A Reflection on Insider Trading and Confidence in Markets

by Don Boudreaux on November 11, 2009

in Financial Markets, Prices, Regulation, Seen and Unseen

Here’s a thoughtful piece on the merits and demerits of criminalizing insider trading.

Among the most common arguments made today in favor of the criminalization of insider trading (as opposed to letting corporations, in competition for capital, decide which information is and isn’t appropriate for insiders to trade on) is expressed in these paragraphs of the article linked to above:

“I think there are some libertarians who think we should allow it,” says Wharton finance professor Jeremy J. Siegel. “But I think insider trading is not a good thing. It makes it more risky to buy securities. When someone is offering to buy or sell, it might be that he or she has some inside information and you are going to get duped. So you cannot trust that you are going to get a fair price.” Put simply, insider trading means other investors pay more than they should when they buy and get less than they should when they sell.

….

[I]t’s important to prosecute insider trading cases because the practice can hurt individual investors and undermine the public confidence that allows firms to raise money in the capital markets, says Eric W. Orts, professor of legal studies and business ethics at Wharton. “The danger is you lose a broad public faith in the markets, and people take their money out.”

I’ve never understood why so many people find this “confidence in markets” argument to be compelling.

If insider trading (on non-proprietary information) causes asset prices to reflect more accurately the true, long-run values of those assets, then insider trading should increase confidence in markets.

Put differently, ordinary investors would be less confident in markets that take an average of t units of time to incorporate into asset prices a piece of relevant information than these investors would be in markets that take an average of t+1 units of time to achieve the same adjustments to asset prices.

To the extent that insider trading causes prices to reflect asset values more quickly and more accurately, general investors should be more confident in asset markets and, hence, more likely to invest their earnings in such markets.

When Jeremy Siegel says that, with insider trading, “you cannot trust that you [a non-inside investor] are going to get a fair price” — I immediately ask: why not? Precisely because insider trading brings asset prices into closer alignment with their ‘true’ values more quickly than would be the case without insider trading, on average the prices at which investors buy and sell assets will be more ‘fair’ — i.e., more truthful — with insider trading than without insider trading.

Suppose, for example, that shares of Acme Inc. are now selling for $50 per. Suppose also that an insider knows that Acme’s CEO and CFO have been cooking Acme’s books to make Acme appear to the public to be more profitable than it really is. If that insider can trade on that non-public information — obviously, by shorting Acme stock — the price of Acme stock will start to fall immediately upon the commencement of such insider trading.

Any trader who buys Acme stock after this insider trading commences gets a ‘fairer’ price — a more truthful price — than that trader would have gotten if Acme’s shares were still trading at $50 due to the fact that information about Acme’s true financial state remained private and unincorporated into Acme’s share price.

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mandeville

Regulating insider trading is nonsense. People who advocate it are "conditioned" to think its fair, when it's the exact opposite. All human action is based on the specific information people hold. It is not immoral that this information is unevenly distributed. The attempt to regulate the distribution of information is futile as well as immoral.

Even if you outlaw insider trading, some people still receive the information faster than others when it is released. Using the logic of the regulators, shouldn't that be unfair too?

Insider and outsider trading have no effect on long term stock valuations. The only thing they affect are the names on the stock certificates. People who have positioned themselves to know more than others should be allowed to invest in their knowledge. No one has a right to equal information just like they don't have a right to equal property or education.

Short of signing confidentially contracts, insider trading is a property right. Arguing for laws against this right would be similar to establishing "fair exchange bureaus" or a "just price" for goods and services, and are idiotic. People don't have a right to equal knowledge.

mesaeconoguy

I agree with the sentiment of this piece, theoretically.

Theoretically speaking, it seems like a very obvious theoretical improvement to our current situation.

Information asymmetry is best resolved, theoretically, of course, by marketplace negotiation and price discovery.

In theory, of course.

Theoretically, I may not be professionally allowed to express various opinions without risking regulatory scrutiny right now.

Theoretically speaking.

LAD

I disagree that investors would have more confidence. In a race to the broker, the insiders would always get there before the third party shareholder. That being the case, even the most educated investor would be a fool to invest without insider status.

denisehubbard

The SEC may be finally doing something proactive. Just read SEC requested a copy of STOCK SHOCK--new movie about market manipulation and naked short selling of Sirius XM stock (among others). Amazon has the movie on DVD, or stockshockmovie.com has it.

A.J. Lenze

The article makes a good case for insider trading being a good thing in certain situations. But what if an insider has information that he plans to announce. If insider trading is allowed, wouldn't it be possible that he would delay the announcement to give himself and his friends a chance to act on the information BEFORE other non-insiders do. Yes, these actions would cause a stock to better reflect the information, i.e. the stock would go up if the news is good and the insiders buy or would go down if the news is bad and the insiders sell or short. And I know that this has been documented in many cases where information has been withheld from the public. But it seems to me that the stock's price would reflect its value EVEN BETTER if the information were announced rather than delayed.

Methinks1776

A.J., sometimes it's not possible to announce the information because a deal is being struck and nothing can be announced until it's done. Sometimes the company wants time to prepare for a conference call. Nobody wants to stop the trading day to blurt out announcements and run conference calls.

But, the most valuable information insiders bring to the market, IMO, is information that will NEVER be publicly announced until it's too late - fraud. Yes, it would be better if they announced the fraud to everyone, but that would sort of defeat the purpose of defrauding people in the first place and criminals don't like to shine spotlights on their activities.

A.J. Lenze

Methinks, I agree that there are reasons to delay announcing news. I'm just saying that allowing insider training might provide company leaders another reason. Wouldn't you agree that anytime news is delayed it's bad for investors?

Where I don't agree with you is that seeing what insiders are doing in the market or seeing how a company's stock reacts to what insiders are doing is better than knowing the actual reason, the news itself, that insiders are doing what they're doing.

Let me give you an example. Say the drug company has an experimental drug going through FDA approval. They get that approval at 5pm one evening, but instead of immediately accouncing this, they wait 24 hours and, during that period, buy as much company stock as possible. In response to all this buying, the company's stock rises, and alert investors might notice all the buy orders and the rising stock price and guess that FDA approval happened. But that's a GUESS and, while valuable, it's not as valuable as KNOWING what happened.

Methinks1776

Oh, I wouldn't argue that it's better to get information via insider trades. But, with fraud, that's pretty much the only way you'll get the information

Usually when companies get approval, they release that information right away. I'm not sure exactly how the notification process works, but the company will only hold onto the information long enough to write a press release and for the trading day to be over. Of course, that doesn't always stop someone at the FDA trading on that information before it's even released to the public or a senator. The senator can trade with impunity since insider trading rules don't apply to politicians.

Also, companies generally frown upon insiders trading on material information. Many companies - particularly certain financial firms - have policies about trading any stock at all. Those rules are the creation of the company and employees who break them risk their jobs. In fact, when I worked for such a company, my husband absentmindedly bought shares in one of our accounts without first asking my firm for permission. I was hauled into the CEO's office and my job was spared only because it was pretty obvious I wasn't aware of the oversight and the stock had no connection to our firm whatsoever. I have no problem with company imposed insider rules - which I think work better anyway. I take issue with the SEC's rule.

Pete

From a strict value perspective, the good/bad determination of insider trading should compare the time of transaction to the time of information disclosure. If you believe that inside information will eventually become public, it is better to know it sooner rather than later because a buyer will eventually feel the effects and a seller can never know whether there is pertinent information percolating behind the scenes.

I understand that "getting duped" weighs heavily on the person it happens to, but that event seems likely to happen anyway and more people are "duped" when valuable information is withheld from the market.

Methinks1776

How many people would have been spared their fortune if some insider clued the public in to the accounting fraud it was engaged in? Nobody at WorldCom had plans to ever reveal that fraud. An insider was the only way the market was going to find out about it before the company completely blew up because the shift of expenses from the income statement and into capex was not information available in public disclosures. You HAD to be an insider to know that.

Kimble

No. No. No.

Confidence in the market is very important, it is what allows people to participate in the market. Why would anyone bother playing a game they cant win? If the big gains are going to be had by those with inside knowledge, and ordinary people cannot attain inside knowledge, then they are going to lose out. Their potential for outperformance would be reduced significantly.

Another problem is that you assume that the information temporarily on the "inside" will be reflected accurately in the price once it is made public. More often it is not. The price is more likely to over shoot the real price.

Finally what makes you think that participants in the market want accurate prices when they invest?

David Stinson

Perhaps one argument in favour of limited restrictions on insider trading might relate to insider trading by those insiders that also control disclosure of material information to the public. I am wondering if unrestricted trading by these insiders might present them with an incentive to withhold information for longer in order to better profit from the asymmetry. The counter-argument is that it would be in the commercial interests of corporations to enforce their own internal restrictions on these insiders and make sure investors were aware of the restrictions, as a means of ensuring investor confidence in the extent of disclosure.

Methinks1776

David, I agree with you with regard to companies imposing their own restrictions. Such conditions of employment should always be at the pleasure of the company offering employment.

I am wondering if unrestricted trading by these insiders might present them with an incentive to withhold information for longer in order to better profit from the asymmetry.

That's a moot point because by trading on the information, he releases it to the public. Of course, it might provide incentive to always release information in that manner, but the market will soon cotton on and he will be paid very little to release information this way.

SaulOhio

I think the most important fact here is that if the inside information is valid, and negative, the stock price is going to go down no matter what. The insider trading just adjusts the price sooner. Banning insider trading is just shooting the messenger. The message remains.

Akalish21

Lets not kid ourselves. Unless you are the original purchaser of stock you are betting against the person you buyit from. If he or she (the seller) knows more about whats going on and sells because the stock is going to fall, the buyer loses. If the buyer knows more about the stock and is buying because its going to rise, the seller loses. The stock market is legalized gambling at its best. Insider trading is like knowing the next card in the deck while playing poker. NOT FAIR.

lionel from france

Criminalizing insider trading is unnecessary because it will be very difficult to prove such conduct. Insiders will simply be more cautious in the future. Insider trading does not stop in the future nor even slow down. Ask yourself if very successful trading can exist in the long-run without inside information or something like this you can use faster than other people. Only chartists and astro-traders believe that!

fredfoldvary

Insider trading should be legal, but the corporate charter should state whether the company personae may practice it. That way investors may buy shares of companies that do not engage in it, or those that do. The default, if this is not stated, can be that inside trading is allowed by the corporation charter.

anon

what Goldman, Bank of NY, and JPMorgan, and biggest elite bankers are doing right now in combination with their hired powers in the Senate and their buddies that run the Fed and Treasury, SEC, and government is FAR WORSE than any insider trading example you mention in your post and FAR WORSE than Madoff. People just don't realize but Goldman has co-opted government and is just printing money for themselves. Legalized counterfeiting. It is shocking the corruption.

Curious

If $50 is considered a fair price (without knowledge of the accounting fraud), then when the price drops below that, people will start buying.

If the insider cannot sell, the price will stay at $50 and they won't buy.

When the fraud is revealed to all, the price will immediately drop to, say $5. Nobody will trade between $50 and $5, because the new fair price is $5.

Thus, with insider trading permitted, it is the people that buy for $49, $48, $47... all the way down to $5, that get screwed.

Methinks1776

Assuming for the sake of your hypothetical that the entire market agrees on a single fair value (it doesn't) and that the fair value doesn't change (it does), your analysis is still incorrect.

Thus, with insider trading permitted, it is the people that buy for $49, $48, $47... all the way down to $5, that get screwed.

If, the books are secretly being cooked in an effort to artificially inflate the stock price (*cough*WorldCom*cough) than anyone who buys the stock at a price above $5 is getting screwed - in the absence of an insider.

The screw job is not coming from the insider, but from the crooked officers of the company. The insider is simply revealing that information to the market. With or without the insider as the messenger of the bad news, buyers above $5 are "screwed".

In fact, I would argue that the insider is doing a service by revealing the information sooner and preventing even MORE people from buying the stock as it dips below fair value ahead of the bad news breaking.

Curious

Scenario1: You believe the stock is worth $50, due to insider selling price dips to $25 and you buy. Then the fraud is revealed and price drops to $5.

Scenario2: You believe the stock is worth $50, so you don't buy, because in your opinion it's priced fairly. Then the fraud is revealed and the price drops to $5.

Which scenario do you prefer?

Methinks1776

Curious,

In scenario 1, why would you continue to calculate a fair value of $50 in light of the new information - a huge order so willing to chase the bid that he happy driving the price down by 50%? When that happens, it's time to reevaluate your fair value calculation.

If I were you, I would not buy. I would probably join the seller.

Scenario 2: bully for you. But somebody is long that stock, so they will get hurt. I don't know why you assume nobody is long the stock just because it's at fair value.

Keep in mind that it is entirely possible for someone to have better resources than you and to conclude - using no insider information whatsoever - that the fair value is not $50 but $5. He may behave in much the same way as an insider. In fact, it can be pretty difficult to distinguish between a smart order and an insider and everyone who doesn't have the better information or analysis will be worse off than the party that does. There's nothing magically worse about revealing the information through an insider rather than through an analyst who used mosaic theory to figure out the fraud using publicly available information.

Curious

Thanks for the responses.

Fair value is based on fundamentals. It has nothing to do with trading price or how large order somebody submitted.

Yes, people can come up with different fair value (somebody is buying at $50 and somebody is selling at $50) but those valuations are based on identical information - fair play.

Not so with insiders using privileged information.

Methinks1776

Fair value is based on fundamentals. It has nothing to do with trading price or how large order somebody submitted.

True. However, what the large trade is telling you is that the fundamentals might have changed while you weren't looking. Fundamentals change as new information is revealed.

but those valuations are based on identical information - fair play.

Completely untrue. Information in the market is never identical and rarely do people have the same information at the same time. Information is discovered and one process of discovery is through the process of trading.

Curious

Absent insider trading, price and volume reveals nothing about fundamentals.

If no trader is allowed to trade based on new fundamental information, how can trading reveal anything about it?

Economiser

Because information is never equal (whether inside or not). Even absent inside information there's a lot of knowledge to be gained by trade orders and their effects.

Some participants are really good at analyzing publicly available financial information and can come up with a better estimate of fair value than I can (e.g., Warren Buffett). Some participants have more time than I do to parse through publicly-available financial data (e.g., anyone employed full-time as an analyst). Some participants are better-trained and smarter than I am. All of their trades move the stock's price and are valuable information for me, just as my trades are valuable to other people.

Fair value calculations don't operate in a vacuum. If I do all the research I can and come up with a fair value of $5 for a stock, but it's historically always been trading at $50, that fact makes me cast doubt on my own analysis. Maybe I'm right in the end, or maybe I'm missing something big about that company. Either way a difference that big would give me pause.

Curious

Economiser, you're missing the point.

Having access to the same information, levels the playing field and makes it a fair play.

Whether you're good at analyzing that information or whether you have time to analyze it, is irrelevant.

Insiders have access to information that nobody else has. That makes it unfair.

Methinks1776

Lots of things are unfair, Curious. Allowing insiders to trade is more beneficial to all market participants and that's what matters.

Sorry, but economiser is not the one missing the point. If we had to eliminate everything that is "unfair" in the world, we'd have to nuke the planet.

Curious

If I sell you a business for $50k and I know that the books are cooked and it's worth only $5k, would you still claim that allowing me that trade is beneficial to all (me and you)?

Methinks

That wouldn't happen because I would do my due diligence.

Economiser

Those are simplistic analogies. In Scenario #2 *someone* will buy at $50, and that person is getting hosed. In Scenario #1 the buyer buys at $25, so the degree of harm is greatly reduced.

Also, in Scenario #1, if I saw a stock trading at $50 and thought it was fairly priced, and all of a sudden a huge sell order came in that caused the price to halve instantly, I'd question my valuation in light of this new information. I wouldn't simply run out and buy.

Methinks1776

all of a sudden a huge sell order came in that caused the price to halve instantly, I'd question my valuation in light of this new information. I wouldn't simply run out and buy.

Sorry. I had the comment box open a long time and didn't see your post before saying the same thing. That's exactly how a good trader would think about it. Want a job? :)

Economiser

Hah, sure! Beats what I have to do all day...

Methinks1776

mmm....don't be so sure

Economiser

Agreed. Take a step back and the argument is even stronger:

Assume that the fair value of the stock is $5, and the management cooks the books to get the price up to $50. Methinks is correctly arguing that insider trading will make the price correct from $50 to $5 faster, which gives a more accurate measure of the company's value.

But in a world where insider trading is legal, the price never gets to $50 in the first place. The price starts at the fair value of $5, and management starts cooking the books to get the price to, say, $10, then $15, then $20. At some point along the way the insiders realize that the books are cooked and start shorting the stock. This brings the stock back to fair value faster - it turns major accounting frauds into minor accounting frauds. You could say that in this example everyone who bought on the way up OR the way down is a victim of the insider trading prohibition.

Methinks1776

That's a great point.

hutch

"In fact, I would argue that the insider is doing a service by revealing the information sooner and preventing even MORE people from buying the stock as it dips below fair value ahead of the bad news breaking."

i think this is the important part to remember. when people talk about insiders profiting off of private information, they often only have the most upper of upper management. in face, this won't be the case. after having worked as an auditor for a few years, top management is among the last to know what the numbers are. there is a chain of accountants and analysts at the company who will see the trends before the ceo does. and if there is some fishy stuff, more than the top will need to be involved. quite often, those guys have no idea how to book an accounting entry.

Methinks1776

Based on my own experience with CEOs and CFOs of large companies, I have no doubt what you say is true. However, wouldn't an order to fudge the numbers - booking expenses as capex to boost EPS, for instance - have to come from the top? I have a hard time believing that someone in the chain of accountants would make that decision autonomously, but I have no first hand experience with that chain.

André

I think you inverted the words here (faster price adjustment=greater confidence, which differs from what is actually written):

Put differently, ordinary investors would be less confident in markets that take an average of t units of time to incorporate into asset prices a piece of relevant information than these investors would be in markets that take an average of t+1 units of time to achieve the same adjustments to asset prices.

iamse7en

Important distinction. I get it now. It's about de-criminalizing it, rather than legalizing it. "Legalizing" it may mean it's legal to do the practice with any stock, whereas with if it's just not criminalized, then firms can decide which information is and isn’t appropriate for insiders to trade on.

Gil

Howz about banning 'outsider trading'? Leave companies private and snuff out the stock market. Everyone knows the further away you are the management the more the stock market is a casino without the drink.

vidyohs

"Everyone knows the further away you are the management the more the stock market is a casino without the drink."

???????????Huh?

Gil

If you buy a few shares in a company that has mllions and millions of shares then how are you not a gambler? At least those who have sizeable share holdings of a particular company have some management control. At least the casinos have drinks to help people fritter away their money.

Ryan

Excellent analysis, as always. You are correct that allowing insider trading would make stock pricing more accurate, more quickly. Securities markets would be more trustworthy than they are now -- at least in aggregate.

But the article makes a good point. An individual buying a stock might have reason to be wary. This might have some chilling effect, and reduce transaction volume.

The key word here is "might." Whether or not a potential buyer would be wary depends on how often books are cooked. The odds that a buyer thinks he might be duped. How quickly insider information is reflected in stock prices. The reputation of a given company. The reputation of that company's sector. A host of other factors.

Could well be that none of that much matters, so the chilling effect from wary buyers not buying is nil. Could also be that they are significant.

I could see a game theoretic analysis placing different payoffs for different situations having some use for finding out what the possible effects might be. But really, we don't know. Too much uncertainty.

Still, my gut tells me that you're right. If our goal is to create the most possible wealth, then insider trading should be legal. But my gut also tells me that legalizing insider trading would have at least a small cost to accompany its large benefit. Almost nothing happens without at least some small tradeoff.

Methinks1776

But my gut also tells me that legalizing insider trading would have at least a small cost to accompany its large benefit.

As long as the cost outweighs the benefit, you win. There are always people in the market at an informational disadvantage, yet they still trade. But, that's not the trade-off anyway. We have an expensive but ineffective rule that requires an army of SEC agents to enforce and a court system to prosecute. Since there's rarely a conviction, it doesn't serve as a deterrent. So, we spend a lot of money to pretend we have a law that actually works when, in fact, there's plenty of insider trading anyway. In this way, the insider trading rules are very similar to our ineffective but very expensive drug laws.

hutch

my biggest concern with insider trading is transaction costs, ie bid-ask spreads. i took a financial markets course that talked about the theory behind the spread, and it has a lot to do with how much the market maker believes the person on the other side of the trade knows that the trader doesn't know. the greater the likelihood the guy on the other side of the trade knows something the market maker doesn't, the higher he charges to sell the stock and the lower he pays to buy the stock. the reason for this is that he is taking on risk by making the market and moving the stock into and out of his inventory, so he is compensated for this by taking a bigger profit on each transaction.

but ultimately, i think don't point is that firm's should be the one's who make the decision about what kinds of information the stock can be traded on. they should be the ones making the tradeoff decision between better traded prices and higher transaction costs for trading in the stock.

and for what its worth, the argument that insider trading rules protect investors is bunk. like methinks said, you're never guaranteed a fair price, whatever that is. even when everyone finds out the same time, its only the fastest traders who get the benefit, and chances are, no matter who you are, that isn't going to be you. if you see ge post some crazy good results and you hit buy right that second, by the time your trade is processed, the price is already up five percent. without insider trading rules, you can know that when you decide to trade, all information is out there are you're getting the best price possible.

Methinks1776

Hutch, I'm a market maker. I'm not that bothered by people who have more information about the security I'm trading than I do. I can always hedge, so it doesn't effect my spread much.

What effects my spread more by a huge factor is when I'm unable to hedge because the SEC doesn't want anyone shorting stock because there's enormous political pressure for the market to go up. That's when I start charging an arm and a leg to provide liquidity.

Sam

What about the accountant who figures our the quarterly profits. Should they be allowed to buy or sell right before they release the information?

mwm37

I think what's missing here is the transparency of who is buying and selling. right now, I can't tell who is interested in selling a stock (or buying) at any given instant.

In your Acme example, if I, and everyone else, knew that it was an Acme insider (or a high-level but not officially-identified-as-insider employee, or a wife of an insider, etc) that was shorting, then I'd certainly agree that the stock could fall with release of that information. Unfortunately, stock market transactions are largely anonymous, and *that* is the basis for a valid asymmetrical information argument.

So, *if* you had easily accessible, fully-transparent, information about buyers and sellers, then you might have a chance to convince more people that "insider" trading helped with market efficiency.

Methinks1776

Oh, BTW, there's a thingamajig in finance called the "mosaic theory". That's when someone uses only publicly available information to figure material non-public information. It's perfectly legal to trade on that because you are not officially in possession of material non-public information even though you technically are.

Methinks1776

You don't have to invade people's privacy or even know that the trade is an insider trade to be able to take advantage of the information. You just have to learn how. You should not be protected from a lack of skill by a dumb law that doesn't apply to a large number insiders anyway.

mwm37

take advantage of exactly what information? that someone/anyone is shorting (or engaging in whatever trade)?

Methinks1776

Trades carry information. A very valuable skill for any market participant to have is the ability to read the information in a trade. If an unusual order comes to the floor, the fact that it's unusual is information that can be used to adjust your trade.

Simplified example: an unusually large order for calls comes to the floor, that means that somebody FOR WHATEVER REASON thinks that the stock is going to take off. You begin buying the stock to take advantage of the information. You don't even have to write a single call option or trade with the suspected insider to trade on the information yourself. The professor is wrong when he says that somebody always has to get the short end of the stick when an insider enters an order. The "duping" is not a foregone conclusion.

Methinks1776

"It makes it more risky to buy securities. When someone is offering to buy or sell, it might be that he or she has some inside information and you are going to get duped. So you cannot trust that you are going to get a fair price."

I call B.S.

You are NEVER "guaranteed" a fair price in any trade. What about the poor schmuck who buys the shares of stock five minutes before the stock is halted awaiting a press release about some big loss? He didn' t a "fair" price. Why is it more fair for him to find out via press release than through an insider trade?

Please don't anyone drag out that tired old meme that you will at least have a chance to if everybody finds out at the same time. When market moving information is released through a press release, the stock is first halted, the market makers have at least half an hour to reset their market either way higher or way lower (depending on the news) and when the stock opens for trading, it is already fully adjusted for the news. Voila. The only chance you will have is to the chance to panic while the trading is halted.

Insider trading is mostly seen in the options market, not in the stock market. Insiders are pretty easy to spot and they rarely dupe anyone. They do, however, provide some very very useful information. The better, more market moving the information, the more the insider will want to trade in size and the more likely he is to tip his hand. It's possible for an insider to trade in size small enough to not set off any alarms, but he won't accumulate a large enough position to really take advantage of his information that way.

taimyoboi

"If that insider can trade on that non-public information — obviously, by shorting Acme stock — the price of Acme stock will start to fall immediately upon the commencement of such insider trading."

Uh, the insider can't short the stock to another insider. Hence Siegel's point. Someone has to get screwed before the market can impound the new information into the stock price.

kpan

Someone has to get screwed if someone's eavluation on stock is over optimistic or generous that make him or her to buy at a price that is higher than the insiders' evaluation. Therefore someone is destinated to screw if he has a wrong evaluation and insiders' action may suppress that the price go to far.

Methinks1776

Are you under the impression that you will somehow be less screwed if you bought the stock five minutes before the press release?

CD1

Are there exceptions?

Could a judge about to make an important ruling trade in the stocks affected by his decision?

In this case, I fear the profit motive might interfere with the application of the law. For example, let's say a company is defending an obviously frivolous case, such that a ruling in favor of the company (discounted by the market with a near 100% probability) would not move the share price, but an unfavorable ruling would decimate the stock. Wouldn't the judge have a huge financial incentive to short the stock and award massive damages?

Should congresspeople be allowed to trade in stocks affected by regulations they are getting ready to propose?

SaulOhio

A judge or a congressman has a power that no other insider does: The use of force. That is the reason this is probably the only kind of exception there is.

Methinks1776

There are exceptions.

First of all, one of the reasons it's so hard to get an insider trade charge to stick is because it's not illegal to trade on any old inside information. It's only illegal to trade on MATERIAL non-public information. The problem is that it's not always clear what information is material and what isn't - even when the information is released to the broader market via press release.

And, of course, some people are just exempt - politicians for instance.

kpan

Why is it illegal to trade on Material non-public information? Does one enter a trade because he believes that he know something that others do not know and try to take advantage of his or her knowledge?

Methinks1776

Yes, but all traders think that.

Personally, I think it's illegal solely because the SEC can charge people in high profile cases that create a lot of media hoopla and allow the SEC to justify its existence to the American public.

lee_kelly

It seems like the classic asymmetrical information argument, but prices adapt to compensate for risk. It's a silly argument that betrays a misunderstanding of what prices do.