Max Planck Institute for Foreign and International Criminal Law

Despite the globalization of financial markets and the processes of unification in financial regulation across the globe there are many elements in the structure, organization and regulation of financial markets that show a remarkable perseverance against unification. When it comes to regulation and enforcement, these differences appear not only in the “law in the books” (density of regulation; scope of criminalization of the breaches of financial regulation; procedural powers of enforcement entities, etc.), but also in the “law in action” (enforcement intensity; allocation of resources within regulatory and enforcement agencies; exercise of prosecutorial discretion, etc.). It is one of the basic assumptions of the research project that these differences can be explained by complex interrelations between the structure and functioning of national financial markets, the national regulatory framework and enforcement processes as well as the broader context of their legal, economic and political environment.

There is a considerable body of literature in economics on the relationship of legal traditions, financial regulation and the development of financial markets. There were also efforts to develop a methodology for the comparative analysis of enforcement intensity. Yet previous studies mostly concentrated on the effect of regulation and enforcement on capital markets (such as growth in market capitalization in general, or the cost of equity capital), and viewed enforcement, be it private, civil or criminal, as a homogenous variable.

In this research, the focus lies more on the scope of criminalization of the breaches of financial regulation, and on the relationship of civil and criminal enforcement. The basic research question of this study is the following: what accounts for the differences in the scope of criminalization of the breaches of securities regulation, and for the differences in enforcement intensity?

Our hypothesis is that these differences are the result of the interplay of at least three factors:

1. the political and economic environment of financial regulation as a whole;
2. the status of criminal law and the relationship between civil/administrative and criminal enforcement;
3. institutional and organizational practices, recruitment processes, attitudes of officials in regulatory authorities and law enforcement agencies.

In our research project we have selected insider trading as a case study. Selecting a set, well-defined and relatively autonomous (in terms of interconnectedness with other parts of securities laws) element of regulation will enable us to cut “vertically” through all levels of analysis.

The prohibition of insider trading evolved – based on the general securities fraud definition of US federal securities regulation – in a row of judicial decisions in the United States, a development driven by the SEC and federal prosecutors. In the US, it is still not codified today. The common law nature of the prohibition enabled authorities to respond to the development of US financial markets, redefining the law on securities fraud and insider trading over the decades. Meanwhile, up until the 90´s, insider trading had not been illegal in most of the European countries, including those with sizeable capital markets like the UK or Germany. The introduction of the prohibition into German law was part of a large-scale overhaul of German securities laws and financial regulation, partly driven by the EU policy to make European capital markets more unified and competitive with their US counterparts. Accordingly, the prohibition of insider trading is a legal transplant in German law. Thus, a comparative research will also enable us map the learning processes through which regulatory authorities and law enforcement adapt to new elements of securities regulation and criminal law.

In the analysis of the interconnectedness of financial markets and financial regulation both on the national level and on global scale, the framework is based on multiple paradigms in political economy. Concerning the convergence of US and German capital markets we wish to draw on those approaches in international political economy (IPE) that depart from a purely external concept of state power and market power, and theorize the notion of “structural power” to describe the their socio-economic, class and institutional dimensions and sources (f.e.: Germain, 1997, 2010). Yet in the particular case of a US-German comparison, where certain elements of market structures do seem to show a remarkable persistence despite broad-sweeping state interventions to change and “internationalize” them, some aspects of the “varieties of capitalism” paradigm (Hall & Soskice, 2001) in comparative political economy (CPE) could also be a useful tool of analysis.

When it comes to research questions whose ultimate subject is the law, however, two of the weaknesses of both approaches prove to be particularly problematic: on the one hand, both share a tendency to ontologize the distinction between markets and institutions, and, on the other hand, a focus on formal state institutions and organizations which tends to disregard the social sources of state capacity.

The large presence of retail investors in US capital markets (one of the major differences compared to Germany), could, for instance, shape, through the political incentives it creates, regulation; these, in return, could influence policy-decisions in regulatory authorities and enforcement agencies; and it could also further the development of the law, in the case of insider trading, for example, through prosecutorial narratives about the rationale of the prohibition (“Wall Street vs. Main Street crime”; “cheat on the average investor”) and to extend or change the scope of the prohibition.

Approaches in political economy, furthermore, also tend to regard regulation as a formalistic and technical entity. We think, however, that each legal system has an inner logic and a moment of inertia which is partly constituted by is internal dogmatic structure and partly by its application by regulatory authorities, law enforcement agencies and the courts. In this respect, in our research project we also wish to draw on the system theory approach in legal sociology, especially on the works of Gunther Teubner (f.e.: Teubner, 2001).

The basic assumption of the system-theoretical approach is that politics, law, and economics constitute differentiated and autonomous sub-systems, which are cognitively open, but normatively and operationally closed. This means that no subsystem is immune from the stimulation of its external environment, but stimuli are processed according to the normative and operative structure of the subsystem and not the environment. To take an example from business criminal law, hastily drafting legislation in response to corporate scandals might correspond to the operational logic of the political sub-system, but it can easily disrupt the operation of the legal sub-system, as it is processing the legislation according to the wider normative principles of criminal law and criminal procedure.

The system theory approach, however, views law as a static entity, as "law in the books", and provides no theoretical tools to analyze the "law in action": the dynamics of litigation; the organizational dynamics in regulatory agencies and law enforcement, and the interpretative practices, views and attitudes of legal professionals, all of which substantially shape the way laws are applied. In this project, we also intend to map the latter in relation to insider trading with an empirical, qualitative research.

The first phase of the research involves the analysis of the development of insider trading regulation and case law in the context of the evolution of financial markets in Germany and in the USA. This also encompasses the analysis of all insider trading cases in the USA and Germany (both civil and criminal) from the period 1980-2010 (USA) and Germany (1995-2010) to establish trends in "everyday enforcement" as opposed to landmark cases which further develop the law.

In the second phase of the research, we will conduct interviews with acting or former officials at regulatory agencies and prosecutor`s offices both at the senior level responsible for policy-decisions and with those who regularly investigate insider trading cases and make decisions about suing individuals or about pursuing criminal charges, and who represent the government in such cases in court. We will also speak with compliance professionals working for SROs, funds and other financial institutions, as well as with traders. In this phase, in line with the methodological approach of "polymorphous engagement" (Gusterson, 2008), a method applied in the ethnographic research of closed professional elites where access could be a problem, documents such as policy statements and court submissions will also be analysed.

The first phase of the research, including the case analyses, has been concluded in January 2011. Currently, we are conducting interviews. The last rounds of interviews are scheduled for November 2011.

Prof. Dr. Dr. hc. Hans-Jörg Albrecht

Prof. Dr. Roland Hefendehl