaboration of fund insiders to perpetrate the scheme—the insiders selectively disclose nonpublic information to outsiders. The valuable information they disclose is, specifically, the exact holdings in the portfolio of a mutual fund. As the author shows, such disclosure is selective because the fund insiders reveal the information only to preferred clients, such as hedge funds. When a trader has discerned a fund’s pattern, he can plan his own trades accordingly by front-running the fund’s trades for financial advantage.