On 16 March and 14 October, CEPR held the first two of a series of workshops devoted to issues of financial regulation. The meetings began with short presentations followed by longer `off the record' discussions of the issues raised by the presentations. The first meeting focused on `Security Market Regulation and the 1987 Crash: The Brady Commission Report' and was funded by the International Stock Exchange. The introductory presentation was given by Bruce Greenwald (Bell Communications Research). Greenwald, a staff economist for the Brady Commission, outlined the significant features of the crash, discussed the proposals of the Brady Commission and, finally, dealt at length with his own views of the role of `circuit-breakers' in such situations.

Greenwald emphasized certain features of the crash in the US markets. The equity and futures markets completed unprecedented volumes of trades during the period surrounding Monday 19 October only in the options markets were trading volumes below normal. Not all of this trade took place in an orderly fashion, however: in the OTC Market, for example, prices for essentially contemporaneous trades frequently differed by as much as 20%. Greenwald claimed that from 2.00 p.m. on 19 October until the late afternoon of the following day, equity markets became separated from any stable reality.
Greenwald pointed out that it was against this background that the Brady Commission drew their conclusions. Greenwald's presentation focused on one particular recommendation made by the Commission, to introduce `circuit-breakers'. The role of circuit-breakers had been largely misunderstood in the public debate, Greenwald claimed: they were perceived only as mechanisms for shutting down trading. But circuit-breakers also, and more importantly, consisted of mechanisms for re-opening trade in an orderly way within as short a time as possible. Greenwald suggested that carefully planned circuit-breaker mechanisms, which included procedures for collecting orders and disseminating demand information widely so as to re-establish orderly trading, would have provided financial officials with an alternative and superior means of managing the crisis.
His analysis suggested that one of the strongest arguments for a trading halt was the breakdown of normal information transmission that occurred late on Monday and on Tuesday. The large price movements of the previous Wednesday to Friday did not in themselves present a severe problem: information still flowed smoothly and participants were generally aware of trading opportunities. There was nothing inherently wrong with such large price movements, according to Greenwald, so long as they are `fair' i.e. as long as there are not large asymmetries between the information available to market specialists and to their customers. When information transmission breaks down, however, the primary function of a circuit-breaker should be to reinform participants.
The discussion of Greenwald's presentation centred around four issues: the usefulness of circuit-breakers, the importance of portfolio insurance, the role of capital adequacy and the international transmission mechanism of market shocks. Not surprisingly, the comparative performance of the UK and US markets received considerable attention. It was generally agreed that, despite the introduction on several occasions of `fast markets', UK markets did not experience the very large spreads in contemporaneous trades that were displayed by their US counterparts. Workshop participants were concerned that the existence of circuit-breakers might tend to induce price movements and might delay closing of positions and exacerbate clearing problems. Greenwald accepted the first point but suggested such price movements would not have a major impact. He responded to the second and third points by suggesting that many of the credit-related problems seen in October were due not to actual payment delays, but rather to unfounded rumours about financial solvency. If trading halts serve to improve the information of market participants, he argued, they may be helpful in quashing rumours and the difficulties they create.
Participants generally agreed that insistence upon capital adequacy was expensive: large quantities of capital must be kept at hand but are almost never employed. The possibility of capital adequacy insurance was discussed in detail. The existence of such insurance would create problems of `moral hazard', however, and this might offset its potential benefits. There were conflicting views of the importance of portfolio insurance. Some participants argued that its general absence in the UK helped performance, whereas others regarded it as of secondary importance. Finally, participants at the workshop generally agreed that our knowledge of markets was still imperfect, and inadequate for the analysis of policy measures. The international transmission of shocks and the relationship between cash and futures markets were singled out by several participants as areas where our knowledge is particularly limited.
The second workshop, funded by Mayer, Brown and Platt as well as the International Stock Exchange, was devoted to the topic of insider trading. It began with four presentations, followed by an `off the record' roundtable discussion. The first presentation was given by Nicholas Manne (International Stock Exchange), who outlined the different types of insider trading violations that occur, the difficulties that the Exchange faces in attempting to prevent insider dealing, and the general detection processes it employs.
Manne suggested that the majority of cases of insider dealing are `one-off' incidents involving individuals who do not regularly receive such information. For such individuals the probability of detection is very high. The small minority of regular insider traders are, unfortunately, far harder to catch. Manne also emphasized the considerable differences between the US and UK in approaches to detection. He argued in favour of the UK approach, while conceding that the technology and powers available to US regulators (e.g. ability to see itemized telephone bills) were clearly beneficial.
Jeffrey Gordon (Mayer, Brown and Platt) then discussed the implications of some recent US cases of insider dealing. He identified the legal difficulties that can arise because of the difficulty of identifying accurately the victims of insider trading. Gordon pointed out that in the case of the litigation involving Drexel Burnham many of their clients have remained loyal despite suggestions that Drexel Burnham had been tipping `arbitrageurs' about their takeover plans. Gordon conjectured that this loyalty may arise because the rapid accumulation of shares by arbitrageurs may actually ease the final takeover. In the Drexel Burnham case there may even be room for the defence to argue that there had been no breach of duty to shareholders of the companies. Gordon's general conclusion was that we should be careful not to go too far in terms of increased surveillance and enforcement of insider dealing.
Paul Grout (University of Bristol and CEPR), the workshop's third speaker, pointed out that the literature on insider trading focused on the issue of whether the activity is harmful or not. Grout pointed out that while proof of harm is necessary to justify regulation, it is clearly not a sufficient argument. Almost all potentially harmful activities that can occur in trading situations are dealt with by conventional market mechanisms, enforced by contractual obligations. Research should concentrate instead on the precise nature of the `market failures' that can arise in the presence of insider dealing.
In his presentation Grout considered the market failures that can arise because of the presence of asymmetric information, transactions costs and monopoly power. An employee who discovers a new idea which is of value to his employer can increase his personal wealth by selling the idea to a competitor or by trading in shares of the company before the discovery is announced. Both actions can harm existing shareholders, but the former is controlled by conventional contractual obligations while the latter is controlled by the power of criminal law. Why should these activities be treated differently? One reason, Grout suggested, was the difficulty and cost of detection of cases of insider trading. Activities with low detection rates can be curtailed more effectively by increasing the perceived severity of the penalty upon detection: the prospect of criminal proceedings could perform that role in the case of insider trading.

The final presentation to the workshop was given by Richard Carter of the Financial Services Division of the Department of Trade and Industry. Carter discussed the history of the treatment of insider trading in Britain. He gave particular emphasis to the period leading up to the 1977 White Paper, showing how the rationale for legislation changed over time. Carter then outlined current UK practice and compared this to the European Directive. He discussed the difficulty of defining an insider and how UK and Community views differ at present.
The discussion concluding the workshop covered many areas, but two received particular emphasis. Not surprisingly, participants were concerned with the `efficiency' aspects of insider trading, particularly whether it increased bid-ask spreads in markets, whether it reduced incentives at the margin to invest in wealth-generating activities and whether it led to over-investment in information gathering. It was noted out that one problem with `incentive' arguments in favour of insider dealing is that such dealing can encourage market volatility because an insider can make money from an unanticipated change in an asset's price. Participants differed in their assessments of the damage caused by insider trading: no one, however, was prepared to argue that there should be no restrictions on insider trading. Participants also differed in the importance attached to the distributional as opposed to the efficiency consequences of insider trading. The second issue highlighted in the discussion was the difficulty of harmonizing insider trading legislation within the EC. Most workshop participants believed that differences in capital market structures across member states would prevent the Commission from achieving significant harmonization of legislation in the EC