Insider Trading

Here's a link to a discussion of insider trading -- specifically, an interview of law professor Henry Manne, who believes most such trading ought to be legal click here.

I bring it up specifically because I've been thinking about mergers, and an impending merger is one of the classic contexts in which charges of insider trading arise. I'll refer to inside traders as ITs for short.

A merger offer, as we discussed here last week, will generally involve a "control premium," i.e. a price for the stock of the target company above its market value. If one were aware ahead of time that such an offer was, well ... in the offing ... one would of course start scooping up the stock in order to sell it again after the offer has become public and the control premium is on the table.

The big question is: who does the IT cheat? and how?

The IT certainly isn't committing a fraud in the classic sense. At common law, a fraud is a misrepresentation by one party upon which the counter-party relies, to the counter-parties' legal detriment. If the IT buys up stock of a merger target through a public exchange, it seems to me just stretching a point to the point of torture on the rack to claim that the sellers of that stock are reliance upon anybody's representation (through silence) that there ISN'T any merger in the works.

Furthermore, in general the sellers will get a higher price if there has been some leakage of word of the impending merger than they'll get if there hasn't been, so clamping down on the ITs and limiting the buying in the pre-announcement period is what does them hard. Not the IT, but the prosecution thereof.

More tomorrow.