Professor Bainbridge...on law, politics, religion, culture & food

Why the insider trading prohibition is mandatory rather than just a default rule

I recently received the following email from a fellow corporate law professor:

Steve: I'm teaching insider trading to my corporations class today. I use your casebook, and I just read through your Insider Trading book. I like your summary of the property rights rationale for insider trading regulation, and I'm with you 100% right up to the end. But, if you want to treat insider information as a property right like trade secrets, how do you deal with the fact that insider trading liability is not waivable by the corporation-- i.e., the party with the entitlement?

It seems, following the property rights theory, that inside information should be a right of the corporation in the first instance, but it should be up to the firm after that to decide whether they want to allow insiders to use it (just as firms can, I presume, allow insiders to use trade secrets). Part of the answer here might involve the desirability of federal enforcement of insider trading. But couldn't the information be a property right with federal enforcement? That is, the firm ought to be able to opt-out of enforcement actions. They can't, of course. But doesn't that hurt the property rights theory? Maybe we just have to throw up our hands and go with the public choice explanation at this point (SEC won't allow corps to waive b/c they want to keep enforcing these cases)?

It's a great question. I answered with an excerpt from my article "Insider Trading under the Restatement of the Law Governing Lawyers," 19 Journal of Corporation Law 1 (1993). In this article I argued (1) that the rule of legal ethics actually authorize insider trading (I know that sounds nuts, I was surprised too when I realized it) and (2) that the rules should be changed to forbid lawyers from using confidential client information to make inside trading profits. In the excerpt that follows, I deal with the question of whether the prohibition should be a default rule that the client and lawyer are free to change or a mandatory rule. I conclude that it should be a mandatory rule (albeit somewhat tentatively, I must admit).