FOR EDUCATIONAL USE ONLY
4 J.L. Econ. & Pol'y 465
[FNa1]. Richard A. Booth is the McGuinn Professor of Business Law at Villanova University School of Law. His recent research focuses on the impact of investor diversification on a range of corporation and securities law issues.
[FN1]. HUI HUANG, INTERNATIONAL SECURITIES MARKETS: INSIDER TRADING LAW IN CHINA (Kluwer Law International, 2006).
[FN2]. Hui Huang is a Lecturer in Law at the University of New South Wales, where he specializes in business law.
[FN3]. See generally In re Cady, Roberts & Co., 40 S.E.C. 907 (1961).
[FN4]. HUANG, supra note 1, at 177-79, 197-203.
[FN5]. Id. at 22-23, 125-30.
[FN6]. Chiarella v. United States, 445 U.S. 222 (1980); Dirks v. S.E.C., 463 U.S. 646 (1983); United States v. O'Hagan, 521 U.S. 642 (1997).
[FN7]. HUANG, supra note 1, at 163-67.
[FN8]. Id. at 170-73.
[FN9]. Id. at 173-77, 321-39.
[FN10]. Id. at 28-37.
[FN11]. Id. at 37-93.
[FN12]. Id. at 311-15.
[FN13]. Id. at 37-56, 95-124.
[FN14]. Id. at 62.
[FN15]. Id. at 13.
[FN16]. Indeed, one study indicates that in recent years, turnover in China has been higher than in any other country in the world. See Utpal Bhattacharya & Neal E. Galpin, The Global Rise of the Value-Weighted Portfolio, AFA 2007 Chicago Meetings Paper (November 2005), available at http:// papers.ssrn.com/sol3/papers.cfm?abstract_id=849627 (last visited May 27, 2008).
[FN17]. HUANG, supra note 1, at 66-68.
[FN18]. Id. at 66-68.
[FN19]. Id. at 67.
[FN20]. Id. at 67.
[FN21]. Id. at 65-66.
[FN22]. There does not appear to be any law in China that is the equivalent of the 1933 Act in the U.S.
[FN23]. HUANG, supra note 1, at 46-48.
[FN24]. Id. at 95-124.
[FN25]. Incidentally, options avoid the two biggest problems that Manne largely ignored: the incentive to delay disclosure and the potential for gain from a decline in price.
[FN26]. See Richard A. Booth, The Missing Link Between Insider Trading and Securities Fraud, 3 J. Bus. Tech. L. (2008), available at http:// papers.ssrn.com/sol3/papers.cfm?abstract_id=975949 (last visited May 27, 2008).
[FN27]. HUANG, supra note 1, at 253-305.
[FN28]. See Richard A. Booth, The End of the Securities Fraud Class Action as We Know It, 4 Berkeley Bus. L.J. 1 (2007), available at http:// law.bepress.com/expresso/eps/978/ (last visited May 27, 2008).
[FN29]. HUANG, supra note 1, at 303 n.280; Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 730-31 (1975).
[FN30]. See Booth, supra note 26.
END OF DOCUMENT
Thursday, December 25, 2008
an interesting review of a "comparative law" book on china's insider trading law
In International Securities Markets: Insider Trading Law in China, [FN1] Hui Huang, [FN2] has undertaken to describe the state of insider trading law in China and the rest of the world--particularly the United States--and to suggest how the law of China should be applied in the context of China's emerging economy and markets. Needless to say, this is a prodigious task. The law of insider trading in the United States has been evolving since at least 1961, when the SEC decided In re Cady, Roberts. [FN3] But even with almost fifty years of experience, the debate continues in the United States about what constitutes insider trading, how the law should address it, and indeed whether it should be illegal at all. To complicate matters further, other countries have adopted approaches to insider trading that differ significantly from that of the U.S. [FN4]
In China, there is no lack of law relating to insider trading. As Huang describes it, the securities law of China (as adopted in 1999) includes five articles in the civil code that specifically address insider trading, plus one other that sets forth twelve categories of information deemed to be material and so presumably to define the kind of information that might give rise to insider trading. [FN5] According to Huang, these provisions were taken directly from U.S. law. The problem is that it is unclear what this law means and how it should be applied. Should China follow the U.S. and interpret the law of insider trading as based ultimately on fiduciary duty as in Chiarella, *466 Dirks, and O'Hagan? [FN6] Huang finds this theory confusing if not incoherent. Moreover, China does not have a well-developed law of fiduciary duty. [FN7]
In the end, Huang finds U.S. law wanting and recommends that China adopt what he calls the equality of access theory of insider trading, which he carefully distinguishes from the parity of information theory. [FN8] Huang, who seems to have read almost all of the U.S. scholarship on insider trading, suggests that the U.S. shied away from the former because of confusion that it meant the latter. [FN9] To the contrary, I would argue that U.S. law is about equality of access as Huang advocates. The ultimate question in the U.S. fiduciary duty-based system is how one obtains material nonpublic information, and thus whether it may lawfully be used for personal gain.
This is strange reading for someone from the common law tradition. The notion that one could have a well developed law of insider trading set down in a civil code and yet not know what it means is bizarre. In the U.S., as Holmes aptly put in The Common Law, the life of the law has been experience. We adopt statutes after we find a problem that does not respond to common law solutions.
In China, there have been eleven cases of insider trading since 1991. [FN10] Although Huang suggests that this constitutes vigilant enforcement, he nonetheless devotes considerable space to the question of whether insider trading is a problem in China and why. [FN11] He describes his book as a qualitative empirical study of insider trading. By that, he means that it was based on thirty-one interviews with regulators, market professionals, directors, investors, lawyers, judges, journalists, and academics. [FN12] On the basis of this study, Huang concludes that insider trading is widespread and harmful. [FN13] Huang seems to think that it is very important for China to crack down on insider trading because the U.S. does so. The idea seems to be that for the market to be robust, it must emulate the U.S. market.
For an American reader, one of the more interesting features of the book is its description of the Chinese stock markets and corporation law. Turnover is much higher in China than it is in the U.S. In 1998, turnover on the Shanghai Exchange was 355% compared with 70% on the New York Stock Exchange. [FN14] But these numbers are deceptive in that, as of 1998, only about 34% of the shares of companies listed on the Shanghai exchange *467 were tradable. [FN15] Thus, it would appear that the rate of turnover in China is about fifteen times what it is in the U.S. That suggests that there is much more stock-picking going on in China than in the U.S. [FN16] Accordingly, investors in China should be much more worried about insider trading than U.S. investors, who appear to follow more of a buy-and-hold strategy. (There is no mention in the book of mutual funds or other institutional investors, except for brokerage houses that appear to be engaged in active trading.)
Huang argues that insider trading is widespread in China because, among other reasons, there are problems with executive compensation and the law governing corporations. [FN17] According to Huang, the median salary of directors and senior officers in China was about $4,000 in 1998. [FN18] For example, the chairman of Houjian Corporation was paid $4,400 in 1998, while his corporation had sales of about $1 billion dollars that same year. [FN19] Stock options are not widely used in China. There are several reasons for this. Generally speaking, Chinese corporations do not have authorized but unissued shares. Nor are they permitted to buy back their own shares except in very limited circumstances. Also, officers and directors cannot sell their shares while they remain in office. [FN20]
Moreover, according to Huang, the Chinese government controls the number of listed companies in China with a quota system of sorts. [FN21] Thus, it appears that many companies seek a listing on one of the stock exchanges and proceed to sell stock before they have figured out what to do with the money. [FN22] The suggestion seems to be that a listing is seen as a license to engage in insider trading. Although Huang does not say so, I suspect that insiders account for most of the trading in China. In other words, it seems likely that much of the volume in China comes from insiders trading in each other's stocks.
It is telling that all eleven of the insider trading cases arising in China since 1991 have involved traditional insiders or issuers. [FN23] In the U.S., most of the notable cases have involved outsiders. Traditional insiders seem to know where the lines are drawn. This suggests that U.S. insider trading law may be more about leaks and keeping secrets than it is about fairness.
*468 Although Huang recognizes that there are significant problems with corporate governance and executive compensation in China, he devotes most of a chapter to lambasting the idea--first propounded by Henry Manne--that insider trading is a victimless crime that likely makes the market more efficient. [FN24] This is particularly ironic in that Manne advocates insider trading as a medium of executive compensation.
While I am sure that Manne would disagree, the largely option-based system of executive compensation that we have in the U.S. today is quite similar to what he advocated in 1966. Options can be seen as legalized insider trading, albeit with advance disclosure to investors and a cap on the number of shares, and without the risk that goes with the need to buy shares before disclosure of market moving news. [FN25] In this setting, secretive insider trading is a bad thing. It upsets the bargain between officers and investors. Witness the flap over timing and backdating in connection with option grants. [FN26] Indeed, I would argue that we could improve on the system we have if option grants were announced in advance or the exercise price were set shortly after a grant.
Huang devotes yet another long chapter to the need for private securities litigation. There, he discusses at length the problem of devising a remedy when no one seems to suffer harm. [FN27] As I have argued elsewhere, diversified buy-and-hold investors can tolerate what one might call honest securities fraud--fraud without insider trading--but they would favor a remedy in cases in which insiders use the occasion to extract gain from the market. The remedy should be disgorgement of gain (or loss avoided) to the issuer. [FN28] This is quite the opposite of the system we have that grants a windfall remedy to traders in securities fraud class actions but effectively denies a civil remedy for insider trading. To his credit, Huang discusses (in a footnote) the possibility of issuer recovery as a remedy for insider trading, but he dismisses it because the issuer suffers no harm and, as a non-trader, has no standing to sue under Blue Chip Stamps. [FN29] To the contrary, in a market composed primarily of diversified investors, issuer recovery works just fine. When the issuer recovers, investors recover because the value of the issuer increases by just the amount extracted by the insider. The fact that stockholders may have traded in the meantime is of little concern when *469 they own two hundred to three hundred different stocks (as most who invest through institutions, such as mutual funds and pension plans, effectively do). It all comes out in the wash. As for standing to sue, Huang understandably misses the rather fine point of our federal system that the issuer can always sue insiders who gain from a breach of fiduciary duty. [FN30]
It is not clear to me that anyone should seek to emulate U.S. law in this area. But it is quite clear that an emerging economy like China has problems that differ from those that arise in an economy with well-developed corporation law, established markets, and diversified investors. The bottom line is that China should fix its corporations law before it worries too much about insider trading.
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Journal of Law, Economics & Policy
Spring, 2008
INSIDER TRADING SYMPOSIUM -- JANUARY 27, 2007
Book Review
*471 HUI HUANG'S INTERNATIONAL SECURITIES MARKETS: INSIDER TRADING LAW IN
CHINA (2006)
Cally Jordan [FNa1]
Copyright © 2008 Journal of Law, Economics & Policy; Cally Jordan
It takes courage to tackle the subject of insider trading law in China. Insider trading is a notoriously contentious area for which there is little satisfactory legislative or judicial response, no matter where you look.
To attempt to address issues associated with insider trading law in China, one of the most opaque, idiosyncratic and fast-changing markets in the world, is a perilous task indeed. Hui Huang is to be commended for taking a stab at it in International Securities Markets: Insider Trading Law in China, and a good stab it is. [FN1] But a stab is all it can be, given the paucity of empirical information available and the dynamism of the markets. No sooner have you put one foot in the river, than the river has rushed on.
This is a book written in a hurry. It had to be. This accounts for its main drawbacks. A more thorough and leisurely editing would have improved the readability, balanced out the unevenness in treatment of different sections of the book, caught the odd stylistic infelicity ("black horse" for "dark horse," for example [FN2]) and provided a more thoughtful and less perfunctory conclusion.
But this is to quibble. The book makes an important contribution to the literature on Chinese markets, for several reasons: its privileged insights into the operation of and perceptions of participants in the Chinese capital markets, its comparative perspective, and its unflinching critique of the clumsy adaptation of United States legislative models and other approaches to insider trading to the Chinese markets.
In the face of the dearth of reliable empirical evidence, Hui Huang adopts two strategies. First, he compiles what known, verifiable, information exists. Each formal insider trading case in China is documented and discussed. [FN3] In addition, there is a useful tabular summary of the cases for *472 purposes of quick reference and comparison, which provides a snapshot in time. [FN4]
Secondly, using a qualitative methodology, Hui Huang conducted thirty-one "semi-structured" (i.e., based on "prearranged questions") and in-depth interviews during September and October 2003, to obtain empirical data on insider trading in China. [FN5] Interviewees included regulatory and stock exchange officials, market intermediaries, lawyers, financial journalists, judges, academics, a listed company, and three "ordinary investors." The geographic distribution of the interviews included Beijing, Shanghai and Guangzhou.
Huang readily acknowledges the criticisms which have been directed at such qualitative methods, and the resulting anecdotal nature of the results. However, as insider trading is "by nature a hidden form of misconduct," other forms of empirical analysis are simply not practicable.
The observations emerging from the interviews, albeit anecdotal, are fascinating. For example, interviewees were asked their opinion on the views of Henry Manne, who, in a classic 1966 paper, [FN6] argued for the potential benefits of insider trading. The response of an ordinary investor interviewee? "[I]nsider trading is obviously unfair and harmful. How can he [Professor Manne] think of such silly ideas? He is clearly out of touch with the market and makes those arguments for self-amusement." [FN7]
Despite the very small number of reported cases, the unequivocal view of those interviewed was that insider trading in the Chinese markets was "widespread," "rife," "everyday," "extensive," and "ingrained." [FN8] In fact, Huang finds that insider trading seems to be considered a necessity in Chinese markets. As one interviewee noted, "Many people do not trade shares unless they have inside information. We simply have no choice in such an environment." [FN9] The securities industry was a "big dye vat, and you cannot possibly keep yourself clean." [FN10] Faced with the impossibility of acting otherwise, market professionals appear to attach little professional opprobrium to insider trading. Intermediaries may appear weary of the "vicious competition" in the market but yearn, to no avail, for a cleaner, better regulated, market. [FN11]
So why do investors trade in such a market? According to Huang, they accept the highly speculative and likely distorted nature of the market, and trade there for lack of alternative investment opportunities. [FN12] There is *473 also an "if you can't beat 'em, join 'em" attitude among investors, making it "very common in China that people openly talk about insider trading and actively seek inside information." [FN13] Everybody wants to be an insider, and a vicious circle of insider trading practices results.
Although there are numerous other factors that play into the insider trading phenomenon in China, one factor dominates the market: the dual role of government as regulator and shareholder. The China Securities Regulatory Commission (CSRC) faces a daunting array of obstacles in pursuing its regulatory mission, ranging from the high degree of social tolerance for insider trading to evidentiary obstacles and lack of resources. [FN14] However, as significant as these impediments may be, the overwhelming reality is that the CSRC is directly controlled by the government. In addition, listed companies in China are characterized by a highly concentrated ownership structure, with the state as the controlling shareholder. This noxious combination results in a pattern of regulation referred to as "regulatory art." [FN15] Regulatory standards vary with the state of the market, and according to Huang, "[W]hen the market is bullish, the CSRC is inclined to tighten the regulation; when the market is bearish, the CSRC is prepared to loosen the regulation." [FN16] Not only may interested government agencies benefit directly through the illegal market activity of others, but there is also evidence of active collusion, for example, in the falsification of business financial records. [FN17]
Perhaps not surprisingly, the government may be the biggest market manipulator of all, through the use of editorials in the official government newspaper, the People's Daily (Renmin Ribao). According to an example provided by Huang "in response to the overheated market in 1996, the People's Daily published an editorial which bitterly criticized the mania of trading shares As a result, the stock market slumped dramatically on three consecutive days. Likewise, after two years of bear market, the People's Daily published another editorial to stimulate the market in 1999." [FN18]
The second valuable contribution of this text to the literature is its comparative perspective. True, there is perhaps an overly detailed discussion of the complexities of U.S. law in this area. [FN19] But, at the least, the discussion leaves no doubt as to the troubled and difficult analysis which has been brought to bear on the regulation of insider trading in the U.S. The discussion of the U.S. approach to insider trading, though, is highly pertinent to the extent that the Chinese legislation, for better or worse, has been *474 strongly influenced by the concepts and regulation emanating from the U.S. [FN20]
The text examines the regulation of insider trading in several other jurisdictions as well, including the United Kingdom, the European Union, Singapore, and Australia. In particular, Huang finds favor with the modern Australian "information connection" approach to insider trading, due to its simplicity and inclusiveness. According to Huang, "it is the use of inside information, not a person's connection with the company whose securities are traded or some other entity, which can harm the market Furthermore this approach is more conceptually straightforward and thus assists market participants to understand insider trading law." [FN21]
The discussion of non-U.S. regulatory approaches to insider trading could have been even more extensive, given the author's trenchant observations on the difficulties of importing, holus bolus, U.S. regulatory models into China. [FN22] After all, China is a "civil law" country where concepts based on the common law notion of "fiduciary duties" will find little traction. Additionally, the U.S. approach to insider trading is complex and fraught with conceptual difficulties and longstanding judicial controversies. [FN23] "The theory underlying China's insider trading regulation is unclear," as Huang observes, and in "hastily importing experience from overseas, notably the U.S., without critical and careful thinking, China seems to have stuffed its insider trading regulation with theories that are in fact mutually contradictory. This has resulted in confusion in applying and interpreting provisions, and adversely affected the efficacy of the insider trading regime in China. In order to regulate insider trading credibly, China needs a clear underlying theory." [FN24] Fortunately for Chinese regulators, Insider Trading Law in China provides the welcome conceptual clarity and analysis to light the way forward.
[FNa1]. Cally Jordan is an Associate Professor of Law at the University of Melbourne. She is a frequent speaker on corporate governance, capital markets and corporate law, has written proposals for the reform of Hong Kong corporate law, and spent nearly five years living in Asia.
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