Bringing Insider Trading Laws into the 21st Century

As our economy has battled a global pandemic, investors and shareholders have been on a roller coaster ride as stock prices have fluctuated, and corporations have had to quickly pivot and change how they conduct business. From the Justice Department investigating senators on both sides of the aisle for insider trading to companies trying to buy-back stock, fears of how the COVID-19 pandemic will impact our markets and investment portfolios have underscored corporate trading practices. However, in the context of a global pandemic or other emergencies that can drastically affect the market, do our insider trading laws have the effect we expect them to?

Case in point, shares of genetic testing company Invitae fell as much as 14.4 percent and then gained as much as 13.2 percent in the same day after the company announced the pricing of a public offering of common stock. (Chatsko, The Motley Fool). As a high growth company, and after making multiple acquisitions in the first quarter that needed to be paid off, Invitae offered 20.4 million shares at $9 each, after the shares had traded at $18 in 2019. Id. This more recent offering ended up diluting existing shares owned by existing investors. Id.

In another instance, a case was filed by a union pension fund in May 2020 against Carvana, an online used car retailer, accusing the controlling shareholders, the CEO Ernie Garcia III and his father Ernie Garcia II, of insider trading. (Leonard, Bloomberg Law). On March 30 and April 1, 2020, Carvana sold 13.3 million Class A shares at $45 each, raising $600 million in an offering that was only open to company insiders and “certain existing investors.” (Cuccinello, Forbes). At its first-quarter earnings call, Carvana posted a larger-than-expected loss of $183 million but strong revenue growth of 45 percent year over year. Id. The following morning, Carvana announced it was expanding its “soon-as-next-day touchless home delivery” to 100 more cities in 25 states, wiping out all of its previous stock price losses and ending the day up 10 percent. (Cuccinello, Forbes) (Leonard, Bloomberg Law). On May 18, Carvana announced a public offering of 5 million Class A shares at $92 a share. Id.

The suit claims that when the first offering took place in late March, the “insiders used their knowledge of Carvana’s actual performance – before the results were published that quarter – to take a large chunk of the company on the cheap.” (Leonard, Bloomberg Law). The plaintiffs argue the Garcias knew Carvana was uniquely positioned to address growing customer demand in safer car-buying experiences and have experienced massive growth between February and March. (Cuccinello, Forbes). By selling Carvana shares to the controlling stockholders for “bargain-basement prices,” the suit argues the defendants’ robbed the company of hundreds of millions of dollars of capital. Id.

While the facts surrounding the Carvana case remain to be seen, regardless of whether the offering was solely motived by the greed of the controlling shareholders, or if there was some underlying strategy to allow the company to pivot, the current pandemic has highlighted some of the shortcomings of our nation’s insider trading laws. Some have argued that when corporate insiders are forced to sit on their information, markets are inefficient since they do not incorporate all relevant information. (Dent, Case Western Reserve University Faculty Publications) (Dorfman, Forbes). Others argue that without constraints corporate insiders would obtain outside financing to fully exploit their informational advantages. Id. In other words, the prospects of enormous trading profits would induce managers to change decisions to the detriment of the corporation. Id. Although insider trading restrictions keep insiders from profiting through their knowledge before anyone else has a chance, the restrictions also force them to absorb losses when their knowledge assures them that the stock price will drop. (Dorfman, Forbes). If insiders could trade on their knowledge immediately, stock prices would adjust accordingly as the market notices trading. This would make markets and corporations more efficient in reacting to events like a global pandemic. Id. Removing restrictions on insider trading does not open up more people to losses or being taken advantage of by corporate insiders, the laws around insider trading just delay the inevitable. Id.

With the speed of today’s information networks, many investors have access to automatic alerts on stocks they own or are considering investing in. To bring insider trading laws into our modern landscape of how business is conducted and to allow corporates insiders to move more efficiently, we need insider trading laws that allow for a more rapid system of incorporating inside information into markets where everyone can see and benefit from a more efficient market.