ETH Zurich, Spring 2015 Law & Business Transactions Insider Trading Gérard Hertig

I. Misappropriation of Value ? RPT : Benefits as well as value diversion risk Decreasing benefits/Increasing risks: → self-dealing → taking of corporate opportunities → trading in companies shares Trading in the company’s shares may: Increase market information Improve liquidity Show owner commitment Aim at manipulating the share price (e.g. for tax or inheritance reasons) Be based on non-public price-sensitive company information Regulatory responses Prohibiting price manipulations on public markets Regulating ‘insider trading’ G. Hertig2 Misappropriation / Targeting Insider Trading / Major Regulatory Issues / Enforcement

II. Targeting Insider Trading Prophylactic restrictions on short-term trading: – No ‘rapid fire’ buying → selling or selling → buying – ‘Rapid fire’: Less than six months intervals – Profits or avoided losses: Allocated to the corporate treasury Trading in the company’s shares may: Improve liquidity Show owner commitment Aim at manipulating the share price (e.g. for tax or inheritance reasons) Be based on non-public price-sensitive company information Regulatory responses Concerns: Insiders generally benefit from non-public corporate information Actions: Prohibiting price manipulations on public markets and/or Prohibiting ‘insider trading’ G. Hertig3 Misappropriation / Targeting Insider Trading / Major Regulatory Issues / Enforcement

III. Major Regulatory Issues Defining ‘insiders’ – Directors and insiders – Controlling and major shareholders Types of firms – Listed and/or public firms – Closely-held firms Defining the information advantage – Non-public – Price sensitive Effective enforcement → G. Hertig4 Misappropriation / Targeting Insider Trading / Major Regulatory Issues / Enforcement

IV. Enforcement Core variables – Enforcement agents: private or public enforcers – Sanctions: Disgorgement of profits, treble damages, fines, prison terms Enforcement-friendly environment – Burden of proof – Enforcement appetite and popularity – Public budget and private rewards G. Hertig5 Misappropriation / Targeting Insider Trading / Major Regulatory Issues / Enforcement

Enforcement Levels and Impact Levels: Higher in the US, some non-US activism in recent years – France: Increased its cross-border insider trading information request from 182 in 2006 to 279 in 2013 – Japan: 9 cases filed for criminal prosecution in 2006 compared to 11 in 1992–1999 – Brazil: 34 administrative proceedings opened between 2002 and 2013 Impact: – Limited effect on volume/profitability of trading by insiders – Some empirical studies: Decrease in cost of equity, increase in market informativeness/liquidity – Other empirical studies: Only results in more expensive takeovers G. Hertig6 Misappropriation / Targeting Insider Trading / Major Regulatory Issues / Enforcement

SEC v. Texas Gulf Sulphur Company F. Supp. 262 (S.D.N.Y 1966) Insiders may include employees as well as officers, directors, and controlling stockholders who are in possession of material undisclosed information obtained in the course of their employment. An insider's liability for failure to disclose material information which he uses to his own advantage in the purchase of securities extends to purchases made on national securities exchanges as well as to purchases in "face-to-face" transactions If legitimate business reasons require a period of nondisclosure, the insider should forego transactions in his company's securities during that period. However, to establish a violation of Section 10(b) and Rule 10b-5, the undisclosed information must be material. There is nothing in the Act which precludes insiders from purchasing stock of their company or from being beneficiaries of the company's incentive stock option plan. On the contrary, it is important under our free enterprise system that insiders, including directors, officers, and employees, be encouraged to own securities of their company. The incentive that comes with stock ownership benefits both the company and its stockholders G. Hertig7 Misappropriation / Targeting Insider Trading / Major Regulatory Issues / Enforcement

It is obvious that insiders will know more about the company or have more specialized knowledge as to at least some phase of its business than an outside stockholder can have or expect to have. Often this specialized knowledge may whet the speculative interest of the insider, particularly if he believes in the future of his company, and may lead him to purchase stock. Purchases under such circumstances are not encompassed by Section 10(b) and Rule 10b-5 However, where an insider comes into possession of material information which he uses to his own advantage by purchasing stock or calls on the stock of his company prior to public disclosure, he violates Section 10(b) and Rule 10b-5. Material information has been defined as information "which in reasonable and objective contemplation might affect the value of the corporation's securities.“ Material information need not be limited to information which is translatable into earnings. But the test of materiality must necessarily be a conservative one, particularly since many actions under Section 10(b) are brought on the basis of hindsight G. Hertig8 Misappropriation / Targeting Insider Trading / Major Regulatory Issues / Enforcement SEC v. Texas Gulf Sulphur Company (2)

1.The most that can be said of the individual defendants' knowledge after the drilling of K-55-1 is that they had "hopes, perhaps with some reason," that it would lead to a mine. The results of K-55-1 were too "remote" when considered in light of the size of TGS, the scope of its activities, and the number of its outstanding shares, to have had any significant impact on the market, i. e., to be deemed material. 2.Another question is whether information which may have special significance to an insider because of his professional background, is material. Most insiders necessarily have educated guesses about the prospects of particular company programs. If they announce their educated guesses before purchasing and their guesses turn out to be wrong, they would be subject to suit; and if they purchase and keep their educated guesses to themselves and they turn out to be right, they would again be subject to suit. T The creation of such a dilemma would result in insiders not buying at all although insiders should be encouraged to have a stake in the companies for which they work G. Hertig9 Misappropriation / Targeting Insider Trading / Major Regulatory Issues / Enforcement SEC v. Texas Gulf Sulphur Company (3)