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.
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[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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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.
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.
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.
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.
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.
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.
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.
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.
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.
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)?
I agree with the sentiment of this piece, theoretically
Theoretically speaking, it seems like a very obvious theoretical improvement to our current situation.
I
Information asymmetry is best resolved, theoretically, of course, by marketplace negotiation and price discovery.
In theory, of course.
That wouldn't happen because I would do my due diligence.
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.
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.
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