Moreover, people sell shares of stock to each other all the time without insider information. If the stock tanks after the buyer bought it because of some news that had not yet hit the tape when the seller offered it, by your logic the buyer was defrauded. The porsche had a faulty engine, but the seller didn’t know. Can the buyer of the stock sue the seller? No. Can buyer of the porsche sue the seller. I think so.

Your second scenario….that’s not how insider trades work. Insiders enter orders in the open market. Privately calling me does not. But if they did happen the way your describe, I wouldn’t trade with you because I am not a moron. What idiot would offer me shares at the closing price when the company is on the cusp of announcing news that would send its stock skyrocketing? Why is he not seeking to profit from this news? Why isn’t he trying to buy calls instead or asking me to sell to HIM at the closing price? a half-wit would smell this rat. No trade. And actually, I would probably hang up the phone and short the stock. You inadvertantly gave up the information (that Porsche is bust) even though the words tumbling out of your mouth are saying exactly the opposite. Actions speak louder than words, Gecko. That’s why the actions of insiders in the market carry so much information.

If you want to continue this, we should move it to email. methinks76@gmail.com

I’ll play along. You’re wrong – in scenario A, I am not at all guaranteed to be the last to act. I see an unusually large order appear in the stock (with ten shareholders AN order would be considered unusual, but whatever). I immediately think that somebody knows something. I watch to see if the order is done and the seller goes away. When he doesn’t (and by “he” I don’t care if it’s one guy or a thousand – an unusually large order implies things), I join the order or better yet, step in front of him by a penny and get done ahead of him. I keep stepping in front of the other 9 insider shareholders so that I always get done first. So, it’s very likely that I’ll actually get out of my position before they get out of their’s because I’m alerted by a change in trading behaviour in the stock. I will be almost garaunteed to blow out of my position at a better price than they. BTW, this behaviour in response to a suspected insider is the common response. Also, it’s the response to any large order – hence the demand for dark pools. So, results of scenario A&B are pretty similar.

I can’t prove a negative – that the effect doesn’t exist. I think that companies may very well use a self-imposed prohibition on insider trading as a marketing tool for their shares if they think the public will perceive them better. There are fiduciary issues too. I have no objection to private companies imposing their own rules on employees and officers and rules restricting fiduciaries. But, we’re talking strictly about a broadly imposed SEC ban here.

Imagine you are one of ten shareholders in a company. The company has been a decade-long success, but its accountants discovered 10 minutes ago that the company will be bankrupt within a month.

Now consider two scenarios. In scenario A, the other nine shareholders are accountants with the firm. In scenario B, the other nine are your neighbours (outsiders). In scenario A, you will discover that the company is going bankrupt when the nine accountants sell all their shares, and you will be the last to try to mitigate your position. In scenario B, you will learn that the company is going bankrupt through a news release or because one or more of your neighbours sells all of their shares. In scenario B, you will have some non-zero chance of acting on the news first, some non-zero chance of acting second, etc. In scenario A, you have a zero chance of being anything but the tenth person to act. So it seems to be better to be a shareholder in a company with fewer insiders capable of trading.

The logic seems sound to me. But note that the logic doesn’t actually have to be correct for insiders to be willing to restrict their trading in order to attract outsiders to the markets. It just has to be true that the common perception that insider trading can hurt your returns keeps enough people away from the markets causes insiders to do something about it. I don’t know if that’s true – I’m becoming more and more doubtful that the magnitude of the effect matters. But nobody has said anything to convince me that the effect doesn’t exist.

Some clarification on why I would still be willing to trade in that company’s shares: If everyone else has all the information and I don’t, then I can safely assume that the information that everyone else has is reflected in the price of the stock as they not only trade with me but also each other.

That’s what makes this scenario not analogous to trading on material non-public information and makes it kind of a useless thought experiment when thinking about insider trading.

How will they lose money because of the insider trader? If you are long shares and bad news comes out, whether it comes out through an insider trade or through a press release, you will lose money. Remember, all the guy trading on material non-public information is doing is releasing the information. He’s not creating the information. He is the messenger, not the message. The message is what changes the value of your stock.

You said you were making the case for a rule banning insider trading (that is – trading on material non-public information). I was responding to that.

Personally, I think we have some very efficient markets and some very inefficient markets. The market over-all is at best semi-efficient and I think that those inefficiencies are caused by a lot of stupid SEC rules that have nothing to do with insider trading. The Asian exchanges are learning from the SEC’s mistakes, according to the regulatory circulars I’m reading from the Hang Seng and a few others. People do drop out of the U.S. market because of these inefficiencies all the time – yet the public is begging for more of those rules.

Conceded: the history of court cases in the early 1900s and then legislation later on doesn’t look much like the industry lobbying for its own shackles.

Thus, they are slow to respond and THAT is what hurts them – not the insider trade itself.

Blame is immaterial to my point. If some number of people know they are not as fast and knowledgeable as insiders and expect to lose money because of it, there will be less money in capital markets as a result. That’s got to be true at the margin.

The only way it’s not true is if no investors suspect insider trading or no investors are afraid of it. Are you arguing one of those things?

Not sure what you mean by “making the case” in your last para. If I had to say whether current capital markets are closer to semi- or strong-form efficient, I would go with the latter.

And now you’re claiming that the reason my taxes are so high is all that money we’re spending on the SEC? Really? All that money we spend on Medicare, Social Security, and Defense, and it’s the SEC budget that’s bankrupting us? Let’s be serious.

Now, I think you’re either an idiot or you’re just being an ass for the hell of it. I will spell it out for you – whatever taxes you pay for the SEC’s bloated budget to support insider trading headlines, you could save.

You seem obsessed with the notion that insider trading is against the law from everyone – despite my repeating myself ad-nauseam that it’s not against the law for a large group of people – politicians. Insiders aren’t even forced to be circumspect. They can just trade from abroad. If you have a computer, you can trade with impunity from Dubai. If you have a computer and you’re a politician, you can trade with impunity from Maryland. Now, please tell me again how this rule is protecting you from the big bad world.

I am giving you anecdotes and anecdotes is all you’ll ever get because nobody is going to ‘fess up to an insider trade and deciphering which trades are for sure driven by insider information and which aren’t. That is also the reason that the SEC can almost never get an insider trading conviction.

You act as though the rule always existed and exists everyhwere. Compare the markets before and after the rule, normalizing for other changes.

You’re right. We’ve gotten all that we’re getting. I get a lot of insight about how people think from discussions like this. They are very valuable to me, so I thank you.

I said people get caught off guard. They don’t understand the information that is being conveyed to them by changes in price and changes in trade size because they are convinced that the rule prevents people from trading on private information. Thus, they are slow to respond and THAT is what hurts them – not the insider trade itself. I never said they leave the capital markets. They don’t – not permanently. If people leave permanently, they are in the extreme minority and they’re probably leaving because they think they lack the skills to run their own portfolio. But, their money rarely leaves. They just leave the investing to someone else.

You’re making the case for a semi-efficient market – a market where all public information is known and factored into the securities prices. I’m making the case (sort of) for strong-form efficient market – a market where all public and non-public information is factored into the securities price. In your words – a way awesomer market. But, in making the case, you’ve made me think about this issue. I usually don’t. So, I’m glad you’re making the case.

uh, we ARE discussing equity markets. Are you not aware that equity markets provide access to capital? Are you also not aware of the CAPM model? Liquidity reduces the risk premium for equity financing, thus reducing the cost of capital. Capital can come in the form of debt and equity.

I don’t need luck with my trades. I’ve been doing this too long and too successfully to rely on luck. But, thanks for the well wishes anyway.

I agree that the rule hasn’t hampered market efficiency – much. Since we don’t know how much more or less efficient the market would have been within this period without the rule, it’s hard to say for sure. There is not that much market-moving insider information in the first place. Second, the rule doesn’t seem to be hampering insider trading all that much anyway. Finally, there have been much more important developments to make markets more efficient – computers, for instance.

As for Bob Moffat, we’ll see if the SEC has enough evidence to make the charge stick. It usually doesn’t.

Is the rule right? Insiders bring information to market. What people object to is the fact that they financially benefit from doing so. I don’t think benefiting from serving the market what it demands is “not right”.

Since the rule is pretty ineffective at preventing insider trading, I don’t think we can reasonably conclude that that people are guaranteed to not buy lemons because it exists.

And now you’re claiming that the reason my taxes are so high is all that money we’re spending on the SEC? Really? All that money we spend on Medicare, Social Security, and Defense, and it’s the SEC budget that’s bankrupting us? Let’s be serious.

Finally, you seem obsessed with the idea that some insiders trade in spite of the rules against it. I don’t doubt that they do, but so what? Many insiders don’t trade on inside information, and those that do are forced to be circumspect about it, reducing the gains from it. Your argument amounts to saying that insiders are already extracting as much profit from their information as they possibly can; there’s no way it could get any worse, even if we condoned it. That’s nonsense.

The claim is even less credible when you consider how much of your own information about the prevalence of insider trading is based on anecdote and guesswork. You observe certain favorable trades and conclude that they must have inside information, but you have no ground truth to confirm that against, and you’ve given no indication that you’ve done any rigorous statistical work to validate your hypothesis or to test other hypotheses. Indeed, you haven’t given any indication that you have any idea how to go about such testing.

Please note, by the way, that I am not criticizing you for not having done those sorts of tests, nor suggesting that you should go do them. You sound like you make a good living doing things the way you do them, and more power to you. However, you can’t expect people to take seriously your forecasts about what would happen under a certain rule change if you don’t back it up with something more than anecdote.

In any case, I think we’ve gotten all there is to get out of this conversation. Arguing with you has helped me clarify my own thoughts on this matter, for which I thank you.

BTW, you keep tossing “fraud” around. You have yet to establish that insider trading is fraud. “Isn’t it obvious” is not a supporting argument.

Also, you should know that “the people” don’t want justice. The want bullshit, which they call “justice” to make themselves feel better about bullshit.

Finally, Viking, as usual, asks a good question.

Everybody isn’t privy to market moving material non-public information, so that’s not the claim I made. You should read and attempt to understand more carefully. Just to help you out: “We see it every day” is not the same as “everybody does it”.

That I can’t prove it to you is the whole point. That’s why the SEC can almost never get an insider trading charge to stick. But, you explain to me why a stock tanks 30 minutes before the earnings are released if material non-public information not behind the trades?

So, not “three months,” then?

Split hairs much? Way to miss the point. You don’t realize that 3 seconds after information hits the ears of anyone with the ability to write an order ticket, it’s stale as day old bread, do you? You don’t seem to know that companies report earnings 1.5 to almost 3 months after the quarter closes.

I don’t understand why you don’t understand why I think that.

I understand why you think that way – you don’t understand the way the process works and you’re having a difficult time grasping the concept. If you’re allowed to trade on non-public information and you do, nobody gives a crap what comes out of your mouth about earnings estimates anymore – by trading, you’ve already told the market what your earnings will be. You no longer have the power to mislead people with your jibber jabber. That’s what everyone is talking about when they say “insiders bring the information to the market faster”. The real come out as insiders trade to take advantage of the information asymmetry. It gets factored into the price before the earnings release. The earnings release just confirms the price at that point. Got it?

Second, yes, estimates are just guesses. Nevertheless, some guesses are better than others. Creating an incentive for company executives to deliberately make those guesses worse is not a great idea.

Well, I just pointed out to you that lack of insider trading restrictions doesn’t do that. Company executives already have the incentive to fudge earnings estimates and regularly do that! They change estimates based on whatever they think will be most helpful to them. Some think they need to outperform estimates and regularly underestimate earnings. Some think they need pie in the sky estimates to pump up stock price (AT&T and WCOM come to mind) and regularly over-promise. Insider trading rules aren’t giving you better estimates.

Clearly not, or prices would be unable to change. Prices are a distillation of all the information percolating around in the marketplace. As such, they are only as good as that information.

No. Prices are the main source of information. New information doesn’t come out every moment of the day for stocks. Yet, prices change. Prices convey both information that may affect the stock and also people’s opinions. An opinion is also information – and the only way to convey an opinion is by transacting at a price. Thus, prices carry all information and they convey it in real time. When a price moves sharply, the first question out of a traders mouth (right after “son of a bitch”) is “what’s the news?”. Price is most often the first indicator of news. If you get news before the price moves, you are one lucky SOB! That’s the dream – which, btw can happen without insider trades.

When Asian growth levels off to rates more comparable to Western levels, I expect we will see either a change in their rules or a flight back to Western markets.

Rules will always change. For the better or for the worse is the question. However, Asia seems to be learning which rules strengthen the market and which rules are just a waste of time. The United States is looking into regulations that would significantly impede liquidity and price discovery. American firms are moving to Asia because of that and some are dropping out of the U.S. exchanges entirely. FINRA lost something like 2,000 member firms over the last year. U.S. exchanges are fighting with the SEC because they’re also losing members. Foreign companies don’t want to list in NYC because useless SEC rules make it too expensive – Sarb-Ox is a large culprit. So, I don’t agree that it’s all Asian growth related.

If growth rates become equivalent, why would capital return to a market with rules that cost everyone money but don’t have the desired effect? I don’t understand your logic.

Wow, you clearly have no idea what I’m talking about when I say “baptists and bootleggers.”

I thought I did, but maybe not.

Yes. I even already told you how to handle that. Only an idiot would continue to make sucker trades. And there’s no shortage of idiots.

Below the threshold, nobody notices, and outsiders can profit in the market, as you report you have done.

meh. It’s only subject to some kind of threshold if people know how prevalent it is. The main reason that the SEC can almost NEVER get a conviction is that insider trading is almost impossible to prove. Thus, while it happens all the time, few people are all that aware of it. And I repeat – ALL POLITICIANS CAN AND DO TRADE ON MATERIAL NON-PUBLIC INFORMATION. So, for some, there is no rule at all.

The threshold isn’t the number of insiders who can trade on non-public information. After all, there were no insider trading rules during the 1929 crash, yet insiders didn’t avoid the crash. The threshold is how much market moving (market in the specific stock) insider information there is compared to all other information. Only surprises move markets and surprises, by definition, are few and far between.