Why the stock market isn't fair

    But in the markets, the notion of what is public and what is private and what can and cannot be shared is rooted in the legal constructs of the securities laws surrounding insider trading and Regulation FD. The definition of when the line is crossed is important to recognize: how many people must know – when is information considered public?

    "Expert networks", as sources of information, have always existed, alumni networks being just one example. Technology, however, has made it possible for loose networks of people, relatively or very unknown to each other, to come together to share information. Expert networks of consultants using technology infrastructures are the part of the focus of the current probes.

    The same technology that makes new networks possible makes their activities much more discoverable by law enforcement.

Enforcement Matters

    Recent research by Lauren Cohen of the Harvard Business School and his colleagues suggests that Regulation FD has had a beneficial impact on limiting the impact of school ties and alumni networks in certain areas of the capital markets but not others.

    Comparing pre- and post-Regulation FD and US and UK information, their research shows that in the US, after Regulation FD, the advantage of alumni networks to sell side analysts has been eliminated (while in the UK and the US pre-Reg FD those advantages remain). This suggests, strongly, that Regulation FD has worked very well in the analyst arena in curbing the advantage of insider information.

    But in the current insider trading probes, subpoenas are being issued to mutual funds. Interestingly enough, Cohen's results for analysts – and the elimination of information advantage -- do not hold true for mutual funds. Professor Cohen says, "there has been no change" in the results pre or post Regulation FD for mutual fund managers.

    Why the difference? Why would Regulation FD have had a positive impact on squelching insider information for analysts but not mutual fund managers? Cohen says it's because Regulation FD has heretofore been targeted at analysts, but not mutual funds. Until now, significant cases have not been brought against mutual funds although the law applies equally in each case.

    This may be because it was easier for enforcers to learn about meetings between management and analysts. As the research shows, and as applies to all legal constructs, it is not just the law but enforcement of the law that builds the context that changes behavior.

    Clearly, insider trading can impact each of us in ways we would not ordinarily imagine. For those who are privy to a great deal of inside information while sitting on boards or consulting to companies, the need to consider issues of confidentiality and prudence – and the impacts on the capital market system have never been more important than now.

    Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance, a board advisory firm.