Insurance Against Misinformation in the Securities Market

Abstract

Prepared at the request of the Task Force to Modernize Securities Legislation in Canada, this study describes and evaluates evaluate a new capital markets insurance concept: securities misinformation insurance. This new insurance would compensate investors for losses caused by securities law violations. The most powerful objection to this new concept is that investors do not need a new insurance program for securities misinformation losses. Individual and institutional investors already can spread securities misinformation losses by holding a diversified portfolio. Nevertheless, a securities misinformation insurance program has the potential to provide systemic benefits: improved compliance with securities laws (resulting from cost internalization by issuers and governance efforts by the securities misinformation insurance program) and enhanced investor confidence (resulting from the signaling effect of what amounts to a warranty of compliance with disclosure requirements). Whether a new insurance program would in fact produce these benefits would depend in significant part on the design of the program. An excess insurance approach would be cheaper and less intrusive, but it would be unlikely to enhance securities law compliance. A primary insurance approach would be more likely to enhance securities law compliance and, possibly, investor confidence, but it would be more expensive and intrusive. Under the latter, primary insurance approach, the securities misinformation insurance program could become a strong securities market regulator. The "regulation" would come in the form of underwriting requirements and other requirements imposed through litigation against the responsible parties. This study addresses these and other important insurance design questions by outlining three different securities misinformation insurance scenarios. The first scenario presents a government sponsored, primary insurance program. The second scenario presents an industry sponsored excess insurance program. The third scenario presents a private market excess insurance approach.

Keywords: insurance, securities, regulation, financial markets

JEL Classification: G15, G18, G28, G38, K22