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As a hypothetical:

Company A is a competitor of Company B. Management of Company A thinks that Company A is so much better than Company B that Company B will soon go out of business. After getting approval from all major stakeholders of Company A, management publicly announces plans to short Company B and provides their reasons for doing so, but these reasons are mostly subjective. For example, the management of Company A believes that Company A has a better culture, smarter employees, and more efficient processes.

Later on, Company A does short Company B, and Company B shortly thereafter goes out of business, making Company A a lot of money. Has Company A (or its executives acting on Company A's behalf) committed insider trading?

According to rule 240.10b5-1, insider trading is defined as:

among other things, the purchase or sale of a security of any issuer, on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information.

On the one hand, there was no breach of trust as Company A, with approval from stakeholders, made a good faith effort to publicize their actions and information used to justify these actions in advance. On the other hand, a reasonable person might argue that management of Company A had an unfair advantage over other investors in Company B in that they were acting on "nonpublic information about that security". Specifically, management of Company A knew firsthand what Company A was actually like- information that is relevant to the prospects of their competitor, Company B. The general investing public outside of Company A had to rely on the claims of management, which might reasonably be taken with a grain of salt since many companies claim to have "the best" culture and talent.

I understand that this question is fairly speculative, so to make things a little less theoretical, I would prefer answers that provide specific regulations, court cases, or legislation addressing the following issues central to this question:

  1. Is there some privileged information that simply cannot be acted upon even if made public since it cannot be publicly verified in an objective way (e.g. the firsthand impression of management of how well the company is doing)? To put it another way: is an indirect duty of trust owed by management of a company to the entire general investing public- not just investors in the company itself?
  2. To what extent does getting the approval of stakeholders in Company A and publicly announcing planned actions in advance protect against insider trading regulations? (Note that this is different than the typical case of employees filing plans to buy or sell stock in their company in advance because (a) this involves another company's stock and (b) the plan is publicly announced after becoming aware of information relevant to the stock price of Company B not before.)
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2 Answers 2

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The management of Company A does not have a duty of trust to Company B

As such, they can act on whatever information they like.

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  • If no one could tell Company B was about to go under and the CEO of Company A received non-public information from the CEO of Company B because they were brothers-in-law, I'm not sure that this analysis would hold. But somebody in the chain who owes a duty of trust to Company B has to disclose secrets about Company B. This question presumes that there is no such information.
    – ohwilleke
    Dec 5, 2022 at 18:14
  • So based on this answer, I take it that it would be fine for Company A to short Company B before Company A announced a new product that was likely to cause Company B's stock price to go down since management of Company A only owes a duty of trust to stakeholders of Company A (who are presumably benefiting from this trade) but not to investors in Company B. Is this correct? Dec 6, 2022 at 0:45
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    Also, if this is the case, I am curious why companies don't do this all the time, i.e. shorting their competition before better than expected earnings or major product announcements. Dec 6, 2022 at 0:48
  • I think “no duty of trust” means A can take actions based on this information that benefit A and consequently hurt B. But A cannot use this information for trading stock, because that hurts everyone investing in shares.
    – gnasher729
    Dec 6, 2022 at 7:31
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    @IñakiViggers Because there is such a thing a tippee liability for insider trading. If the CEO of Company B was engaged in insider trading and the CEO of Company A knowingly benefited from that crime, the Company A could also be guilty.
    – ohwilleke
    Dec 6, 2022 at 16:48
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Does non-objectively justifiable optimism constitute insider trading?

No. The premise that traders' "reasons are mostly subjective" implies that they did not act on material information at all. Consequently, this defeats the notion that "management of Company A had an unfair advantage over other[s]".

management of Company A knew firsthand what Company A was actually like- information that is relevant to the prospects of their competitor, Company B.

Based on your main premise, the trade stemmed from mostly subjective reasons. A trader does not really need to publicize much of its hunch, train of thought, or of its own background in order to perform a transaction about a competitor's securities lawfully.

17 CFR at §229.10(b)(1) provides that filing good faith assessments of a registrant's future performance is optional, but any such filings "must have a reasonable basis for such an assessment". This reinforces the notion that company A has no obligation to disclose its hunch about others, since (1) a hunch falls short of reasonable basis; and (2) from subsequent references to "outside reviewer" in that same statute it is inferred that the term "registrant" means the company that makes the filings (i.e., company A), not a third party (i.e., company B).

Is there some privileged information that simply cannot be acted upon even if made public since it cannot be publicly verified in an objective way (e.g. the firsthand impression of management of how well the company is doing)?

Yes, but that entails a breach of fiduciary duties (which is in line with "in breach of a duty or trust or confidence" in the excerpt you reproduced), or scenarios such as "misappropriation of material, non-public information from its lawful possessors". SEC v. Berrettini (US Dist. Court, N.D. Illinois, Nov 2012). These premises have nothing to do with management's explicit speculation or educated guess.

For instance, 17 CFR at §240.0-6(a) prohibits the disclosure of information which "has been classified by an appropriate department or agency of the United States for protection in the interests of national defense or foreign policy". The fact that disclosure is prohibited implies that so is any transaction that takes advantage of that privileged information.

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  • "No. The premise that traders' "reasons are mostly subjective" implies that they did not act on material information at all." So information is not material at all even if reasons are only mostly subjective? For example, an employee tells the CEO about a great idea that they have, and the CEO encourages them to pursue it because the CEO subjectively thinks it is a good idea. Is it ok for the CEO to then go and short a competing company on the hope that this idea is successful (assuming that the CEO has approval from stakeholders in their own company, so that there is no breach of trust)? Dec 6, 2022 at 1:11
  • Also, do you agree with the other answer, which says that management of Company A "can act on whatever information they like" (even non-public information that they are the lawful possessors of, e.g. knowledge of a big product announcement that Company A is about to make) since they do not owe a duty of trust to stakeholders of Company B and they are not breaching the trust of their own company? Dec 6, 2022 at 1:19
  • @imadethisacct2askdumbquestions "So information is not material at all even if reasons are only mostly subjective?" In fact, "information" is a misnomer in the scenario you outlined. Company A is not acting on information, but on its managers' subjective reasons. "do you agree with the other answer" Yes, subject to the issue of tippee liability that ohwilleke pointed out. But the comment about comparative performance and sectorial correlation is neither relevant from a legal standpoint nor necessarily (or "usually") accurate from an economics standpoint. Dec 6, 2022 at 22:07

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